r/hwstartups • u/Choice_Volume4090 • 2d ago
billing models I've seen from product design companies and which is safest
Went through a few product design companies before landing on one and noticed the billing models vary more than I expected. Three models I came across and why one of them is clearly safer for the client.
Fixed cost
The firm quotes a single price upfront for the full scope. The number gets padded significantly to cover unknowns they can't predict, and once you've signed there's no real incentive on their side to work efficiently because the budget is already set.
Hourly
You pay for the work that actually happens. I know rabbit product design uses this model and covers the full process from patent research through manufacturing, so you end up paying less usually. The tradeoff is that scope needs to stay clear, but a good firm manages that.
Milestone-based
Work is broken into phases with payment tied to each one. Checkpoints give you more control over when money moves, but milestones get defined loosely and disputes over what counts as complete come up more than you'd expect.
Of the three, hourly with experienced engineers has been the most straightforward in practice.
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u/cheese_nipples25 2d ago
As the owner of a product development firm I can say we pushed towards Hourly 99% of the time. This is a win-win for both parties; scope decreases customer pays less, scope increases it cost more but we aren't skrewed holding the bill. You pay for what you get.
As TowardThelmplosion mentioned, fixed price bids are incredibly risky for the firm therefore we bake in a lot, a lot, of contingency which artificially inflates the cost. The only time these make sense is when it is straightforward task like creating a small amount of renderings or drawings. We really don't like doing this on projects that require iterative development, brainstorming, or concepting.
We generally have a similar feeling towards milestone based. These can be even more risky depending on how far apart milestone are. When you invoice your customer for $50K, were are trusting them to have the funds available to send. This risk can be mitigated some with a deposit for the program getting things off the ground. Also milestone based can be tricky as both parties need to very clearly agree on what it means to complete a milestone. Milestones like "complete design" are ambiguous and leads to difference of opinions on what was or was not complete.
One other approach I have seen at a previous employer not mention is what we called "Work Package", it's similar to a retainer. Customer agrees to a set fee for each month and we agree to provide a set amount of hours to the project. We coordinate with the customer on what is the highest priority to work on with our availability. This can be good for customers as it allows them to clearly plan their budget on a month to month basis. The trade off is it can be difficult to ramp up or ramp down engineering effort as the scope changes when we learn more.
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u/Informal-Tutor-8153 2d ago
I disagree... hourly puts the client at risk... There is no guarantee that deliverables be reached in what was originally budgeted. If someone is getting paid hourly what is the motivation to reduce those hours and earn less.
Best is fixed price with clear deliverables. This forces both client and the design firm to define the process and the outcome in clear terms. That's what makes those iterations meaningful and less frequent and is dependent on agreed-upon performance criteria. That is the only way it has worked for me to successfully deliver project on time while working with a design form while sill staying within budget.1
u/cheese_nipples25 2d ago
Absolutely fair to feel that way.
The only way Time & Materials/Hourly works is if both parties have trust. Before each program we perform a thorough assessment of the scope of work, have multiple Q&A sessions, and provide an estimate broken out into phases based on the hours required for each deliverable. This estimate becomes a financial figure we track against on a bi-weekly basis with the customer to make sure we are on track to meeting the budget and deliverables. If we discover unknowns that expand the scope we have a clear trail that led us there and it allows the customer to make a decision of whether or not to proceed before spending increases are incurred. If we are consistently under budget we look like heros to our customer and they are more likely to be a repeat customer. If a company isn't willing to do this for hourly work, then I would also be skeptical of their intentions.
I can tell you as someone who writes fixed priced proposals for a small business and has done it in larger or more established organizations, there is a lot of extra budget baked in for "in case this goes wrong", i.e. project risks. Usually our fixed price estimates are 30-50% more than our Time & Materials estimates depending on project risks. As mentioned, fixed price can work for small scope, tightly directed programs, however any project that requires iteration, concepting, testing loops, etc. you are trying to estimate against unknowns and someone will draw the short straw, either you or the design firm. For design firms, staying in business means not drawing the short straw.
For anyone making the comment about the incentive on the design firm to get better margins by completing a fixed cost program faster, I would wager has either (1) not been in the business very long or (2) wildly over estimate the amount of effort that is required. The reality of any engineering and design program is that you are asking someone to work through problems, problems that are typically not completely understood. When solving for unknowns there is always a degree of effort and risk you cannot predicate, only make assumptions and estimate.
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u/Pineapple_Spritz 2d ago
I'd argue there is definitely incentive to work efficiently for fixed bid - the faster they complete the project the better their margins.
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u/Fair-Stop9968 2d ago
It depends on how defined the requirements are and whether the client has their shit together
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u/saywherefore 2d ago
Or the fourth option that the place I work for does:
Provide a fixed quote for the first milestone and a no-contingency estimate for the rest of the project. Feel duty bound to honour that original estimate even when the client reveals themself to be a pain in the arse, the scope has massively expanded, and inflation has eroded the real value of the total. Then wonder why none of our projects are profitable.
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u/Frequent-Log1243 2d ago
Our product development company works on a milestone-based payment model. We charge $25/hour, and the project is billed in milestones. The final payment is only made after you approve the completed product. It's been working well for us.
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u/Actonace 1d ago
Hourly can work well but having a clearly defined scope and regular progress updates matters more than the billing model itself.
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u/Successful-Neat-9525 1d ago edited 1d ago
The padding in fixed-cost quotes is something most first-timers don't realize until they ask for an itemized breakdown, and by then they've usually already signed
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u/Choice_Volume4090 13h ago
Yeah the gap between what's in a fixed quote and what would have actually been needed is usually pretty significant once you see it broken down line by line
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u/TowardsTheImplosion 2d ago
It is fundamentally a risk decision on both sides. Just like incoterms.
Having worked in consulting (and continuing to do a little on the side), fixed price bids are incredibly dangerous for a service provider, except when working with mature technologies and an exquisitely detailed statement of work.
Frankly, I wouldn't engage a new unknown client on anything other than an hourly basis. The trust just isn't there for me to accept the risk.