The Golden Rule of Contracting
The Fallacy that Kills Us and How to Flip the Script
There is one thing that all contractors (especially new ones) are very bad at. It’s one of the most challenging things to do properly, and the error is committed by both individuals and monolithic institutions — always and probably forever. Contractors are notorious for underestimating the amount of time it takes to complete a project. I’ve been contracting for over seven years, and I — to this day — still make the mistake. It wasn’t until a few years ago when I read a book that explains this false-estimation tendency in scientific terms. This article is about the phenomenon known as the planning fallacy, and how contractors can use it to their advantage to get paid more fairly, increase their income, and start providing better estimates based on the information at hand.
The Inevitable Problem · Imperfect Estimates
Have you ever been late on a project? In school, or in your professional life? Unless you are some divine contracting guru, chances are you have, and you have more than once. Late projects, especially in the professional world, are one of the biggest reasons business relationships go sour. Often, it’s not because of the clients distaste for the late work (if you’re doing a fixed price contract), but you — the contractor — realize you spent way too much time on a project and feel at the end the transaction wasn’t fair. Dually worse is that you the contractor are really the one to blame, which can further damage your self esteem as an independent person trying to make a living. Late projects and fast estimates inevitably cause considerable psychic pain. They can burn you out.
If this has happened to you, the good news is you’re not alone. Everyone makes this mistake. In fact, even Nobel Prize winning scientists do. In his brilliant book, Thinking Fast and Slow, Daniel Kanheman documents his own bout with overly optimistic estimates, even after discovering the bias which he termed, the planning fallacy. The planning fallacy was first articulated in 1979 by Kanheman and Amos Tversky in a paper titled: Intuitive prediction: biases and corrective procedures. Another anomolie of the planning fallacy, is that this error still exists even when the contractor (the one doing the estimate) has made the mistake in the past.
Here is an excerpt from their 1979 Paper:
The context of planning provides many examples in which the distribution of outcomes in past experience is ignored. Scientists and writers, for example, are notoriously prone to underestimate the time required to complete a project, even when they have considerable experience of past failures to live up to planned schedules. A similar bias has been documented in engineers’ estimates of the completion time for repairs of power stations (Kidd, 1970). Although this ‘planning fallacy’ is sometimes attributable to motivational factors such as wishful thinking, it frequently occurs even when underestimation of duration or cost is actually penalized.
The planning fallacy largely exists due to a neglect for the likelihood of mishaps, accidents, and unpredictable, yet sometimes probable events. For example, in a typical software development project there is a possibility of a developer or designer getting sick, having a family issue, multiple bugs, updates to frameworks, delayed feedback from a client, or even death of one of the assigned contractors. Although each of these cases may be unlikely, the likelihood of at least one of these incidents is actually very probable. The problem here, is that our intuition almost always ignores these potential events — we imagine everything in a project going perfectly and use our impression as an anchor for our prediction.
Another problem with our optimism, is that even when we do give additional room for ‘slippage’, it is almost always never enough because our initial impression still acts as an benchmark for this slippage. Kanheman and Tversky propose that in order to come up with better estimates, one must ask the external question, how long do these projects usually take? By taking yourself outside of the variables in the project, you’re able to see it from a more objective angle. Typically the longer the project, the more proper estimate it requires, because of the higher risk involved.
The Golden Rule
Now it seems like the planning fallacy leaves the contractor in a catch 22 situation. If they increase the estimate, they feel the client won’t buy — but if they reduce the estimate, they’ll get screwed. Well there is actually good news to this. The planning fallacy only exists in the mind of person tasked to complete the work (the internal expert), not the person issuing it. In fact, studies show that the non-expert actually overestimates the time it will take to complete a project. They practice what is known as a the pessimism bias. This is huge insight for general contractors, because it proves how actually increasing the length of time needed will actually work out better for the contractor and the client. The contractor will have enough time to complete it, and the estimate won’t appear crazy to the client.
This brings us to our our golden rule of contracting: anchor your project estimates at double the time your intuitive impression is. This will always leave you much better off, reduce your likelihood of burnout, and you’ll be able to complete the project to a much more professional degree. Nobody wants an unfinished product even if its cheap. They would rather have something that’s polished. Something that has seen iteration and is either development ready or market ready. By using our impressions in an estimate, we not only screw ourselves over, we screw the client over. For them, hiring someone else to come on and start reading and transferring code, components, and assets is a huge waste of time and addition to the bill.
Optimistic Estimates Are Greedy
When one estimates a tight deadline, whether it’s their impression or not — they often do it for the sale, which in a way is a form of greed. You want to close, without thinking of the repercussions of inaccurately estimating the time you need to complete the project properly. In an hourly rate project this is unethical, and in a fixed rate project it’s uneconomical.
Moreover, there are multiple theoretical explanations for the existence of the planning fallacy, one being the authorization imperative. This theory proposes that optimistic estimates parallel the concept that it’s better to ask for forgiveness (for lateness), than permission (lengthly deadline). I’m sure every contractor has experienced this before. We estimate low so we can get the sale. This may work for an hourly bid, but if it’s a fixed price — we truly shoot ourselves, and possibly the business relationship in the foot. Also, since you estimated low, it becomes very difficult in the future for you to bid high with that particular client. You’ve become a low-price commodity tool, not a high-delivering consultant.
So, whatever feelings you have of ‘giving the client a break’, or being generous for providing a tight frame, these are false. You are doing a disservice to both parties by giving an inaccurate estimate. This why our Golden Rule of Contracting is better for both parties. Often times, it’s better to be less optimistic. Prepare for the worst and hope for the best.
We all suffer from bad estimates, whether it be the time to complete an assignment, to the time a huge engineering and construction agency takes to build a bridge. It happens at the organizational level, government level, and personal level. An example of this can be seen in my native Toronto, where the Union Station redevelopment recently increased it’s total project budget by over $200 million and deadline by almost 4 years. The planning fallacy is everywhere.
On the bright side, we also learned that outside observers are actually more pessimistic, and they typically overestimate the time it will take to complete a project. By using the double estimate golden rule, understanding averages, and asking outside experts — we can create healthier projections that are ultimately better for business. Imagine if space travel, civil engineering, or medical projects were seemingly not completed to perfection? The world would be chaos. Independent contractors need to be wary of this likely bias especially when they’re estimating fixed price projects. Although there is no science of preparing the best and proper contract or estimate, it’s safe to say that creatives very much consistently undervalue their work. This can lead to exhaustion and contempt for the very thing they loved in the first place.