Budgeting Fixed Price Projects

Budgeting on Fixed Price Projects

Budgeting strategies on fixed price projects can be elusive. I categorize most strategies as falling into one of two camps: Top Down and Bottom Up. Here I compare the benefits and drawbacks of each.

Top Down Budgeting

Top-down budgeting uses revenue to measure progress against budget. In this case, the budget is essentially the total amount of revenue we'll be recognizing on the project. For example, we sold a $500,000 project; its budget is $500,000.

One benefit of top-down budgeting is that it can be discussed more openly with customers. Divulging cost and therefore margin to your customer is typically not a positive, especially if it comes the context of difficult scope or schedule conversations.

Likewise, internal conversations about projects can be had more openly if they omit resource costs. While it may make some uncomfortable, discussions about resource costs should not be off the table, as they reflect in the project's ultimate margin and contribution.

The biggest drawback to Top Down Budgeting is that progress measurement is difficult without using some sort of proxy for literal revenue. That is because on Fixed Price projects, revenue is typically measured via periodic (often monthly) Milestones. In the vast space between those milestones, the PM will be forced to rely on other, non-primary measurements of forward motion.

For proxy measurements, a PM's judgment may serve, updating a percentage complete amount on a Milestone. Alternatively, some translate hours to dollars using either a Project 'Planning Rate', a Role Rate, or simply a Resource Rate. In this case, we're substituting effort for value and hoping they correlate. This approach has the possibility of either over-shooting or under-shooting reality, especially when projects are oversold or undersold. It is also reliant on timesheet completion, which can present problems in some organizations.

Bottom-Up Budgeting

Bottom-up budgeting uses cost to budget the project, and is superior when the amount of revenue on a project is fixed. After all, if your revenue is fixed for the project, the only variable that you might care about is cost.

It comes with it the drawbacks discussed above - discussions surrounding cost can make people uncomfortable, both for clients and resource.

Interestingly, it also tends to need some sort of proxy measurement. Literal cost-per-hour is easy for contractors, but not so easy for internal resources. In addition, cost per hour for internal employees is, similar to a planning rate, somewhat fictitious. Salaried employees' cost does not continue upwards as they work additional hours. Therefore, overtime costs may be reflected in this approach, that, technically, do not exist although may reflect in burn out and turnover.

Conclusion

I recommend exploring cost-first measurement with your project managers. It takes a little longer to explain, but results in clearer measurement along the path to project completion. It also sets up more strategic conversations within the organization about resource costs and the approach to staffing services projects.