Digital agencies employ numerous pricing and project budgeting models when bidding on and executing projects. In this handy guide, we explore the pros and cons of several approaches to estimating projects and managing budgets and deliverables.
Keeping budgets and deliverables on track for digital projects of all sizes will always be challenging. Even the smaller projects typically have many moving parts that directly tie in with larger business goals, brand storytelling, design standards, marketing efforts, and other initiatives that span an entire organization. Throughout the process of bringing these projects to life, stakeholders discover new ideas and potential pitfalls that can impact expectations, timelines, deliverables, and so on. Things can quickly get complicated.
After 20 years of managing digital projects of all sizes, we’ve learned what works, what doesn’t, and how best to make project stakeholders happy while also keeping deliverables on track and on budget. Here are some project budgeting and pricing approaches to consider for potential upcoming engagements.
Four Common Approaches to Digital Project Budgeting
While agencies and their clients often negotiate project budgets based on criteria unique to their working relationship, four common methods stand out.
1. Fixed Bid-Fixed Scope
In this scenario, a vendor agrees to deliver a fixed set of services for a fixed price. For a digital project, price and features are typically agreed upon up front and the project team chips away at executing deliverables within that fixed price. This is how most RFP arrangements work.
From a company’s perspective, this project budgeting approach seems like a low-risk way to get what you need for a set price. You get x number of features for a known amount of money. You reach out to a handful of potential vendors who scope out your project for free, then compare pricing, approach, and experience. The vendor benefits because they know exactly how much they can expect to invoice over a certain period of time. Win-win, right?
If your nonprofit is applying for a grant to cover costs, this approach can be particularly relevant as well. Most grantors want to know what their money pays for before they cut a check.
On the surface, this approach may seem to make sense, but as we’ll see in the points below, a fixed bid-fixed scope project budgeting approach can be fraught with potential peril.
Creating detailed project specifications before you actually build anything is a waste of everyone’s time and money. Sure, there’s a good chance you’ll get some things right, but if you bring real end users into the project process—and you should—your team will undoubtedly find their assumptions challenged by some piece of new knowledge learned along the way. Specifications shift, new feature ideas arise, others get tossed out. In order to create a better digital product, teams should embrace this continued learning. With fixed bid-fixed scope projects, that quickly becomes problematic. Here’s how:
- These projects set up a ‘culture of no’ where the vendor must typically dissuade any new ideas or feature requests that are ‘out of scope’ from the proposal, even if those requests will result in a better product. This is unfortunate.
- In-scope/out-of-scope is often a matter of interpretation, especially when applied to the specifics of how a certain feature or deliverable should work. This can result in extensive negotiations and revisions that eat up valuable time and money.
- The majority of risk falls on the vendor/agency to deliver under often unreasonable expectations. This is especially problematic in the digital agency world where projects can last months or sometimes even years. How can you know exactly what your priorities will be one year from now? You can’t. Things change.
- RFPs suck. For a detailed list of reasons why, read our post Five Compelling Reasons to Ditch the RFP. Plus, many very capable agencies don’t respond to RFPs. With few exceptions, we don’t. Oftentimes, these organizations have the most experience, which means you’re robbing your project of potential quality.
Project execution aside, the cone of uncertainty dictates that agency vendors estimate high up front in order to account for all the unknowns when a fixed bid-fixed scope project is just getting started. Yet if you bid too high you risk losing the work. If you bid too low, you have difficulty covering costs. It’s the age-old quandary of the service-based business.
Plus, even if a high bid wins the project, it’s entirely possible that a digital project may go over budget anyway due to the previously mentioned unknowns. The alternative is that an agency vendor must be stringent about scope creep, micromanaging deliverables to the point where client and project team relationships become strained. Even the most experienced vendors struggle with this scenario. Using fixed bid-fixed scope, a project is setup for failure before it even begins. It’s a race to the bottom.
2. Hourly/Time & Materials
The tried and true process of an-hour-worked-an-hour-paid is standard and simple. Mightybytes started off this way back in the day. It’s also how many freelancers in our industry bill for their work. Many service-based companies use some form of time and materials (T&M) billing in their business.
Tracking time to a client’s project, then sending a bill based on the hours worked is probably the easiest way to manage a service-based business. This method keeps things simple, which is likely its biggest strength. It can work well for small, quick turnaround engagements.
It can be tough to scale T&M billing across larger teams, which can also lead to misunderstandings in what constitutes billable vs. non-billable hours. It can also be tough to use this approach on large projects. More importantly, however, there are some serious flaws in the hourly billing logic:
- It focuses attention on effort, hours, and rates rather than value or desired business outcomes.
- By not producing some sort of cost estimate up front, it places the majority of risk on the client.
- With its focus on production rather than outcomes, it can subliminally encourage mediocrity (i.e. “We billed more hours but did we solve the problem?”).
- Conversely, hourly billing actually penalizes efficiency or technical advancements. (i.e. “We got the project done in half the time thanks to this new software. Now we can only bill half the amount.”)
It is worth noting that retainers, the kissing cousin of time and materials billing, operate a bit differently. Each agency structures retainers to suit their own unique needs, but a few common traits make this approach different than the hourly billing method described above.
- Retainers don’t typically roll over from month-to-month.
- Clients pay retainers to have a dedicated resource available whenever needed. As such, some agencies may not bill hourly on retainers whatsoever.
- Some retainers may only apply to a certain service an agency offers, such as SEO or social media management, for instance. Other services may be billed differently.
3. Fixed Bid-Managed Scope
When using a fixed bid-managed scope approach to project budgeting, price typically remains fixed while project deliverables are shuffled and reshuffled based on changing priorities and new learning that happens throughout. The rigorous ongoing prioritization process that occurs on a fixed bid-managed scope project is typically rigid enough to help both teams find a good blend between features and budget to support a viable product, while also flexible enough to accommodate shifting priorities and continuous learning, which results in better solutions.
Fixed bid-managed scope projects operate under a few assumptions:
- You’ll probably have more ideas than money to execute those ideas, and that’s okay. Validate then build the most important ones first.
- Continuous learning happens on every project and typically yields better solutions. Project teams should have the freedom to explore these opportunities.
- Transparent communication and ongoing prioritization helps project stakeholders share the risk.
- Budget reporting and recommendations for shifting a project based on shared priorities happens frequently.
A fixed bid-managed scope approach fosters better communication, more transparency, and aligns everyone around a common goal. Plus, it keeps finances and priorities in line with one another. If a feature needs to be put back in the icebox for a future release in order to maintain time or budget constraints, that’s okay.
This is Mightybytes’ preferred way to manage project budgets. By taking a fixed bid-managed scope approach to projects, the lines of communications always remain open and there are no surprises for anyone. Our team members know what they are focusing on at any given moment, and our clients are aware of what deliverables are coming down the pipeline and what the budget status is. It’s a healthy relationship to have and nobody is stressed about whether the project will be delivered to budget. It always will.
It can be tough to sell fixed bid-managed scope projects. Embracing uncertainty goes against human nature. While clients appreciate adhering to a set budget, they also often want to know exactly what that budget will produce. People tend to think in terms of features and deliverables rather than desired business outcomes or problems solved because features are tangible and easy to grasp.
The ongoing prioritization process inherent to a fixed bid-managed scope project negates the possibility of committing to a fixed scope. Plus, while clients may give lip service to the idea of continuous learning and shifting priorities, in reality that can be a challenging way for many people to work, even if it does produce superior results.
A fixed bid-managed scope requires you to track project progress, typically using a time-based medium. If you are against time-tracking or T&M billing for the compelling reasons noted above, this approach can appear to embrace bad practices. However, by continuously adjusting scope and managing expectations around deliverables, fixed bid-managed scope projects have a much higher chance of coming in under budget.
If you want to learn more about this approach, the fine folks at Atomic Object blog about it regularly.
4. Value-based Pricing
In his Quick Guide to Value-Based Pricing on the Harvard Business Review, author Utpal M. Dholakia defines the practice:
Value-based pricing is the method of setting a price by which a company calculates and tries to earn the differentiated worth of its product for a particular customer segment when compared to its competitor.
Given this, value-based pricing requires that you adhere to a few key principles:
- Offer specificity: your value proposition needs to be very clear; there’s no room for squishy solutions.
- Differentiated worth: what of value do you offer that your competitors don’t?
- Price-to-value application: how much is that differentiation worth in financial terms to a potential buyer?
As with the other fixed bid project budgeting and pricing options, value-based projects deliver a very succinct set of features for a set price, which clients appreciate. Value-based pricing can also be an effective way for agencies to ‘productize’ services. If you know exactly what it will take to produce a desired outcome and exactly what the value of that outcome is to a potential client, it can be a great way to produce high value-high margin work.
Value-based pricing requires a very clear understanding of what it will take to produce value for a client while also producing profit for an agency. While this project budgeting approach might be easy for a single developer or contractor on a small project, it can be quite difficult when managing large projects with lots of unknowns and many stakeholders. Digital projects, especially large ones, can, by their very nature, be squishy. So can value assessments. What’s high value to one client can be less so to another. And what about continuous learning? If you’re not careful, projects can run amok.
Plus, outside the agency world, cheap solutions are a dime a dozen. Need a ‘free’ website fast? Wix, Squarespace, and dozens of other online services are more than happy to oblige. This creates unreasonable expectations, as it can be difficult for the uninitiated to differentiate the value of these services versus something custom and more complicated.
Value-based pricing is, essentially, a fixed bid approach that focuses on outcomes. Given the inherent uncertainty and complexity of many large, ongoing projects, however, we have found that it can be tough to nail down scope specifics to achieve the specificity required for a value-based pricing approach.
While we haven’t yet cracked the code for perfect value-based pricing at Mightybytes, we appreciate this approach to project budgeting and will continue to explore it. In our experience, value-based pricing works great when executing very specific, well-defined tasks in shorter periods of time. Inevitable uncertainty at the outset of a larger project could result in miscalculations, which could end up blowing a project budget, especially with a larger team. If you want to learn more about value-based pricing, check out Jonathan Stark’s book Hourly Billing is Nuts.
Other Common Agency Pricing Methods
The list above is by no means comprehensive. Agencies get creative in the methods by which they price their products and services. Here are two other common pricing approaches.
Some agencies charge day rates for certain services. This is common practice in the film and video industry where contract production specialists like cinematographers, grips, gaffers, lighting technicians, production assistants, and so on may only be needed on set during a shoot. It can also be very useful for agencies that offer discovery workshops, design labs, digital strategy consulting, or other services that can be accomplished in a single day, making this, in effect, a more manageable variation on the fixed bid-fixed scope pricing approach mentioned above.
Per Sprint Pricing
Agencies that specialize in agile or SCRUM methodologies may adopt a Per Sprint Pricing approach to their services. In this scenario, the agency charges a set fee for clearly defined features delivered at the end of a specific time block. Agencies define this time block based on their internal processes, but common sprint timeframes are 2-4 weeks. The agency then estimates the number of sprints it will take to complete a project to come up with proposal costs.
Project Budgeting in the Real World
No approach to digital project budgeting is a one-size-fits-all solution. Your project details and how the agency you work with prefers to bill will ultimately drive whether or not one approach is better than another—each comes with its own set of pros and cons. We hope this breakdown empowers you to make better decisions around budgeting for upcoming digital projects. Got questions? Feel free to contact us. We’d be happy to help you figure out the best solution.