Fixed-Fee vs. Time-and-Materials: Which Outsourcing Pricing Structure is Right for You?

By Jeffrey Ransden

Outsourcing design or consulting services is a popular solution for OEMs with too little staffing or too little expertise. In fact, many medical device manufacturers consider the trend critical as they strive to run lean. Although the nature of an outsourcing relationship can take many forms, often it is the financial arrangement between client and vendor that can cause the most friction.

There are a myriad of financial arrangements to consider when outsourcing design and development services, but most fall into two broad categories: fixed fee or time and materials. Simply put, a fixed-fee agreement is a predefined scope for which the vendor is paid an agreed amount. A time-and-materials agreement is a predefined scope for which the vendor is paid for every hour worked.

Fixed-Fee Agreements

The primary benefit of fixed-fee arrangements is transparency of total cost. This type of agreeement ensures that the vendor has “skin in the game” because they are incentivized to work efficiently, remain focused on the goal, and run a tight ship. If a scope of work runs over budget, the vendor should be contractually obligated to complete it. If the vendor finishes the scope early, the excess budget is still paid to them. The fundamental key to success in a fixed-fee arrangement is quoting in small, manageable, risk-mitigating scopes of work. The pitfall is that it is a fixed fee for a fixed scope. Anything that is not specifically called out in the scope will cost extra. To that end, it is critical to clearly define the scope at the start of work. OEMs should detail the deliverable as well as require that the result will be of high quality.

Time-and-Materials Agreements

The time-and-materials approach offers smaller increments of cost, with the client paying for hours billed. The client can dynamically redirect the vendor’s resources at will, and the vendor is incentivized to keep refining the work product. In this type of arrangement, the key to success is a clear understanding of the required tasks and how long it should take to complete them.

The pitfall with a time-and-materials agreement is that it is unlimited scope for a fixed hourly rate. Anything a client requests will be done, even if it is not necessary or the most expeditious path to the solution. The client must be diligent about controlling the budget. Too often, questions are raised after hours have been expended, which can slow progress.

Which Way Do You Lean?

There are advantages and disadvantages associated with both types of agreements, and it can be difficult to choose whether a fixed-fee or time-and-materials arrangement is right for your organization.

In some cases, the needs or structure of your organization might dictate whether you choose a fixed-fee or time-and-materials agreement. Your business philosophy or history may cause you to lean toward a fixed-fee or time-and-materials agreement.

Organization traits that might make a company more suited to fixed-fee agreements include the following:

Traits that might make an organization lean toward a time-and-materials arrangement include the following:

Disagreements

Regardless of the mode you choose, there will almost certainly be disagreements.

For a fixed-fee arrangement, disagreements are almost always centered on scope or “I thought this was included” discussions. This is a usually a failing in client-vendor alignment regarding the desired quality of the final result. The vendor is responsible for sharing work examples, the quality of the work product, and how it was shown to be valid. The client is responsible for putting aside personal perceptions, openly accessing what they are being shown, and commenting on whether it meets their needs. Clients request and receive many services and items that are not included in the scope. All too often, these are forgotten or undervalued by the client. A savvy fixed-fee vendor will do this to build a relationship. But the vendor will also include these on the client’s bill and invoice $0 as a “professional courtesy” to gain visibility.

With a time-and-materials arrangement, disagreements usually center around the “Why did it take you two hours to take three dimensions from that part?” discussion. Accounting for time must include sufficient detail to satisfy clients that the hours were spent diligently. Even with this, much time is wasted on challenging how the hours were spent and why discrete tasks took certain amounts of time. Consequently, the vendor will often eat hours or write them off in the interest of maintaining a good relationship. In our estimation as a vendor, up to 30% of client management time is spent on these types of conversations when working on a time-and-materials basis. Wise service vendors have rigorous timekeeping habits and software, and they establish solid trust with clients early on in the process.

How to Choose

There is no perfect answer to the question of whether to choose a fixed-fee or time-and-materials agreement when outsourcing design services—or at least the answer has to be nuanced. In particular, beyond knowing your organization, there are several key questions you should ask.

How accurately does the vendor bid jobs? This is good for time-and-materials vendors who give price estimates as well. Although the price may be cheaper for the fixed-fee client, if there is an error, the vendor may be less inclined to continue working if it’s “losing its shirt.” A vendor that can provide good historical data on finishing projects on budget and on time is a good sign. For a gut check after your initial meetings, see if they can quickly lay out a development timeline and come to a reasonable cost estimate. Some of it will have to pertain to your specific business area, but they should be able to answer the question, “How long will it take to design a widget of known complexity with approximately x number of parts in it?”

What processes does the vendor use to ensure they are either on the correct path or not continuing down a poor one? Not only should your potential vendor be able to explain with examples how they do this; they should be able to give you examples of criterion on a past project that led them to a new path. How far did they have to “auger in” on a design before changing direction?

A good indicator of their effectiveness in this area would be the degree to which they use rapid prototypes to debug issues and at what stage they employ them in the design process.

What value does the vendor put on client input? Although it seems obvious, a vendor must be vigilant to keep customer communication frequent and open. Luckily, a vendor’s true colors show early if you are paying attention. Does it happen naturally and easily? Does the vendor seem to “get it?” If you can’t come to an agreement on scope or what you want the vendor to do, that’s a fair indication of how much your input will be valued later in the process.

Don’t Let History Be Your Only Guide

All too often, a client will choose a fixed-fee or time-and-materials agreement because that’s the path their company has always followed. Don’t be that client. Evaluate each project based on its individual requirements, time pressures, budget, and desired outcomes. Carefully examine proposals and service providers from both camps. Only then will you be prepared to make the right choice, both for the project and the company.

Jeffrey Ransden is engineering manager for Synectic (Milford, CT), a Mack Molding company that specializes in full-service product development. 

[image courtesy of STUART MILES/FREEDIGITALPHOTOS.NET]