Project Risk and Fixed Bid vs. Time and Materials

When I was getting my MBA, I read that by outsourcing projects under a fixed-bid basis, you (as a company hiring an outside firm) are lowering your risk in the project.  This is true, if you believe that your primary concerns in the completion of your project are whether it is completed on time and on budget.  Your primary goal should be delivering business value, not meeting a budget.  (Yes, I understand that budgets are important.  Keep in mind that a budget should only be a means for planning resources and comparing ROI and meeting a budget does not guarantee that you receive business value.)  By choosing a fixed bid route, you are actually increasing your risk of not delivering business value.  It’s not hard to see why, if you look at the process from the point of view of both the business and the implementation team.

When a project is on fixed bid, the implementation team is incented to keep the scope as small as possible.  This obviously makes it more difficult to make changes if one or both sides feel that the change alters scope.  My experience has been that scope request changes on fixed bid projects result in hurt feelings on one or both sides, doing little to build a feeling of teamwork between the parties involved.  This results in significant push-back when scope changes, even necessary ones, are requested.  When a project is billed on a time and materials basis, the implementation team is more willing to change scope because the focus becomes on meeting the business stakeholders’ wishes rather than avoiding losing money.  (There is a risk that your implementation team will be less efficient when they are billing on time and materials, but if they are concerned about building a good reputation and earning your repeat business, believe me, they will do what they can to deliver your functionality in a timely and efficient manner.)

On the other side, it follows that the business has more control over the project when it is being billed on a time and materials basis.  In this case, it is the business that has the financial risk; therefore it has the right to control the scope and delivery of the project.  Lastly, by running a project on a time and materials basis, the stakeholders are forced to determine which features are important to them, and which ones are merely nice-to-haves.  The reason should be obvious: when on fixed bid, the goal of the business team is to get as much value for their money as possible.  However, cramming as many features as possible into the implementation doesn’t necessarily result in a better product.  Having to pay for each feature individually really allows the business team to focus on what’s really important.

I am not trying to argue that projects billed using time and materials have less risk than fixed bid.  Overall, it is important to point out that one approach does not have more risks than the other, but each has its own risks which should not be ignored.  In the end, choose the approach that works best for you, your team, and your outsourcer, but don’t assume that fixed bid is best just because it appears to have low risk on the surface.