Fixed-Bid-vs-Cost-Plus-Contracts.-Which-Should-I-Use

Fixed Bid vs Cost-Plus Contracts. Which Should I Use?

Dec 15, 2021 | Blog Post

It’s hard enough to choose between software companies based on their merits, but it’s even harder to choose between them when they offer two different types of contracts. Startup CEO/CTOs probably get a dozen emails a day from software vendors. How are they supposed to figure out which vendor will deliver the best quality product at the best price?

This article will review just one of the many considerations that go into vendor selection, which is choosing between the two types of vendor contracts– fixed bid and cost-plus.

Fixed Bid

This means the outsourcer will quote you a single price for an agreed-upon Scope Of Work(SOW), usually broken up into smaller installment payments. This seems like a great option, right? If I choose this option, then can’t I just send out a Request For Proposal (RFP) to as many vendors as possible and then select the vendor with the lowest price?

Well, yes you can. However, it’s not always that simple. Why not?

First of all, a vendor will only agree to a fixed-price bid if you both can agree on a DETAILED, and I mean REALLY detailed, scope of work document. This document will have to define every single feature completely and thoroughly. You’ll have to provide them with what every component on every page in the entire app is supposed to do. This will be a very long and tedious exercise, and do you actually know this level of detail on your product idea?

Secondly, the vendor will give you exactly what you asked for, even if it makes no sense at all. So you may get your final build and then discover that several of the feature ideas looked great to you when you were doing the SOW, but when you see them actually built, they turn out to be bad ideas.

Third, when working on a fixed-bid project, it may be months or even years between when you start the project and when the vendor presents you with the finished product. There is no collaboration in between. So what happens if you learn something new about the marketplace two months after starting a project? You don’t get to implement those changes until the entire agreed-upon SOW is done.

The only way to make a change to the scope after a project has begun is to make a “Change Order”, which is essentially an addendum to the original contract. This is time-consuming, laborious, and the vendor can charge you basically whatever they want because at this point you’re “stuck” with the vendor that you’ve already chosen.

In summary, a fixed bid contract has its advantages because it’s clear what you’re getting and what you’re paying. But if you choose this option, you better make sure you: a) know how to define your product completely and thoroughly, and b) trust that your vendor isn’t going to gouge you if you need to make a change order.

Cost-Plus

This model essentially makes an outsourcer an extension of your internal team. The vendor will charge you whatever they are paying for the resource, plus a percentage to cover their overhead.

Sounds simple right? You don’t have to spend countless hours defining scope of work and you can modify your scope along the way as you build, test, and tinker with the product. Furthermore, it is easy to compare vendors because you can just pick whoever has the lower hourly rate, right?

It is true that it is simpler, but the disadvantage is that the vendor, theoretically, has a lower incentive to maximize efficiency or to get the work done on time. After all, they get paid anyway whether you release your product or not, right? Furthermore, you can certainly compare hourly rates but can you compare who will get the job done most efficiently? If you choose this model but you choose the wrong vendor, you might have to put a lot of effort into managing the project and managing the client so that you can hold them to deadlines and maximize their productivity.

In summary, a cost-plus contract allows for more collaboration, reduces administrative paperwork, and provides more flexibility. But if you choose this option, you have to make sure that the vendor is honest, has a strong work ethic, and is held accountable for deadlines and deliverables.

Christian Schraga

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