In a client services business, how you charge can sometimes be more important than what you charge.
It’s not uncommon to experiment with various pricing methods, especially when you are first starting out (I know I did). But it’s important to know that each method has it’s own pros and cons, and to find the method that works best for you will take some firsthand experience.
My next few articles will be a rundown on various pricing methods, the benefits and negatives, along with insights based on my experience.
But why does the method of pricing matter 🤷♀️
“Havin’ money’s not everything, not havin’ it is”
– Kanye West
Let’s not beat around the bush, money is the reason businesses exist. Even if you’re in this to save the world, or you just love talking to people - you still need the cash required to get shit done and keep your lights on.
Software development - like building development - doesn’t always go 100% accordingly to plan. And this is where risk creeps in.
Software projects are inherently risky. There is risk when creating something new, there is risk when working with a new client or a new technology - and there is also risk when working with clients and tech you have used 100 times before.
The method of pricing you use on a project controls where some of that risk sits.
Different pricing methods can shift the risk from you to your client, or can share the risk equally.
What is fixed price pricing? 💵
“Price is what you pay. Value is what you get”
– Warren Buffett
One of the most common methods of pricing a project is fixed price - a single fixed dollar amount your client agrees to pay to you for delivering the project.
Your client agrees to pay you $X (or only has $X), and after understanding their requirements you agree to deliver the project for that amount.
The scope is important in fixed price - as you will require a super tight scope of work up front. You need to thoroughly understand the requirements (both functional and non-functional), and I recommend a detailed scoping session be done with your client before providing your fixed estimate (ideally in a paid Project workshop).
The most common issue I’ve seen with fixed price projects is going over the schedule time. This usually happens from miscommunications and misunderstandings (lost in translation) - and sometimes technical issues (often when integrating with tech that is not in your complete control, e.g. 3rd party libraries, frameworks, or services)
I found documenting the project requirements in my own words helped confirm my understanding - even if the client already provided their own written brief. I would reformat the project scope (in User Story format), and then along with my client step through each feature and acceptance criteria, and ensure everyone is exactly on the same page.
Another common method of risk mitigation for fixed price projects is to add a buffer or safeguard into the pricing, to account for the level of risk involved. This is generally a judgement call based on experience. New technology? Add a buffer. New client? Add a buffer. Unfamiliar industry? Add a buffer.
From the clients perspective, if you enter into a fixed price deal, then that price is fixed in stone (which is fair enough). So although you can go back and have an awkward conversation about more money, it’s your responsibility to make sure you’ve put in all the effort required to deliver on the agreed deal.
Benefits of charging a fixed price? 👍
- Cost doesn’t have to reflect time. You can charge what it is worth for you to complete that project at that point in time. Schedule looking empty? You can charge accordingly to make sure you win the work. Schedule looking stupidly full? You could choose to charge a premium to take on this additional work
- Paying a fixed amount for goods & services is a very familiar concept, so this helps with sales
- One clear figure for your client to justify, especially if they are going back to their superiors
- You are guaranteed the price you agree upon (assuming you deliver the work!)
- Client cannot alter the scope of work (at least without altering price)
- Common to get partial payment upfront (e.g. 30% to 50%, or even 100%)
Negatives of charging a fixed price? 👎
- Your profit margins are reliant on your estimation skills
- You must pre-emptively build in a risk buffer up-front, and this is often difficult to accurately capture when working with a new client, a new staff member, or a new technology
- Your profit is derived from getting the job done as fast as possible. This encourages an environment of haste, and can be counterintuitive to building strong client relationships
- Time and costs overruns can lead to awkward conversations where you ask for more money (and your client is under zero obligation to give you any). That’s the agreement
- Time and costs overruns can lead to a lack of internal motivation (the project seems endless and worthless)
- It can pit client against vendor. Every small change in scope is a “no”, or a price alteration (which can make for a very transactional relationship)
My experience with fixed price 📖
“Perhaps the reason price is all your customers care about is because you haven’t given them anything else to care about”
– Seth Godin
For the first couple of years of running my software agency, I charged fixed price for all projects.
It was simple, and in the beginning helped get clients over the line. I could charge what I needed to order to get my business off the ground, and sometimes going over an estimate was not a huge deal. A couple of weeks over when we were a small company seemed ok, and I justified it as keeping a good client relationship.
But as we grew in size, our overheads also grew. More staff, bigger payroll, larger office, more rent. We relied more on our forecasted profit to keep the business afloat, so going a few weeks over on a project with 3 full-time staff became a problem. And it seemed fixed price projects were the problem.
In retrospect, I don’t really think charging a fixed price was our problem (it was growing pains mixed with internal processes which needed refining). But at the time I believed we had outgrown charging fixed price - and that charging time and materials was to be our saviour.
In the next article I’ll talk about time and materials pricing method.