Why fixed prices won’t fix IT budget overruns

The mere summary of a substantial technology project can be both dazzling and disheartening all at once. First, there comes the recognition of how much impact a technology transformation, whether building a new digital product or migrating to a new platform, can have. “This could remake how we work…or how we earn!” Then comes the fear factor: “How can we possibly keep the costs for this reasonable and predictable? We can’t afford this.”

For those of us in the tech industry, the ever-overrunning project budget is a tale as old as microchips.  Business leaders are determined to keep ahead of market transformations and look to technology (cloud computing, predictive data analytics, AI/machine learning, etc.) as an essential tool for getting and staying ahead. At the same time, they want and need to keep costs reasonable. To solve that dilemma, many decided that fixed cost pricing is the answer. The goal is to set the final price before the project begins to ensure there are no overruns or any other unwelcomed surprises. Does it work? Not when you’re looking for innovation or efficiency. Here’s why.

The fundamental flaw in fixed pricing

Fixed price, at the surface level, seems to be a predictable, cost effective approach to budgeting compared to “time and materials” financing. However, fixed pricing’s fundamental structure does not produce great tech results in today’s era of iterative, agile world of IT development. With technology tools and platforms in a constant state of change, tech teams have learned to work in short, agile bursts that are assessed regularly and reset as needed. Agile development, which embraces the idea that the anticipated final outcome will evolve as work progresses, has become such a commonly understood and accepted approach that you see other departments, from marketing and sales to business development, borrowing the language to describe how their teams more efficiently operate in a world of change: “We are going to be more agile and adaptive in how we work.”

This widespread embrace of agility explains the fundamental challenge of fixed pricing. It’s impossible to “fix” a moving target.  What happens when an IT vendor has to “fix a price?” Vendors are forced to make numerous assumptions in order to determine the price. Even if a team does its best to gather requirements ahead of time and factors in every possible customer, market or technical curve, it’s still tenuous for a vendor to accurately predict a fixed cost.

The alternative: do both better

Rather than using either a fixed price model or a time and materials approach, the most effective IT project/solution financing method is to leverage a hybrid model. Rather than basing the cost only on requirements, the vendor can use strategic assumptions to build an estimated time and material budget. This has to be done in close collaboration with the client and all of the project’s key stake holders. The client then adjusts and finalizes that budget and any assumptions to create a foundational and logical budget framework from which all work and financing can be measured. It’s a budget, but not a fixed one. Instead, it is a collaborative and carefully controlled financial framework that grows or shrinks (yes, reductions can and do happen) over the course of the project to meet changing requirements. What it does is created a communication-centric IT budgeting process that mirrors how agile development teams work. Regular check-ins and adjustments based on progress keep everyone on the same page and budgets well-managed.

Does it work? With the right vendor and communications excellence, it works every time. Here are three tips on how to make agile-inspired IT budgeting work for your IT projects:

1. Define “estimate”

The word “estimate” is often a problem in IT budgeting. The vendor might use estimate for a ballpark figure whereas the client sees as the final number. When vendors give you estimates, find out exactly what they mean. Is this the cost with a small margin for overruns? How small? Ask for percentages and formulas. Good vendors will show you exactly how they estimate and invite you to help them increase its accuracy.

2. Get iterative!

It’s an agile world and the key to smart budgeting is strategic, iterative check-ins. Define with your vendor how often you want to see progress as it relates to the budget. After every week? After every milestone? Ensuring both client and vendor are checking in regularly is key to managing budgets in a change-centric world.

3. Insist on full visibility

Insist on a zero-surprise relationship with your technology vendor. In years past, IT teams would joke about “throwing something over the wall to see what comes back.” With vendors today, there should be no walls preventing constant communication and transparency at every stage of the project. If your team is pushing for elements that will add costs, expect candid feedback from your vendor. If your vendor is taking longer to meet requirements or struggling, expect to know it and have a frank conversation on how it impacts budget and timelines.

In the end, effectively managing to an IT project budget is a shared responsibility between the vendor and the client. Technology advancements will not slow down. Disruptions will not go on vacation. Over the course of any project, expect change but don’t let it derail your budget and project goals. Instead, let your iterative, transparent, dual-party approach throw potential budget overruns right off their tracks.