IT Negotiation Strategies: Fixed Price or Time & Materials?

TORONTO, April 27, 2018 – You're a Chartered Professional Accountant (maybe a CFO or CTO) negotiating a professional services (PS) deal for a new finance or data management system. Now you have to decide whether you want a fixed price or time and materials (T&M) deal.   

Let me tell you a story. In an effort to close a PS T&M deal in which the vendor was quoting the full hourly rates, a sales rep told me he was able to cut the price on the PS estimate by $30,000. I said, I appreciate that, how did you do it? "We were able to drop the estimate from 500 hours down to 350," he said triumphantly. I said, fantastic, what happens if we hit 350 hours and you are still not finished? He said "we’ll just add some more hours."

PS firms love to do T&M deals because they have absolutely no skin in the game. Their configuration resources, supposedly subject matter experts (SMEs), are deployed at an hourly rate that is typically 200-300 per cent higher than those SMEs salaries. Hopefully, if you read the previous blog, you were able to negotiate lower rates while your leverage was still high.

If the requirements should change, no problem — for them. The PS team just keeps working and billing more hours, making more profit with absolutely no risk. Unfortunately, the budget is usually depleted before the work is completed, or the functionality gets trimmed back from the original specifications.

The Risks of T&M

T&M is an obvious concern for the buyer. Ninety-five percent of ERP projects fail because they are either late, under-spec or over-budget. The more work the buyer can do early, picking the right solution to address their requirements, the less risk they will bear.  

In a fixed-price scenario the onus is on the buyer to have their requirements well-defined, allowing the PS firm to accurately estimate the effort for each phase, for each task within the phase and for every requirement within the task. Ideally, the work effort is divided among the PS resources with SME skill levels to complete the tasks with the greatest efficiency. You don’t want a trainee learning on your dime when you’re paying them an expert’s hourly fee. 

There are two problems with fixed-price. The first is the PS provider is going to add a healthy premium to its estimate as a contingency fee to reduce risk and maximize profit. Second, any time the buyer adds a new requirement there is going to be a change request document outlining the details of the change and the additional cost to perform it.

You either accept the additional cost or go forward without the change — you have no leverage at that point. Plus, if it took an SME eight hours to investigate and estimate the cost of the change, double that for the lost productivity and add both to your costs. 

And, don’t forget the travel and living expenses. Having a sales office in your city does not mean the SMEs are all local. An SME flying in Monday morning and back home Friday afternoon, with taxi or car rental charges, four nights hotel and five days per diem, runs up a hefty bill quickly.  

An Alternate Negotiation Strategy

Fixed-Price contingencies are a pretty big premium for your garden-variety implementation. Multi-tenant cloud-based solutions are designed to have a core foundation, which is common to everyone, and a customer-specific layer with configuration options selected to meet each customer’s requirements.

PS has been performed and repeated so many times there should be a huge, re-usable library of interfaces by now. What happened to all that previous experience when it comes to accurately pricing out the PS? 

It never ceases to amaze me that, in the RFP responses and product demonstrations, the PS proponent claims unqualified expertise but, when asked to fix the number of hours required to complete some mundane task, they balk. 

Let’s start to explore a solution and we’ll tie it all together next time. This must originate in the RFP or at least early in the process while you still have some leverage. Ask the PS proponent for the hourly rates. You could even supply a template:

Yes, these are discounted rates. You were prepared for the sales reps’ claim they will lose money on these resources. If the SME at $200 an hour were booked for 2,000 hours a year the revenue would be $400,000. The SME certainly isn’t being paid that much, so no one is losing money, except you. 

Returning to the opening story, lowering the estimate from 500 hours to 350 hours in a T&M deal with no guarantees is nothing more than a theatrical ploy to get a signature. Lowering the $200 rate by 10 per cent to $180 an hour will at least produce a quantifiable saving. 

Now wouldn’t a fixed price deal have the benefit of having yours and the SI vendor’s interests a little more aligned? We’ll talk about that in my next blog post, and how milestone payments can  keep the implementation plan on track.

Phil Downe is an independent IT negotiations specialist and principle with Relations Management Group Inc. based in Toronto. He can be reached at 416-804-7445 or by email.