When starting a partnership for outsourcing a software project, one of the most important decisions to make is to select the contract model.
The two most common software development pricing models are Fixed Price and Time and Materials. Both of them have their pros and cons and their particular scenarios where it is better to use one or the other.
Choosing the right contract is very significant as that increases the probabilities of getting the best end results. However, selecting one could be a complicated task as what works in one project may not be the best option for another one.
Making the correct choice can become the foundation of your success (or failure), so let’s compare and review each pricing model, their pros and cons, and when to use them.
1. Fixed Price
This agreement is a steady sum contract, where the service provider is responsible for finishing the project within that agreed sum.
This pricing contract is based on an estimate of the amount of work that is needed in order to finish the project. That means that all the requirements need to be written and fully specified in order to define the scope of work. Any extra work, and by extra, I mean anything that was not originally specified, needs to go into an additional contract.
In this model, the budget is approved before any development work starts, and as long as the scope of work is not modified, it is guaranteed that it will also remain fixed. All the deadlines are also defined and fixed at the beginning.
If you are working your software solution with this type of contract, it is quite important to have as much preliminary discussion as possible to completely understand and estimate all the work.
Here are some of the advantages of the Fixed Price model:
- Predicted budget: Before starting any work, you know exactly how much it will cost. This is probably the main advantage for the client.
- Predicted timeline and deadlines: As everything is defined, the development team can provide a very detailed plan with specific deadlines.
- Minimal management: Given that all the details are specified beforehand, little to minimum supervision and control is needed on the client side.
These are some cons when choosing a Fixed Price model:
- Lack of flexibility: After the contract is signed, there is no place for changes. The scope of the project cannot be adjusted, so if you want to add a new feature, or if you identify that some functionality would be better if implemented in a different way, it is impossible to adjust that as part of the original contract. All those changes need to be analyzed, estimated, and negotiated separately.
- Communication risks: If a functionality is not clearly communicated, there is always a risk that the final result is not what the client was expecting. That could happen if the project specifications are ambiguous; what is clear for the client could be understood differently by the provider.
- Lengthy planning: As everything needs to be completely understood, and every detail needs to be evaluated before starting, the planning phase usually takes a long time.
- Risk of overpayment: This is not always the case, but given the fact that the service provider needs to evaluate all possible pitfalls and risks that the project could face, those are included as extra development hours just in case those risks happen.
WHEN TO CHOOSE FIXED PRICE
A Fixed Price model could be a good option in the following scenarios:
- You have all the project requirements very clear, fully understood, and very unlikely to change.
- Flexibility is not needed.
- You have limited or fixed budget.
- You have deadlines to accomplish.
- You have a small project with specific features.
- You are building an MVP.
Content related: Why you need to have a minimum viable product (MVP)
2. Time & Materials
This agreement consists of a routine paying for work based on hourly or monthly rates of labor. Clients get a dedicated development team set up for them, and they are billed for the number of hours spent on the software solution.
With this billing contract type, the client plays a more important role during the development of the project as he/she carries all risks related with the scope, something that does not happen with a Fixed Price contract.
The estimation of the scope of work and the deadlines are loose, but the client gets the opportunity to modify, add, or remove as many functionalities as he/she wants, adapt requirements, or totally change direction if necessary. In short, do anything that is needed in order to get the exact results he/she wants.
These are some of the most important advantages you get when using a T&M model:
- Flexibility: This is definitely THE main advantage you get when selecting a T&M model. During the development of the product, you can easily make all the changes to features and scope of work you may need. This is also quite compatible with Agile principles.
- Fast start: As there is no need to discuss, evaluate, and analyze every single detail before starting, you can begin getting results almost immediately.
- Visibility: The client gets a working version of the product at the end of each iteration. If something was misunderstood, this can be corrected without waiting for the final delivery. That means the client gets a software solution that meets expectations. There are no surprises.
- No extra payments: The service provider has no need to add extra hours to the estimates to cope with the worst-case scenarios that could happen. You pay for the actual work done.
- Better quality: The development team is not limited to a tight timeline or budget, so they feel freer to offer the best technical solution they can achieve, which results in a better final quality for the product.
Although T&M seems to be a great deal, there are some flaws we need to take into account:
- Undefined budget: The final price for the project is based on a ballpark estimate; therefore, the client does not know exactly how much money will be spent on it. As the scope of the project evolves, so do the costs.
- Uncertain deadline: Any changes done to the scope of work will logically alter the deadlines originally defined.
WHEN TO CHOOSE T&M
A Time and Material pricing model could be a good choice in these situations:
- You need flexibility to change the requirements and the scope of work.
- The project functionality is not fully known.
- You have long-term projects.
Do not miss the interview with our PM, Eric Delahaye, where he talks about whether or not the ideal contract exists.
To Sum Up
Having seen the characteristics of Fixed Price and Time & Materials contracting models in software development, we have noticed that each has its advantages and disadvantages. There is no silver bullet and absolute answer when choosing the perfect model for your project. Just do not forget that what worked fine in the past may not fit well for your next software solution.
As a client, you should choose the pricing model based on the nature of project you have, your budget, how flexible you want to be, how defined your requirements are, and then by evaluating and weighing all the strengths and weaknesses of each type, you are able to see which one works best given those particularities.
If you are still not sure which model to choose, you can even start a small pilot project using Fixed Price to evaluate the capabilities of your software development partner. Once you feel more comfortable working together, and you both have the level of trust and good communication that is so essential, you move to a Time & Materials model. In that way, you can get the benefits from both worlds.
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