Fixed price or hourly rate? – That’s the question!

Now that you have decided to do IT outsourcing and you have found a supplier whom you believe in the time has come to find out how you’re going to work together and how you’re going to do a contract. Personally I hate doing contracts because it is extremely time consuming and you can always find exceptions and things which are not covered in the contract. Having said that there is no way around if a contract of some sort is needed. Fortunately many times e-mails suffice because an e-mail is – in some countries – considered a contractual binding agreement. That being said I suggest that you get a proper contract especially if you do not know your supplier.

Honesty and integrity

Nothing beats honesty and integrity and I am happy to say that on 70% of 1902 software’s projects we do not have a contract. We always make a verbal agreement followed up by an e-mail. This saves us for a lot of money, trouble and headaches and we do not have to do a new contract each time we do a project.

We do however religiously write an e-mail to confirm any and all changes that occurs in a particular project. By always writing an e-mail when there is a change everyone involved has a chance to object to the change. Further when the project is over and the finished product does not follow the development specifications 100% we will also be able to find out why. At 1902 software we have used Sugar CRM system and Maximizer CRM systems. Both of them are quite good although Sugar CRM is web-based in its basic version.

The options

Aside from the contractual aspects you also have to decide if you want to

• Get a fixed price
• Negotiate a good hourly rate

Fixed price project

Disadvantages

The fixed price option is often the one appealing to most because of the perceived security a fixed price gives. If you choose the fixed price model you have to think of the following:

1. You need a very detailed description of what has to be developed. That takes time to do and it cost money and you have to be sure you know who’s going to do that, is it you or is it your supplier?
2. You, the customer, is pretty much locked to what has been agreed to, if you want change something in the middle of a project it costs extra money (the problem is that some IT outsourcing suppliers take advantage of the situation by raising the price leaving you in a very awkward situation).
3. You have to be sure that you get a copy of the source code when the project is finished.
4. The price of your projects will always be higher on a fixed price because the supplier will have to make allowance for problems, minor changes etc. in their the price.

Advantages

The following is a list of fixed price advantages

1. Ideally you know exactly what your project is going to cost.
2. You can budget your expenses (provided that you do not make changes to the project).
3. Ideally you should not have any big surprises coming up during the project, you get what you pay for (sometimes real-life is different).

An hourly rate

An hourly rate may sometimes be much better than fixed price because of the flexibility it gives you. If the supplier works one hour you pay for one hour.  The problem with hourly rates project are:

1. The supplier can cheat you. In the software development it is very difficult to judge whether a person has worked five hours or seven hours on something. You have to be 100% sure that you can trust your supplier. Get references from other customers for whom the supplier has worked on an hourly rate.
2. You must be careful not to get carried away making changes all the time. It is very easy to fall into the trap of making changes all the time when you work on an hourly rate. The supplier working for you is more than happy to accommodate all the changes you have because the the more hours they work for you, the more money they earn.
3. Cost can spin out of control if you do not monitor it carefully.
4. The supplier must have a system in place to record the hours worked. Read an earlier blog of mine which discuss some outsourcing problems

Advantages

The following is a list of advantages you have if you do your projects on an hourly rate:

1. You have freedom, you can make changes and move things around as it suits you.
2. You do not need to worry about renegotiated contracts when you do changes (this is a major advance as such the renegotiation can be a mentally challenging process)
3. You can better use system such as scrum to manage the project.
4. You can many times negotiate a lower price per hour.

The conclusion

As you can see both systems have distinct advantages and disadvantages, as a general rule you can say that:

You should use fixed price when you know exactly what you want and when you know that changes during development will be kept on absolute minimum.

You shoot use an hourly rate when the scope of the project is unclear on not fully determined or if the project scope is likely to change during development.

Always remember to write an e-mail each time you make an agreement with your supplier however small it is, get a CRM system to help you managing everything.

Finally if you choose the hourly rate option make sure that your IT supplier has a good solid time recording system. You don’t want to get time reports which are rounded off to the nearest 15 minutes or worse the nearest 60 minutes. As a general rule if the developer works 1 hour 35 minutes you should pay for 1 hour and 35 minutes.

This blog was written by Peter Skouhus. Peter Skouhus is president of 1902 Software Development Corporation, an IT outsourcing company based in Manila, the Philippines.

You can read more about 1902 at http://www.1902software.com in English.

You can read more about 1902 at http://www.1902software.dk in Danish.