Fixed-price contracts are standard among B2B and B2C businesses, but not all services have a predictable cost. Sometimes you need the flexibility of a time and materials contract to charge for a service accurately.
Do you know which one works best for your business? Don’t assume the answer to this question. Please take a moment to consider your project needs.
Businesses operating on the wrong pricing model often find themselves in two scenarios:
- They underestimate the cost, losing out on profit
- They lose customers because of an inflexible pricing model that charges too much
Take the time to define which contract suits your business best. By choosing wisely, you can keep your current clients and grow your profits.
Find out how to evaluate which method works best for your business below.
Time and Materials Contract vs. a Fixed-Price Contract
No matter what your service is, it would be best if you had a good idea of how much it costs you to produce your deliverables so you can ensure a profit. For some companies, this formula is pretty black and white. Certain projects follow the same formula with little room for deviation.
These projects are perfect for fixed-price contracts. They have a clearly defined process outlined in the agreement with no question about each party’s responsibilities and deliverables.
Often, businesses start with this model. It’s easy because they can sell their services at an exact, flat-rate cost. However, this approach can come with its share of risks.
The moment a project or service steps out of scope or the time you projected it to take, you cut into your profit. If you choose to price your services via this method, you’ll want to create a buffer in that pricing to accommodate for unexpected roadblocks that may require additional time and resources.
The Pros and Cons of Fixed-Price Contracts
The benefits of fixed-price contracts are that they come with a pricing guarantee. So long as the project doesn’t go beyond the defined scope of tasks and responsibilities, the price won’t change.
These contracts typically provide a well-defined process complete with specific phases and deadlines. Because the scope of work is outlined in the agreement, many businesses find the project pretty streamlined.
However, the padded buffer zone within the pricing means the customer will likely pay significantly more than a service based on time and material contracts.
These contracts also take longer to prep and leave little room for error or flexibility. If the client comes to the table with a new request beyond the defined scope, you will have to reprice the project based on these new expectations.
If you find your services evolutionary, meaning it changes throughout its duration, then a fixed-price contract may not be the best solution for you.
The Alternative: Time and Material Contracts
The alternative to a fixed-price contract is a time and materials contract. In this form of pricing, the customer or client pays for the exact cost of the work based on your hourly rate and cost of materials.
Because of this, these contracts are far less rigid. Instead of a strict scope of work and demanding deadlines, project planning is more generalized. This allows the service provider to adapt to the customer’s needs and budget as they fluctuate.
Services such as construction, software development, web development, marketing, and advertising often fall under this pricing method. It works well for both finite projects and subscription services.
Customers also like it because they have more control over their budget and service. They can track and manage the service they pay for according to their needs instead of paying a flat fee that may or may not exceed their actual needs.
Most time and materials contracts are broken down into phases. Typically, the service provider checks in with the customer at the end of each step to review what has been accomplished and verify where they are in the client’s budget.
The Pros and Cons of Time and Material Contracts
There are multiple benefits to this fixed-price alternative. The high level of flexibility allows you to compensate for unexpected changes or cover unanticipated overages.
Customers and clients like it, too, because it allows them to pay for precisely what they get, and not a penny more. Because time and expenses are tracked in these pricing models, they are easy to audit and offer transparency. Flat fees do not.
However, with this flexibility comes certain risks. It’s easy for these contracts to drift out of scope. A 3-month project can turn into 6-months if the customer keeps adding to the list of expectations.
Also, if your client has a limited budget, you will be required to monitor and gauge your expenditure on each phase to ensure you stay within the client’s limitations. Communication between the service provider and the client is often pretty frequent due to the need to supervise the project from start to finish.
Lastly, efficiency can become your enemy. Because these services are charged by time and expenses, a job done efficiently can end up paying you less than if you set a flat fee.
A journalist who writes a 5,000-word feature in 5 hours shouldn’t be paid less than a journalist who writes an article of the exact word count for the same company in 12 hours. Likewise, just because you’re quick at executing a service doesn’t mean it should be worth less than its usual price.
Have Trouble Keeping Track of Your Time?
For many businesses, time and materials contracts make sense, but they struggle to track their time and materials amid busy workdays accurately.
Guestimating isn’t a good solution, as it can lead to undercharging or overcharging your customers. But how can you get a grip on the task without creating more work for your employees?
The answer comes in a simple, paperless solution called Rhumbix T&M Tracking. Talk to us about setting up a demo where you can learn firsthand how this useful mobile tool can improve your business process.