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Unfortunately, this common assumption is incorrect. The reality is that fixed-bid projects are generally more expensive to the client, more stressful for the vendor, and result in poorer quality results.

Many vendors will rush to complete the project within the allocated time period, because they risk losing their profit margin if the project takes longer than anticipated. Meanwhile, any changes to the project specifications will incur a heavily padded fee to the client. Overall, the fixed-bid project can be an uncomfortable and risky arrangement unless the project unfolds without a single surprise or change request.

Why are hourly-rate projects less expensive than fixed bid projects?

A fixed-bid project is priced by estimating the hours and expenses required to complete the project, then ‘padding’ the estimate to ensure that the vendor remains profitable after the inevitable change requests or unforeseen difficulties. The vendor will typically add 100% or more to the project cost, simply to cover possible costs that might be incurred by unclear requirements or misunderstandings between the vendor and the client. Ultimately, the client pays for this ‘padding’ regardless of whether there were unforeseen changes or not!  For this reason, the fixed-bid rate is a great deal for the vendor, not the client.  

To make matters worse, most fixed-bid vendors will require that the client complete a ‘change order’ if the project requirements change or new features are requested. When they prepare the change order, they use the same process of estimating the cost thus adding even more padding to the total project cost to protect them from unforeseen expenses.  Again, this is a great deal for the vendor, not the client who is now paying a premium (plus padding) for each change they wish to make.

In an hourly rate scenario, the vendor has no motivation to pad their estimation. In fact, a padded estimation might scare off the client before the project even begins. And an estimation that’s too low could result in a surprised and dissatisfied client at the end of the project. Therefore, an estimation performed for an hourly-rate project is much more likely to be accurate and fair than an estimation for the same project under a fixed-bid.  

If the client needs to make some changes along the way, the hourly rate agreement remains the most attractive option. The vendor provides the client with an estimate for the hours associated with the change, but again there is little motivation for the vendor to over/underestimate the hours. Once the client approves the changes, the vendor simply implements the changes and bills for the actual hours worked – no padding, no sign-offs, no negotiation, no stress. Under this arrangement, the client only pays for the hours that were required regardless of the number of changes made.

The hourly rate also benefits the vendor, who no longer needs to make the project ‘come in within the estimate’ to maintain profitability. Their only responsibility to the client is to estimate accurately, bill fairly, and do a good job. The makes it easy for the vendor to keep their client satisfied with minimal risk. If a project takes less time than estimated, the client saves money and the vendor will have a truly satisfied client who is sure to return. If the project takes longer than estimated the vendor will explain the difficulty to the client and get paid for their extra efforts.

Can an hourly rate really result in higher quality than fixed-bid?

Unfortunately, the majority of projects encounter changes and new issues as the engagement unfolds – requiring more time and effort from the vendor.  As these additional expenses pile up, the vendor has to invest additional hours to handle those issues, and starts to lose their profit margin on the fixed-bid project! Now, the client is left in a predicament because their fixed-bid vendor is becoming less and less motivated to do a great job on the project as their profits dwindle.