How digital firms come up with their pricing
Pursuing building a digital product? You are likely going to get a couple of proposals to develop your product. We engaged with a client on web application who received three proposals during their search for a company to work with. The proposals they received varied from $20k to $200k. How is it possible that one company estimated the project at $20k and another at $200k, when both companies were working from the same set of scope and requirements?
There are multiple factors that come into play when you talk to companies about developing your product and getting proposals from them. Certainly the biggest factor is the size and scope of the product, but if we assume you are providing the same set of information around the product to all companies you are considering, then it really comes down to each company’s perspective around some key aspects of the project, and their own business needs.
The factors that determine proposal values are:
1. Effort Required. Based on what a company understands the size and scope of the application to be, they will estimate how long it will take for them to complete the project. Typically, the number of people multiplied by the number of hours each person will be working on the project equals the project’s total hours. If you’re approaching several companies, expect to see price differences because each company is probably seeing the size and scope of the project slightly differently and they are correlating that back to the size of their project team. The pace of their work on the project also greatly affects their price. One company might be proposing one person for 6 months where another company is proposing 6 people for one month.
2. Experience & Expertise. A big factor in the project team and project pace from above is a company’s experience and expertise with the type and scope of product you want to develop. Companies will assess how the project aligns with their experience and capabilities and apply a risk factor. If the project is in their wheelhouse they have much higher confidence they can execute it well and the associated effort involved. You could consider this a confidence weighting. When a company is confident in their ability to deliver, they don’t need as much room to mitigate risk and to account for time they will need to spend learning. However, if the project doesn’t align with their experience, expertise, and capabilities very well, they tend to account for more hours of work in order to mitigate their risk and account for a learning curve. In this case their confidence weighting is going to be low, which will increase the price of their proposal. You can think of it this way: When you know how you will do something you are better at estimating how long it will take to do it. When you have to figure things out along the way, you have to account for the lack of know how.
An important point in this context is that expertise is as important as experience, if not more so. We recently engaged with a library on a web site project. One of the reasons they engaged with us, is because we have the expertise to create a next generation site so they won’t look like and have the functionality of all the other, inadequate library sites. They considered other copmpanies that have developed library sites, but just the experience of doing library sites didn’t give them the expertise to develop a new level of library site. Be sure to balance expertise and experience. Experience is good. The ability to apply expertise is better.
3. Profit Drivers. All companies are in business to make a profit and those of us that are service companies essentially sell production hours. So whether you are getting fixed fee, hourly, or hybrid proposals is kind of irrelevant since they will all be calculated against the number of hours companies think it will take to perform the work. The terms of engagement of when and how much is paid relative to work performed is more important than the type of engagement. If you are misaligned, you will be me misaligned regardless of the engagement type.
How much profit a company wants to make on your project is a significant driver of their proposal to you. The profit a company wants to make on your project probably depends on their current project workload, project mix, financial health, and capabilities. In other words, companies will markup a project more or less based on their financial need for the project. You can typically sense when a company is desperate for a project and pricing accordingly. In the example referenced above of a client getting proposals valued at both $20,000 and $200,000, you can surmise with some certainty that the company at the low end is low-balling the project because they need the work and the one on the high end is charging a premium because they either can’t handle the work currently or believe the client can afford more. We’ve also seen proposal pricing with the opposite reasoning. Where the highest priced proposal is from a company that needs the work and also needs to make up for time when they haven’t had their entire team busy. If a company is trying to make up for lost time then they might need to price high in hopes of being able to have your project fill their financial gap.
We’ve also seen the concept of client affordability come up several times. Companies will price a project at the level they believe a client can afford. So if a company perceives you have deep pockets they might price in accordance with what they believe you can pay as compared to what the numbers actually mean the project should cost.
By the way, our proposal for this project was $62,000 and the client engaged with us. The client didn’t engage with us just because we had the most reasonable price, but when married with our experience and expertise it made the most sense.
In summary, you can provide the same project scope and requirements to multiple companies and get vastly different proposals because each company applies their own combination of effort, expertise, and business needs to their proposal. Ultimately you are probably best served by choosing the company that aligns best with your desired business outcomes from the project and that you feel the most comfortable collaborating with.