This article is part of our Shared Values content series, which explores the foundations of impactful and sustainable public sector project partnerships.
In 2017, the ICT Procurement Taskforce of the Digital Transformation Agency reported concerns with the way Australian Government procures IT, noting it was “not designed to “support agile delivery of digital services that meet user needs.”
A lot has changed since then. Agile is now an accepted way to deliver government services, with the need for digital access accelerating out of necessity during the pandemic response. But have IT project commercial models kept pace?
Commercial models are the language buyers and providers use to agree on how to fund a project or piece of work. Negotiating and defining the right commercial model for both parties upfront is critical to that project’s success because it significantly influences whether the project is put on the path to creating real value.
Choosing the right commercial model for your next IT project
Rather than focusing on the pros and cons for each contract type, I want to draw your attention to the importance of finding balance between risk, control, innovation, and agility – for both buyer and provider. Each model has specific advantages and disadvantages, and the right choice will depend on the project requirements and situation.
First, it’s important to consider how complex and uncertain the work involved is likely to be.
For small pieces of clearly defined or time-boxed work, fixed price or target price models may be the simplest solution. However, for highly uncertain, complex pieces of work, a better solution may be the time and materials or capped time and materials models – where there is expected to be a need to be able to change direction and where there is a focus on prioritizing, evaluating, and delivering work according to its value.
To get the best outcome, a mixed commercial model may be adopted. Where parts of a project are either time-boxed or have clearly defined activities and outputs – such as ‘discovery’ and ‘inception’ events – a fixed price model may be used. The time and materials or capped time and materials model can then be used for delivery where adaptability and flexibility are essential for success.
Beyond any uncertainty about the product, user or outcome, it’s also important to think about the relationship and trust that already exists between the parties. What is the maturity level of the design and delivery team, and how open and honest is the communication between the buyer and provider?
By taking the time to clearly define your product vision, scope of work, and expectations of outcome, you'll be better equipped to shape a commercial model that balances risk, control, innovation and agility. And in turn, achieves the desired impact – a product or experience that meets (or even exceeds) citizen expectations for the right budget, and in the right timeframe.
As mentioned above, here are four options you could consider:
Fixed price model: Typically a single-sum contract where a provider is responsible and accountable for completing a project within the agreed dollar amount stated in the contract.
Target price model: Strives to keep a project within a certain price, with a shared responsibility between provider and buyer to achieve a specified target.
Time and materials (T&M) model: The provider will bill the buyer for the work done by a set number of people on a specific project, plus costs of any materials.
Capped time and materials model: Shares almost all of the characteristics of the time and materials model – except there is a price cap that should not be exceeded.
1. Fixed price model: control or coercion?
Fixed-price agreements are typically a single-sum contract where a provider is responsible and accountable for completing a project within the agreed dollar amount stated in the contract.
Buyers perceive this model as providing them with the least risk – but this may only be an illusion of control. In our experience, fixed-price agreements can be more divisive and contentious than collaborative, reducing the ability of the buyer and provider to build trust and a long-term relationship.
Fixed price models are most effective when the IT project’s requirements and specifications are highly predictable, or where pieces of work are small, standardized, time-boxed and/or familiar. Responsibility for the project’s success is effectively turned over to the provider, but they have the benefit of familiarity and predictability within which to work.
For complex work, or work where there is a reasonable degree of uncertainty or risk, fixed price models fall short. For example, legacy systems may have opaque or missing business rules, or product specifications might be undefined or unclear. External factors – such as shifts in the political environment, market changes, or evolving citizen needs – can lead to unanticipated risks and the use of a fixed price model in these situations can actively work against risk mitigation.
Fixed price models can also limit the potential for innovation because the provider can’t exceed the fixed price. When they uncover new information or unexpected complexity they have two options:
choose to take on the non-billable administrative work of managing this new information through formal change control; or
de-prioritize or remove elements from the project, so the fixed price can still be achieved.
Ultimately, the end solution (and the buyer and user) may lose out when those hard choices are made.
Finally, a fixed price model can reinforce an ‘us-and-them’ mentality. It shifts focus to the output of the work (as opposed to the value of the outcome) with little incentive for the provider to act beyond their contractual requirements. The fixed price may be met in the end, but the project outcome may not be optimal or even useful.
Successful fixed price commercial contracts share the following characteristics:
A clear client vision of the desired results. While it isn’t possible to accurately define a complex product or service, you can record detailed assumptions about features throughout the project, and manage any variations from the initial vision as changes.
- Full provider control for structure, people and timing. This is really the only way suppliers can adjust their effort and spend to meet the project's fixed price. Applying constraints is likely to end in acrimony and failure.
- Allowance for project management. This model may appear to reduce the need to control cost for the buyer, but the provider will need to continually monitor and adjust their effort to stay within the agreed price. The model should provide a certain portion of the expenditure for this administrative, non-value-adding overhead.
2. Target price model: sharing in success
A target price commercial model is a variation on the fixed price model. While it strives to keep a project within a certain price, there is a shared responsibility between provider and buyer to achieve a specified target. This shared responsibility to meet a target price actively encourages a partnership; both parties will work in good faith to reduce the risks and maximize the chance of success.
However, it's important for both parties to agree upfront on how they share risks, price overruns, and savings – and agree on a reasonable target price.
When executed well, this model provides good control over costs. It can be useful for smaller or time-boxed pieces of work, or where there is reliable and detailed information available for estimation of the effort required.
However, there are challenges with new working relationships where trust is yet to be established. A target price model requires significant upfront effort and an explicit definition of all assumptions around the scope of work. Too often, there are implicit or unspoken assumptions on both sides that only emerge during the project.
Thorough project planning, or 'inception' activities, are required to gather these assumptions and dependencies and articulate all the associated risks that may exist. Projects can also benefit from regular mini-inceptions, where you review these previous assumptions and introduce new information.
In addition to this upfront work, there is likely to be significant overhead required to manage scope change. As with a fixed price model, change management processes add non-value administrative costs to the project. It’s also important to have scope flexibility, so a feature can be deprioritized or removed from the product and new features introduced if required.
Unless the provider and buyer prioritize well, and reprioritize frequently, there is a high risk of either building the wrong thing or only building the bare minimum.
Ideally, an effective target price contract will:
Have a clear client vision of the product. The provider must have an open and honest conversation with the client about the product vision, risks, uncertainty, and areas of potential complexity that can lead to overruns.
Break work down into chunks. A series of short-term pieces of work can support continuous discovery, and reduce uncertainty throughout the project.
- Set clear evaluation criteria. Value-based criteria are used to assess product features for priority. Scope prioritization (and re-prioritization) and flexibility is essential to stay within the price target; the buyer and provider need to make the hard choices together.
- Be set up as a close collaboration. Strong joint governance is needed at all levels of the project. The provider and buyer need a shared understanding of risks and benefits, and the ability to track and mitigate those risks as soon as they are identified.
3. Time and materials model: flexible and impact-focused
With a time and materials (T&M) contract, the provider will bill the buyer for the work done by a set number of people. This effectively uses a daily ratecard times the amount of people-days spent on a specific project, plus costs of any materials.
The main advantage of the time and materials model is its flexibility. Requirements can be adjusted, features replaced, and feedback gathered from customers on a regular basis to get the exact product desired. It is without doubt the best model for reducing the risk of building the wrong thing.
This model also provides maximum adaptability when the scope is unclear, or where there is a high degree of risk or uncertainty. Sometimes there is little or no information to do a reliable estimation. There may be a high degree of complexity, or the provider might need to do a significant degree of research or 'discovery' to define requirements.
Time and materials models work well for agile teams because they are empowered to work in an iterative fashion until the check-in point. And because the features are constantly being evaluated and prioritized, no formal change management overhead is required beyond standard agile practices.
Regular showcases provide the product owner with the ability to continue, pivot or stop delivery at any time, albeit with some notice period. If a decision is made to stop, the product owner may decide to push the product into production and save the remaining balance of the contract. If there is a pivot, the provider has the freedom to initiate team changes or rotations to avoid impact on progress and price.
However, a time and materials approach also means that long-range scope and specific milestones or deliverables are not fixed upfront. This can be difficult for traditional organizations to accommodate – especially when their internal business approval and funding models rely on these long-range predictions.
There is also an increased risk of cost and timing blowouts without close controls and active engagement by both the provider and the buyer. This commercial model does not work well as a 'set and forget'.
To use a time and materials model effectively:
Manage the scope collaboratively. The buyer and provider need to ensure the most valuable work is done first. A small product design team can work ahead of delivery teams to identify the next pieces of work through continuous discovery and design. In this way, delivery teams are 'fed' work that's ready for development.
Provide transparent and frequent reporting. This is essential to avoid losing control of costs and/or building features that don’t provide value. The re-prioritization process requires experienced product owners and/or product managers who are engaged on a frequent (even daily) basis.
- Give key customer roles autonomy and authority. An experienced product owner in the buyer’s team needs to be embedded in (or immediately accessible to) teams, and able to make key value decisions and tradeoffs. This model does not work well when decisions are elevated to senior management (with the risk of time delays, competing agendas, or lack of understanding of what is being built), or dependent on creating a request for approval.
4. Capped time and materials model: more predictable flexibility
For a hybrid fixed and flex alternative to the time and materials model, we can consider a 'capped' time and materials model. It shares almost all of the characteristics of the time and materials model – except there is a price cap that should not be exceeded.
Setting up the ideal structure for commercial agility
It’s important to take the time to clearly define your product vision, scope of work, and expectations of outcome, and still empower providers to make informed decisions as new information arises. A well-considered commercial model can resolve this seeming paradox. And with the right structure in place, both parties can ultimately achieve their shared goals of creating something that meets or exceeds user needs and expectations, provides value for money for taxpayer dollars, and delivers meaningful positive impact.
With this approach, the product owner and the delivery team can still work to evaluate and prioritize and deliver the next most valuable product features using good agile practices. The only variation is a change control function to manage features, scope and complexity changes within the price cap.
The change control function does create some additional administrative overhead compared with a pure time and materials model, but that incremental effort can provide the buyer with the ability to control expenditure – and the confidence to adopt true agile ways of working for increased product flexibility and adaptability.
Read more on this topic: Why there’s no such thing as a risk-free commercial agreement.
As a Principal Consultant with Thoughtworks, Anthony O’Connell brings almost three decades’ experience in product engineering, business and product development, lean principles, and change management. He has led large, complex projects to develop and implement solutions to difficult problems, and specializes in the processes that contribute to successful innovation and change across the private and public sector.
