Fixed price or hourly billing: what goes into the quote and contract

In brief

• Under hourly billing the customer carries the risk of the amount of work; under a fixed price the supplier carries it.
• A fixed price can include a contingency for uncertain effort. The difference from hourly billing depends on pricing and the contract.
• In the capped model coming in under the cap benefits the customer and going over it stays with the supplier, so the running total has to be reported along the way.
• Payment instalments can follow progress, agreed dates or both. State the billing conditions clearly.

The billing model affects how the customer and supplier share the risk of changes in workload. Hourly billing follows the work, a fixed price offers predictability, and a cap limits the charge for the agreed scope. The right choice depends on how well the work is defined, likely changes and the budget.

Three billing bases and how they split the risk

With hourly billing, the customer pays for contractually billable hours at the agreed rate. Specify whether materials, subcontracting and travel are included or charged separately. Agree on scope changes and costs above the estimate before doing the extra work.

A fixed price is an agreed sum for an agreed scope. The supplier bears the risk of extra effort and benefits from more efficient delivery. The price can include a contingency, but the difference from hourly billing depends on the estimate, pricing and contract terms.

Hourly billing with a cap charges actual billable hours up to an agreed maximum. Specify what the cap covers and how scope changes are handled. Track spending during the work so the approaching limit can be discussed in time.

A target price is different from a cap. A target-price model can share overruns and savings between the parties. Agree separately on any maximum amount payable by the customer.

Choose a model that fits the work and budget

A fixed price is easier to estimate when the scope, inputs and acceptance criteria are clear. Uncertainty increases pricing risk. If important questions remain open, offer a separate discovery phase or hourly work with budget tracking.

The likelihood of changes is the second measure. If the customer’s organisation has several decision-makers, if the result is tested on users along the way, or if the target is an existing system or building that holds surprises inside it, hourly billing or a cap fits better. Under a fixed price every change has to be handled separately, and that costs both parties negotiating time.

The customer may need a predictable total budget for an investment decision. A fixed price or cap can suit that need. Public procurement also uses different pricing models: the tender documents determine how prices are submitted and compared.

Previous cooperation can help estimate and track workload. It does not determine the pricing model by itself: choose based on the work and the customer’s needs.

Example: the same 120-hour job in three models

The estimated amount of work is 120 hours, the hourly rate €90 and the fixed price €11,500, which includes a contingency for the estimate being wrong. In the capped model the cap is the same €11,500. The figures are exclusive of VAT. The figure in brackets is the supplier’s billing per hour worked, that is, the same money seen from the supplier’s side.

The table shows how the customer’s payment varies by model and actual hours. Under a fixed price, extra hours increase the supplier’s costs without equivalent extra billing. Include the cost of the work in your assessment: the invoice amount alone does not show the margin.

Run the calculation with your own figures. Try effort overruns of 10 and 25 per cent and assess whether the remaining margin is acceptable. The right contingency depends on project uncertainty and the provider’s risk tolerance.

Scope and exclusions are the most important part of the quote

Describe the scope so completion can be verified. Deliverables, a task list and acceptance criteria can complement each other. “An order view showing past orders and allowing reorders” says more than “online-store development”.

Exclusions are the other side of scope, and they are written just as precisely. Name at least these:

• third-party licences, permits and official fees
• producing, cleaning and migrating the customer’s data from the old system
• training, go-live support and maintenance during use
• travel, accommodation and travel time
• work redone after the customer’s acceptance because a requirement changed
• waiting time and additional work caused by the customer’s delay

Record the inputs, decisions and response times needed from the customer. Agree on how delays affect the schedule and costs. Clear terms help determine responsibilities if the starting information or working conditions change.

The billing rhythm follows the model

Agree the billing schedule with the customer. Under monthly billing, approved hours from the previous month can be invoiced at the start of the next. More frequent billing helps identify questions early and reduces the amount of work awaiting invoicing.

Fixed-price work can be billed on completion, as an advance and final payment, or in agreed instalments. Billing mainly at completion increases the supplier’s financing need, so consider duration and costs. Ongoing services can use monthly or periodic fees with separately agreed extras.

An advance is common in a new customer relationship and when the supplier buys materials or licences in its own name. Under point 4.2.6 of the Tax Administration’s invoicing guidance the seller must give the buyer an invoice for advance payments, and if the whole consideration has not been invoiced in advance, an invoice must also be given once the service has been performed. The clearest approach is to invoice only the remaining amount on the final invoice, or to enter the previously invoiced advances on the invoice as deductions with references.

Phasing and progress billing under a fixed price

A fixed-price project is worth splitting into phases that each have their own budget and their own verifiable outcome. Phasing does three things at once: it gives billing a rhythm, it exposes the error in the effort estimate after the first phase instead of at the end, and it gives a change request a natural point at which scope is discussed again.

A payment instalment can be tied to an agreed date, progress or both. State the condition so both parties can determine when it is invoiced. The example below uses project milestones.

Set the final instalment to suit acceptance of the work and project financing. State how any defects will be handled and whether they affect billing.

Time report, acceptance and travel costs

Agree with the customer whether time reports are needed under fixed pricing too. Reports can help track progress even when hours are not the billing basis. Set out their contents, recording precision, frequency and the objection and acceptance process.

The acceptance procedure says when the work is done. Write down the approver’s name or role, the deadline for acceptance, the consequence of not responding and the start of the warranty period. The consequence of the deadline passing has to be agreed expressly: it can be deemed acceptance or the right to invoice without acceptance, but neither arises by itself.

For travel costs, agree the basis and the area. A common wording is that work done in the area around the supplier’s premises carries no travel charge, and that outside that area either a kilometre charge or the actual travel costs against receipts apply. Travel time is a question of its own: is it charged at the full hourly rate, at a reduced rate or not at all. Under a fixed price travel is most often left outside the price, in which case it is billed as incurred.

A change request is handled before the work starts

Small extra requests can also affect the profitability of fixed-price work. Agree in advance on how changes will be approved and priced:

1. The request is recorded as it comes in: who asked, what, when.
2. The supplier assesses the effect on the amount of work, the price and the schedule.
3. The assessment is given in writing before the work starts.
4. A named person on the customer’s side approves or rejects it.
5. An approved change updates the price and schedule as agreed. Record scope reductions too.
6. A rejected request stays on record. It is evidence of what was agreed.

The same process helps with hourly work: a recorded change explains its effect on hours, billing and the schedule.

The contract decides

Businesses generally have considerable freedom to agree on pricing, billing frequency and changes. Applicable law and trade usage can still supplement the contract. Put important terms in the quote or an appendix to avoid having to reconstruct them later.

The Contracts Act and the offer’s terms govern binding offers and modified acceptance. A modified reply is normally a counter-offer, but in some situations the seller must reject it promptly. See quote content and binding effect.

Checklist

• Scope and acceptance criteria are described, so completion can be verified.
• The exclusions are listed by name: licences, data migration, training, support, travel, rework.
• The assumptions about the customer’s deliveries and response times are recorded, and the contract says what happens if they do not hold.
• The effort estimate is built from parts, and each part was estimated by someone who has done that kind of work.
• The contingency on top of the estimate is known as a percentage, and it did not come from rounding the total up.
• The margin’s sensitivity to effort overruns has been calculated, and the risk is accepted.
• The milestone payments cover costs as the work proceeds, and the advance is agreed.
• Instalment billing conditions are agreed: dates, progress or both.
• The change procedure is written down: who asks, who prices, who approves and within what time.
• The acceptance procedure is written down: approver, deadline, the consequence of the deadline passing and the start of the warranty period.
• The basis for travel costs and the charging of travel time is agreed.
• The quote’s validity period and the form of acceptance are stated in the quote, and you know what to do if the order confirmation differs from the quote.