Steven Kury: Interactive Media Development, Business Analyltics and Strategy

Risk vs. Reward, Part I: Flat Price or Hourly Rates?

Contract management is a key skill that any professional, such as an independent interactive media developer or producer, must master to enjoy their projects and longevity in their field.  Doing it well enables both the contractor and the client to get their project off to a good start because it acknowledges their mutual expectations from the beginning.  Simply put, it answers the question of, “who will be responsible for what?”

While a complete contract contains many parts, such as deliverable deadlines, non-compete clauses, intellectual property rights, payment terms, etc.., the focus of this article is not to delve on any one of those particular contract points, but to examine an underlying principle of them.  The principle in question is "risk vs. reward.”

The goal of any astute businessperson is to minimize their exposure while, at the same time, maximizing the margins that they will gain. Here is the key, risk and reward must always be linked. The more risk that one assumes in a project entitles them to more reward, typically money.  And conversely, the less risk one assumes in a project, the less reward.  The clauses in a contract delineate each party’s responsibilities so that the risk of either party suffering an adverse effect as a result of engaging in it is minimized.

It’s like gambling. To illustrate the point, consider Roulette. Nobody bets a dollar in order to win only a dollar if the ball lands in a little square on the wheel with the number that they guess it will. That’s pointless, it’s much less than an even bet, the reward in no way matches the risk taken to obtain it. You wouldn’t even bet a dollar if you were guaranteed that dollar back, there is still no point. But, if the payoff for correctly guessing which slot the ball will come to rest in is substantial, say $25, then it is a worthy bet.

The major question often related to this principle is, “hourly rate or flat fee for the project?” Clients are often content to pay more than they ordinarily would if the project were done on an hourly basis, provided they are guaranteed that their expenses won’t exceed a maximum if the contractor mismanages the project. They generally only care about two things, a fixed price to budget for and the date when it will be delivered.

This can work out quite well for the contractor if he is competent at estimating the time and resources necessary to do the project, and managing its execution. He has a right to charge the client an extra premium above and beyond the relevant time and material charges that he might have charged on an hourly basis. He is shouldering the risk that it won’t cost more than he expected. If he puts more time and materials into it than he planned for, it’s his loss. The client has paid him to assume this risk, like an insurance company.

This works well for straight forward projects that are easily estimated and planned for, but when it comes to complex engineering ones where it is difficult to estimate the length of time needed, this is tougher. Consider this extreme example from my experience. A prospective client, an educational CD-ROM company, wanted me to add two features to a CD of theirs that had been published two years previously. Of course, they wanted me to do it for a flat fee.

The relevant details are (1) that it was developed in Director 4 and 5, (2) the current version of Director at the time was 7, (3) the existing code was complete spaghetti code, with no conventions or organization to it whatsoever, and (4) when I attempted to run it in Director 7, it froze my computer.  I informed the producer that adding the two new features to it was the least of their problems, and that the project needed upgraded to, and stabilized in, Director 7 first. However, his response was that anything short of the new feature work, that they wanted done, in order to do it would be my concern, not theirs. They were only prepared to pay for the desired features.

On my side of the table, it was literally impossible to estimate what was involved in developing the project just to the point that their features could be added to it. The first order of business would be to stabilize the project so that it didn’t crash the computer when it ran in Director 7. That would take time and serious trial and error, not to mention a lot of rebootings of my computer.

After I explained this situation to the producer several times in different ways, it became clear that he didn’t grasp the complexity of his  request. (Anybody who did couldn’t avoid acknowledging the situation.)  My final proposal was to do the project in phases. The first two were to stabilize the project in Director 7 and sort through the code to find the hooks to add the new features to, on an hourly basis. The third was to add the new features to the identified code hooks for a flat fee, to be determined at that point, which was the original request. They were adamant that this was unacceptable, and I opted to decline the project.

This story illustrates a level of risk that I didn’t care to assume, as compared to the risk that I was. The risk inherent to stabilizing the project in Director 7 was not estimable, there was literally no telling how much time it would have taken. However, the features themselves were estimable.

The fact that the client’s producer couldn’t recognize the stabilization issue with the project indicated a separate risk in and of itself. A client that doesn’t respect your professional opinion on a project, and can’t acknowledge the reality of it, is not one that you want to work with.

The principle of risk and reward always being linked is a cornerstone of corporate finance, and business in general. I hope that this story gave a different perspective on the matter, so that you can arrange your contracts to your, and your clients’, satisfaction.

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Steven Kury, MBA, is an interactive media developer and producer.  Over the past 12 years he has contributed to several rich Internet application (RIA) systems, as well as a breadth of marketing communications solutions.  Contact him at steve@steve-kury.biz or (717) 350-6781 to discuss what he can contribute to your project.