Pricing of Agile Projects

Agile mode of product development leans on incremental development with a constant prioritization of the features, while being flexible to changes in them and ensuring product quality in each incremental release.

Outsourcing of Product Development: While companies develop a product internally and outsource a varying portion of the work to vendors for a variety of reasons. For the outsourced portion of the product development, it is a challenge to finalize the budget as the pricing has to be worked out with the external vendor.

Pricing Models: The typical pricing models in software engineering industry are the well-known Fixed Pricing (FP), Time and Materials (TNM), Output based and Outcome based pricing models or a combination of these. While each of these come with their own advantages and disadvantages for the client and the vendor, a suitable pricing model with some variations from the standard models or a hybrid variant is typically worked out as per the context.

Pricing in projects executed in Agile mode: Agile mode of execution poses few challenges as requirements are constantly evolving and changes are welcome without the conventional change management clauses.

The clients (Product companies) prefer FP so that they are able to plan their budget for the product development.
The vendor prefers TNM pricing model as this reduces the chances of cost overruns due to scope uncertainty associated with the agile mode of execution.

Given this situation, the clients and the vendors need to work as partners sharing the risks and rewards by coming to a middle ground instead of the two extreme positions of TNM and FP.

Possible Pricing Options:

Initial Phase:

Clients can accept a TNM pricing initially to refine the specifications, benchmark the sizing of the requirements in terms of story points and such units and understand the stable velocity that the team is able to reach.

Stable Phase Option 1: FP per unit of requirements for example, story points delivered):

Because the sizing of the requirements have been benchmarked earlier, efforts per unit output of requirement is expected to be constant.
Changing requirements: To manage changes in requirements when FP model is chosen, the total number of story points to be delivered can be maintained as per agreed contract while swapping in priority new requirements and swapping out current requirements which are not priority.
Effort Overrun: Since vendor has accepted FP per unit of requirement, the effort overrun is to be managed by themselves. However, in the spirit of working as partners, vendors may be allowed to charge a portion of the overrun to the customer after every iteration/sprint.
Effort Underrun/Savings: If there is an effort underrun, then a portion of the savings is to be passed on to the customer.

Stable Phase Option 2 – TNM with productivity targets: This option tries to address the concern of the clients on the capability and associated productivity of the team.

Defining and measuring productivity is challenging but need to be done (Refer: Software Productivity – Is it still relevant?). Both parties can agree on a method to define and measure productivity and also a productivity target for the team.
- Reward for higher productivity: Vendor team is rewarded for doing better than the target productivity.
- Penalty for lower productivity: Vendor team is penalized for doing lower than the target productivity.

Stable Phase Option 3: Hybrid pricing:

Here the pricing model will be TNM for the portion of software where requirements are still evolving and FP for the portion of the software where requirements are clear and technical complexity/uncertainty is minimum. Other combinations of pricing are possible as well in hybrid pricing mode as needed.

Conclusion

In outsourced agile projects, clients and vendors working as partners and sharing the risks & rewards is the way to go!

References

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