Waverley Blog

One of the most difficult aspects of a software development project is to manage the scope of the project against the planned time, resources, and budget. Often a company will attempt to manage this risk by putting in place fixed-bid pricing when it outsources a development project. Fixed-bid pricing has some real benefits for you as the customer. It forces the teams from both companies to carefully scope the project and it can reduce the risk of cost overruns.

Application Development Outsourcing is Different from Business Process Outsourcing

Outsourcing software application development is not like outsourcing data center management or payroll services. The latter are business processes that are based on delivering a consistent service. Once the service has been established then pricing is more straightforward and it is to the advantage of the customer and the vendor to establish fixed pricing. Both parties reduce their financial risk and can predict their cash flow.

Application development is different from these operational services in two respects, both of which make the outcome less predictable. The first is that application development follows a project management lifecycle from design through implementation and acceptance. The success of each phase is dependent on the success of the preceding phases. This introduces more risk into each phase of the project.

The second way that application development differs from operations is that the final scope of the project depends on the accuracy and completeness of the functional specification. Projects are more likely to start with a robust functional specification if two requirements are met. On requirement is that the customer community is clear on what it wants. The second requirement is that the customer-facing and development organizations are able to capture the needs of the customer community and specify these needs clearly. If it is not possible to meet these requirements, then the specification will likely undergo significant change over the course of the project.

This makes for an inevitable collision between two trends if the project is priced with a fixed-bid contract. Increasing scope risk makes change orders more likely. However fixed-bid pricing gives the project managers for both teams limited flexibility to make changes. This can turn into a nightmare for everyone if the vendor has to request a change order for each unplanned modification in the requirements.

Flexibility and Communication are the Keys to Managing Project Risk

Is there a way to have flexibility over the scope of your project and still be able to manage your pricing risk? Yes, by using a combination of time-and-materials pricing and good project management methods. Time-and-materials pricing gives the project some flexibility to adapt to changing circumstances without having to negotiate new pricing each time a change arises. Disciplined project management enables you to manage the project risk and to prevent the price of the project from getting out of control.

Project management methods include several practices that will reduce your risk:

• At the design and specification phase defining the functional specification as clearly as possible.
• Forming relationships between the project team and your internal team. By immersing the outsource project team in your company’s way of doing business and forming connections with your staff you increase the chances that individuals will make good decisions throughout the project.
• Throughout the project establishing clear communication methods between you and the project team. This can include weekly team meetings, a local presence, and periodic face-to-face meetings. These communication channels increase the likelihood that issues will surface early and can be resolved before they get serious.

Update: Read more on the how a time boxed Agile development style effects the arguments on Fixed vs. Time and Materials here.

Some ideas on approaches to Fixed Bid contracts are also discussed here.