Time and Material Business Model is Injurious to Process Improvement

An incident in a large software development organization:

Here is a part of a conversation between a Sig Sigma Expert (SSE) and the Delivery Head (DH) in a software development/ maintenance organization where most projects were run on a T & M or Headcount based billing for their customers.

SSE: “Initial analysis shows that with minor changes in the processes and the use of some spreadsheet macros, we can eliminate some non-value add steps. This can reduce the effort required by 25% for the current mix and volume of work.”

DH: “But that will reduce my head-count and billing by 25%! My target this year for improving efficiency/ productivity is only 5%. Maybe we can implement the changes a bit every year, and not all at once. If I implement all these change right now, I will miss my revenue and headcount targets – these have the highest weight in my performance objectives.”

Another incident in a different organization:

A Project Manager’s project end bonus was slashed because she delivered her project at a much lower cost than what was estimated (the estimate was done by someone else). She was informed that her lower bonus was because the project total billing was much lower than the project estimate.

Both these incidents occured in situations where the projects were being run in a T & M (Time and Material) mode by a software service vendor organization.

The T & M mode of engagement basically shifts the cost related risks and benefits (cost overruns, cost efficiencies) to the customer, while the vendor organization has a steady return, and cannot make large profits or losses. The T & M mode is suitable in many situations – e.g., when requirements are unclear and likely to change, when the customer wants to work closely with the vendor team, when the customer wants more micro control (sometimes interference), or when the customer-vendor organizations are in the initial phase of establishing a relationship. A variation of this is Committed Head Count, where the customer and vendor agree on a fixed number of staff assigned to the customer’s work over a period, independent of the actual quantum of work. Another variation is the dedicated ODC (Offshore Development Center).

As against this, there is the Fixed Price (FP) mode, where the billing amounts and billing timelines are fixed based on an agreed value and agreed deliverables. The FP contract may have penalties and incentives built in (for delivery dates and/or  quality). Effort overruns are the problem of the vendor, and effort savings are additional profits made by the vendor. Variations of the FP model include billing by volume, quality and timeliness of work done. In such cases the vendor is usually free to utilize the staff in an optimal way (maybe on multiple projects).

Many engagements between customers and vendor organizations start off as T & M, for good reasons. However, they continue in the T & M mode, even when the FP mode would serve everyone better. This could be because of inertia, because no one wants to rock the boat, or because no one has examined the issue for that engagement.

Structurally, the T & M model does not create incentives for the vendor to initiate and pursue improvements that will reduce the effort and headcount. The software industry has got addicted to T & M model to such an extent that head count growth, and billable person-days have become stated performance objectives for senior executives in many software services organizations.

Maybe the title of this post should have been “T&M model kills process improvement”, like the changed statutory warnings on tobacco products. Or is that overstating the case?

Please feel free to share your views, experiences or queries, using the “comments” feature available at the top of this article/ post.

Notes:

Nothing Official About It! – The views presented above are in no manner reflective of the official views of any organization, community, group, institute, or association.


I am Rajesh Naik. I am an author, management consultant and trainer, helping IT and other tech companies improve their processes and performance. I also specialize in CMMI® (DEV and SVC), People CMM® and Balanced Scorecard. I am a CMMI Institute certified/ authorized Instructor and Lead Appraiser for CMMI® and People CMM®. I am available on LinkedIn and I will be glad to accept your invite. For more information please click here.

36 thoughts on “Time and Material Business Model is Injurious to Process Improvement”

  1. Quality Assurance folks have been facing the dilemma of head count billing / T&M billing and productivity improvement for a long time. I have also faced this many times. I was fortunate in some cases where Sr Manager was convinced of the benefit of productivity improvement even in a T&M engagement. After lot of persuasion some of the Project Managers agreed reluctantly to take up improvement initiatives, though many of them fell through the crack.
    In last 6-7 years I have seen some good examples in favor of productivity improvement.
    Example 1 – Suddenly a large ODC (Offshore Development Centre) of strength of 150 people with peak of 200 went into crisis. After successful running of the ODC for 6 years customer started questioning about productivity improvement and value addition. As Quality folk we did some analysis and found that the ODC manager didn’t take any initiative for improvement. Rather he concentrated his energy in increasing headcount and billing. After lot of introspection, the ODC tried to show to customer some benefits (low hanging fruits). The customer was not convinced and the ODC was closed in a span of 4 months.
    Example 2 – In another ODC, the ODC manager took up some challenges to really improve productivity, though partly due to customer pressure and contract condition. After a couple of years they could really show reduction of FTE and ultimate cost reduction. Interestingly, the customer added few more applications in the kitty and ultimate FTE increased.
    Though one or two example is not sufficient to prove the point, but any successful running engagement will have some genuine improvement initiatives. As soon as initiatives stop, you start loosing customer confidence.

    1. Thanks for coming out with this insightful article on challenges for effective PI implementation in T&M projects.we have and we are facing similar challenges.Accurate/consistent estimation is one more important factor which makes orgainisation go for T&M projects since it makes life simpler and risk taking is minimised.unlike other industries like construction/manufacturing,in IT estimations are largely based on gut feel (read as expert judgement :-)).Needless to say this makes all PI initiatives a formality and doesnt get management buyin for real bottomline improvement.

  2. Yes Agreed Rajesh, These day i have noticed that Industries peeping for T&M business model as compared to FP projects. The reason being to my understanding, The organization’s management or the Protfolio feels that providing the resources ends the responsiblity, where as in FP E2E responsibiltiy lies within the organization to dig the P&L where they foresee high risk. Coming to the point of Quality, any process improvement or a continual Improvement here would add more value in a FP project rather that a T&M or RA business model, where the scope of intervention for Quality floks itself is very limited to Juz Contract compliance, which is more focused on Commerical and statutory rather than Measurements and Metrics.

    A very good blog!!! Thanks for bringing to light!!

  3. Hi Devi,

    Thank you for your comments.

    I believe that software vendors need to quickly shift to Fixed Price/ Volume Based pricing, wherever possible for long term survival. Cost advantage alone cannot give business in the long run, as cost differentials are being reduced gradually.

    Rajesh

  4. Hi Rajesh,

    Good post !

    1. The two scenarios mentioned in the beginning are very typical of many organization.
    While the T & M billing may be one of the reasons for not doing process improvement, I think the main problem is individual/department goals handed over from top are badly aligned with.overall organizational business goals. Morever individual’s/department’s goals also conflict with one other.
    I am sure you will agree with me.

    2. Your view ” The T & M mode is suitable in many situations – e.g., when requirements are unclear and likely to change, when the customer wants to work closely with the vendor team, when the customer wants more micro control (sometimes interference), or when the customer-vendor organizations are in the initial phase of establishing a relationship.” is also very true.

    Most of the Agile projects run on T & M mode.
    But really well run Agile projects especially Scrum projects have the Retrospective process built into it, where improvement actions are identified after every Sprint and tracked to closure by the team itself. Customers also have a visibility on the improvements being made by the team, though they first need to be bought in to the Agile way of working first.

      1. Hello Rajeshnaik,

        Good Post !

        T&M mode of operations was relevant 10 years ago when we are not clear about the application / environment and also to minimize our risk on execution. It was a safe platform fo both customer and supplier. Customer often pushes for productivity (10%) i.e. reduction of FTE year on year . Also he would like to retain the same resource for long time. The problem arises here as the cost of the FTE + Infrastucture are increasing YOY.

        Locking senior resource for long is a big mistake as the FTE may also leave due to lack of motivation.

        Hence, we need to shift our gears to new way dynamic short cycle distributed process framework. All with clearly Fixed Cost. This really calls for usage of various tools to estimate and forecast effort / cost. Fixed priced project managers are very sought after as complexities are tricky.

        Process Improvement framework places a lot in this Fixed Model. Usage of Lean , Six Sigma can be effective to drive productivity.

  5. Thanks Rajesh for insight into challenges faced by T&M projects.

    My view:

    1. T&M projects are necessary during unclear / frequently changing Requirements.Also when client wants to micromanage.

    2. Shifting to Fixed cost projects would be mutually beneficial only if both the points mentioned above are no longer existing.

    3. I feel if organization tries to change to Fixed cost even if either above points persists, it would most probably lead to unhappy client or even loss of client.

    4. I agree with Gopinath that Agile (Scrum) has benefited both organization and client.

  6. Rajesh, although a lot of things you mentioned in the article makes sense, there are way to get around the challenges –

    1) Try a Hybrid model…. start off as an T&M engagement for the initial phase, which am presuming is for discovery, elaboration of the requirements – works well for both the vendor and the business since the risk of unknown is very high. But later, after the scope is clear and the estimates are arrived at, moving to FP makes sense… Again, am assuming that this is a development project. I

    2) The leadership can push for what is known in the industry as “increase the lower-tier % of the team”…. Ask the PM to figure out to staff the team in such a way that close to 40-50% of the team is made up of engineers who are less experienced that others – hence their costs to the projects is also low. Build a model which tags 3-4 freshers to an experiences lead. Let the lead coach/train/mentor the younger guys to do the work – (s)he can review the code and ensure that quality is not compromised. That way even if the team is being billed a flat blended rate, the project will still be able to do a better margin as compared to a team which is staffed with engineers all at same level. This model can be discussed with the client also – mention that the leads will focus on building the domain knowledge into the team and the engineers are focused on the technical aspects of the project work. As time passes the engineers graduate to leads and you will always have the option of moving the lead to start another critical engagement which requires all your domain & technology knowledge

    My two cents….quite literally…. 🙂

  7. In my view and experience, Agile(Scrum Methodology) execution works irrespective of the project mode(T&M or FP), although its a smooth sail in T&M mode and the PO should be willing to influence and negotiate between Team and Customer in FP to let go of lesser business value user stories. Either of the mode, the timeline(Sprint), cost(headcount and billing) and changes are all manageable by the Team via a good Sprint planning session. The PI can be defined by the Team for that Project/Release but eventually, its the delivered features that gives the credit to the Team and a happy customer.

  8. T&M is often used between a principal and an off-shore subsidiary, and that is when these conversations are heard!
    T&M is also used when the client manages your resources directly. That is not good either, but often happens. In most cases the client vets the staff too.
    The case of a project manager being punished for efficiency is really a perversion.

    What they all forget is that waste is a cardinal sin.

    Fixed Price engagements are fraught with risk in a domain where estimation is still a black art. Padded estimates are as bad as the waste you mention. It has often been put forward that the client and contractor should work together in T&M mode during the intial analysis phase, and thereafter enter into FP mode. But this is almost never the case. Maybe because Change Management is not “agile” enough to take care of changing scope and attendant changes in financials and staffing? Or the contractual terms are not flexible enough?


    Re:
    > In such cases the vendor is usually free to utilize the staff in an optimal way (maybe on multiple projects).

    I am told some clients will not tolerate this!

  9. Dear Rajesh, When we call an organization has been assessed as CMMI Level 5 (now 1.3), it is assumed that all people in that organization are capable, matured and process improvements must be way of life in that organization. As everyone in that CMMI Level 5 organization is capable enough, there was no need of a special Quality Assurance team micro-managing whether processes are followed, etc. Thus, if I award a project to CMMI Level-5 Org, I am already assured of process maturity and improvements, is that make sense?

    1. Hi Jay,

      Thank you for sharing your views.

      My post was independent of CMMI (I dont think the post mentioned CMMI or assessment or rating or maturity level 5).

      It was more about whether the T & M Model inherently promotes improvements in productivity / efficiency or the Fixed Price model is more suitable for the same.

      I apologise if my post inadvertantly gave the impression that it was refering to CMMI implementation, assessment or maturity levels.

      Best regards

      Rajesh

    2. Jay,

      I am not sure I understand your comment. How is the article related to CMMI (that too v1.3)? Is it necssary to relate everything you read, see, eat to CMMI?

      Varun

  10. Hi Rajesh, Its a very good article titled “Time and material model is injurious to process improvement”. Thanks for this. I agree with Nathan’s point of view . Just wanted to say that Many of the T&M contracts are work orders where SLA s and improvement targets may not be there and hence focus on process improvement is less. But when customer brings in reduction of FTE ‘s, then automatically there needs to be focus on improving internal processes to meet customer expectation in delivery within the available head count. Hence there can be internal process improvements aimed by way of lean six sigma tools to improve measures like productivity improvements per FTE, reducing defects, attrition which would bring in customer confidence and satisfaction would definitely in turn bring in more business from customer . Option of conversion to fixed bid becomes the next solution when customer agrees to it.

    1. Radha,

      Thank you for sharing your views.

      I agree that many T & M angagements have built-in year-on-year productivity improvement and/ or headcount reduction targets.

      However, even in such engagements, if there is an opportunity to reduce the headcount more than the target reduction (e.g., by using a different tool/ automation), there will be hesitation to implement that, as in the short and medium term it would reduce the revenue and profits. Because in a T & M model, the profits are typically directly proportional to the revenue which is based on the FTE (billed headcount).

      In a Volume Based billing/ Fixed Price billing the vendor organization would go ahead and implement the increased productivity improvement because reduction of headcount will not mean reduction of revenue, and it will definitely impact the profits positively. So, the monetary benefits of excess improvements (beyond the targets) are earned and retained by the vendor (not the customer)

      Thanks once again for sharing your views.

      best regards

      Rajesh

  11. I feel that the focus of Process improvements may be relatively more encompassing and intensive in FP engagement models than in T&M type of engagements.

    Many organizations do undertake Process improvements in T&M engagement models due to a combination of external and internal driven forces.

    Externally focused improvements-

    -Productivity dimension: Customer enforced producivity gains..requirement for year on year reduction in head count or doing more with the same.

    -Quality dimension- quality of delivery being a driver of customer perception, improvement initiatives related to accuracy/defect leakage reductions are generally prevalent.

    -Innovations to demonstrate Value adds in order to renew existing contracts

    Internally focused improvements are mostly focused on the people dimension of capability building- Cross training/Upskilling, New Hire recruitment and ramp up processes to maintain the pyramid and scaling strategy, New L&D Programs to expand portfolio of offerings or go an inch up the value chain, etc.

    Regards
    Prakash

  12. Impressive post Rajesh….

    Big question is where does the buk stop? Who has to act on this anomaly?

    PM, SQA, SEPG Manager, Black Belt, Department Head, CEO? or
    Customer, Integrator, Government, NASSCOM, SEI?

    1. Hi Channaveer,

      I am not sure that the buck has to be handed over to any one party/ person.

      Basically, if people in the customer and vendor organizations are aware, then they will shift over to the most suitable model for a given situation. So, this issue (should we change the billing model?) can be part of the annual contract review in all long standing contracts.

      Also, consultants and LAs can also point out places where the business model is creating misalignments.

      I don’t think the Government, NASSCOM or SEI (or CMMI Institute) have any role to play. They have their plates full with other things.

      regards

      Rajesh

  13. Thanks Rajesh for this interesting post. With this correlation between process improvement and nature of engagement, can we make an inference that if we need to do process improvement in T&M engagement, the scope of process improvement should include customer organization as well

  14. Good Rajesh,
    Frankly, its not always the vendor’s fault. As you mentioned, the client side managers should also be willing to get to a good estimate and then go in for FP basis. Maybe they are not too sure of the costs (at any point in time) so are well settled to work in T & M basis.

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