The Trouble with Fixed Pricing

It will come as no surprise that vendors resist fixed pricing. A fixed price contract entails a higher degree of risk for the vendors. Used as they are to an extremely low-risk capacity leasing model, most vendors are not very enthusiastic to move to a fixed price model unless pushed by their customers.

Where does the risk exposure come from?

In any fixed price model, the vendor needs to predict the future accurately enough to price the contract right. Effectiveness of such predictions depend on the quantity and quality of information available at the time of bidding. If high-quality information is available, that make a fixed bid possible and acceptable to the vendors.

In many cases, buyer are unable to provide information of sufficient quality but still demand a fixed price contract. In these cases vendors are, justifiably, reluctant to fixed price the contract.

What is surprising is that is many cases the buyers also resist fixed pricing! This is because they view a fixed price contract as a loss of flexibility and as conceding too much control to the vendors! This issues needs some analysis.

Recollect that a fixed price contract is intended to hold the vendor accountable for results. Hence, once a vendor signs-on for a fixed price deal, he will proceed methodically and systematically to execute the contract according to a predefined plan. Any deviation from such a plan will constitute a change and trigger the change control procedures. In a program that was well thought out before the vendors were brought in, this is not a great problem, but in the case of an ill-defined, early stage program, this is clearly a stifling loss of flexibility.

In addition, there is the issue of perceived lack of control and collaboration. Many buyers are reluctant to carve off a piece of work and put it out for bid. Most IT managers are more comfortable with forming joint teams with vendors with some agreed upon split in responsibilities (“my team will do the requirements and architecture; your team team does the design, programming and testing”). Vendors are naturally reluctant to bet their success on the quality of input deliverables coming from someone else!

In simple terms, a fixed price deal is complicated by factors such a quantity and quality of information, the timing of the bidding process, the need for collaboration, and other such issues. These complications are balanced by the benefits of lower financial risk exposure for the buyer and better accountability of the vendor for results.

Due to these complication, buyer are beginning to turn towards professional consultants to structure and monitor such contracts. More and more buyers are moving away from a do it yourself approach towards the services provided by sourcing advisory firms such as TPI and Diamond Consultants.

It is my take that in the coming months of economic turmoil, more and more buyers will moved towards fixed price models in some form or shape to squeeze higher value from shrinking budget dollars. Such a move, ironically, will rescue Indian vendors from the commodity play in which they are engaged today and move them towards a more professional, accountable business model.

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