Ok. Exaggeration alert.
I don’t hate them the way I hate Okra or cleaning the litter box. But, when stakeholders think that a complex multi-Billion dollar deal can be contracted for a “fixed price” I feel like yelling WHHAAAT??. Which I don’t – or wait until I am on mute! I dislike them for complex situations because fixed price agreements lend themselves to a flood of change orders, which is the antithesis of a ‘fixed price”, when the risks, such as poorly defined scope of work, materialize. It helps me to remember that stakeholders don’t understand contracting in general, the market constraints, or contract management techniques. And, they want price predictability to meet a budget number, meaning they don’t want the price to go over, but it can come in under budget of course. In a recent conversation about fixed pricing, the market told my client it was unwilling to consider a fixed price agreement due to demand outstripping supply. If you are in a similar situation, someone wants a fixed price and the market won’t cooperate, here is what I suggest.
In my consulting practice
I’ve been able to help my clients with price predictability for “budgets” by using a variety of techniques that are more transparent than a fixed price agreement. First, consider breaking the work into discreet small scopes of work that provide the parties with risk transparency. If done properly, both parties understand the risk profile for the scope of work and a supplier could be more willing to place a fixed price per bundle of work. Or, the supplier could use a fixed price for some work and an alternative method for some other bundles. Second, if there is both market risk (a constrained market for example) and performance risk (the supplier could fail to meet milestones or KPIs) consider a fixed price with either a) an economic adjustment or b) an incentive/bonus for meeting or exceeding the performance target. Or, if the market is really constrained, you could use both. If you are considering an economic adjustment, use a neutral third party source like a published index rather than a predetermined amount like 2%. The neutral indicator is more fair over the long term of the contract. Third, use a cost plus model to pay for the costs that “are the costs” and use the “plus” to cover the management fee, incentives and overhead. This can be more challenging to negotiate and manage. However, when cost plus agreements are properly used they are very efficient at driving down unnecessary costs and driving up performance.