Today, we’re going to look at two common pricing models used by service providers, what they are, the pros and cons, and when to use them.
Time and material pricing
Time and materials pricing (T&M) is when a service provider bills a client based on the time a project takes and the cost of the materials that go into it.
An easy example of time and materials is a mechanic. Mechanics overwhelmingly charge on a time and material basis — you pay for their time, and you pay for any parts they have to buy to fix your car.
Pros of time and materials pricing
T&M pricing offers more flexibility when it comes to the service provider. For example, if the project ends up taking longer than anticipated, you’re not assuming any risk since you just bill for the time used.
Alternatively, if the parts end up being more expensive, then you’re again covered as the service provider since you’re not eating that cost increase, but rather passing it on to the client.
Of course, a project may come in under budget and under time… but that’s a less common scenario.
From the customer’s perspective, T&M pricing is often about buying access to the expertise, rather than a specific deliverable. A good example of this is a creative agency. They might bill based on the time used, since a company might not know when they sign the contract exactly what marketing campaigns they’re going to run.
Cons of time and material pricing
The main problem with T&M is forecasting and predictability.
From a service provider perspective, it’s unclear how many resources you need to put against a project — meaning it's difficult to plan your business for other clients.
On the flipside, for the client it’s difficult to plan cost and time accordingly, since the project can potentially take far longer and cost far more than you anticipated.
When to use time and material pricing
The scope of the project is unclear
The parameters are likely to change over time
The project has a very long timeline and murky outcomes
The deliverables are varied, interdependent, and complex
Fixed price pricing
Fixed pricing is when a project is fully scoped at the start and a total amount is agreed up front. The cost of the materials, labour, and time is all baked into the final number.
If we go back to our mechanic example, they might charge a fixed price for routine jobs that they know the cost to deliver. For instance, replacing your windshield wipers might be a fixed-cost project because they know how long it’ll take, they know how much the part costs, and there’s not a lot that can go wrong to massively extend the project timeline.
Pros of fixed price
The main benefit is predictably for the client and the service provider.
For the client, the cost of the project is agreed up front, which means that they can plan their spend with a lot more accuracy.
And for the service provider, it’s a predictable time and cost investment, so they can resource plan with their team more accurately.
A secondary benefit is that fixed price projects are often partially or wholly paid up front, rather than as goods are delivered. For some service providers, this can ease some much-needed cash flow concerns, and give them the space to reinvest in the business.
Cons of fixed price
The primary con of fixed cost projects is the distribution and allocation of risk.
While fixed price projects should have extremely predictable and well-defined scopes, there’s still inherent risk in any project — and if it runs long or ends up costing more, the service provider has to eat that cost.
When to use fixed price
- The project is simple with few deliverables
- Requirements and success criteria are well-defined
- Deadlines are agreed up front by all parties
How you price your work, or how you buy services, is a huge decision. It will impact not only what you deliver and get, but also the entire working relationship you have with the other party.
Time and material pricing leads to a more collaborative working experience as you team up to solve a complex problem. Fixed pricing is a little more hands off, and is great when you just want the sausage, but maybe don’t mind how it gets made.
There’s no one single answer for which one is best. Sometimes, the flexibility of T&M pricing is what you need. Other times, you just want a known price for clearly defined work.
Because pricing is ultimately a tool like any other — it’s not good or bad, it’s about selecting the right one for the job.