Once you decide to outsource software development, choosing the right type of pricing
contract is the first challenge you’ll face as a client. Usually, outsourcing companies
offer three main contracts: Fixed Price, Time and Materials, and Scope Based Model. Each of
them has its pros and cons so there is no one-size-fits-all choice that would suit in all
instances.
To help you make a wise decision, we’ll outline the main differences between fixed price, time and material, scope based model to give you some hints on which one to choose depending on the specifics of your project.
Fixed Price Model Advantages and Disadvantages
This pricing model of a fixed-price contract makes a service provider and a client set the
fixed costs, the project scope, and the determined deadlines in advance, and none of these
parameters can be changed after the agreement is signed. To make accurate estimations,
programmers need to have a clear vision of a final product before the first line of code is
even written. If a client decides to add some features, all the terms, including the set
price, amount of work, and timeline, are to be negotiated separately.
For instance, a fixed-price contract is a perfect solution for a consulting firm when customers
perform work that requires a quick turnaround.
Advantages:
- Fixed costs. When clients go with fixed-price contracts, an outsourcing company cannot charge additional fees even if programmers spent more time on developing than was initially estimated.
- Predictability. A project development process is well-planned and a client knows the release date and total cost of the project from the very beginning. This simplifies project management for all parties to a fixed-price agreement.
- Easy monitoring. Since there is a clear plan and a fixed budget, a client can monitor the progress and see if everything is done on time without being deeply involved in the work process.
Disadvantages:
- Not flexible. It’s hard to adjust a fixed-price contract to the new requirements or market conditions. Usually, any changes require signing a separate agreement.
- Long planning process. Since a service provider needs to understand all the requirements beforehand in a fixed-price model, everything must be discussed in detail, so planning takes much time.
- Risk of overpayment. If the initial estimation is wrong in a fixed-price agreement and a team completes the work earlier than expected, a client pays more than the product actually costs.
Hence, a fixed-price pricing model works well only for short-term projects and some MVPs, i.e. when it’s possible to define all the requirements and accurately estimate everything in advance. In all other instances, this contract type is beneficial neither for a client nor for a development team. That’s why fixed-price projects are not very popular today.
Time and Materials Contract Pros and Cons
In the software development world, the fixed price vs time and materials clash is a
never-ending dispute.
Under the time and material contract, a client is charged for actual time programmers spent working
on the project. All the payments are calculated based on the hourly rate of developers and made
on a regular basis — usually at the end of a month or some other predefined period.
At the same time, a client is free to modify the scope of the project and requirements during
the development process if, for example, some features have become irrelevant, stakeholders changed
their minds, or a company set new priorities.
Like all other pricing models in software development services, time and material agreements
have their pros and cons.
Advantages:
- Flexibility. Unlike with fixed-price contracts, new ideas in the T&M model may be easily incorporated at any time. Features may be added or removed. All unpredictable challenges are resolved as they occur. This is the main reason why businesses choose this pricing model in a time and materials vs fixed price battle.
- Relevant solution. Since the project requirements are being constantly adjusted to the new conditions, in the end, a client gets the relevant product highly tailored to its current business needs.
- No risk of the wrong estimation. When a client opts for time and materials, developers spend as much time as needed to build a high-quality solution and the client pays for actual development hours, so the risk of overestimation/underestimation is eliminated.
- Quick start. With the time and material contract, programmers don’t need to have detailed written specifications beforehand, so they can start coding right away.
Disadvantages:
- Unfixed budget. The final cost of a project cannot be determined in advance if you go with time and materials.
- Uncertain deadlines. As the scope of work is subject to change, it’s impossible to predict the exact release date.
- Proactive client’s involvement. Important decisions have to be made throughout the development process, so a client must be involved all the time.
Summing up, a Time and Materials pricing model is considered the most optimal choice for different types of software development projects, except for small-size projects with predictable requirements. The reason is that nowadays the new technologies are evolving quite rapidly and it’s just impossible to anticipate all factors that will affect the development process at the very beginning.
Scope Based (per milestone) Pricing Model
In this model, a client and development team define milestones iteratively, i.e. the next one is discussed and planned after the previous one is completed. A client approves the deliverables at the end of each milestone and makes the relevant payment only after that. An outsourcing company calculates the amount of money to be charged based on the number of hours developers spent to achieve a milestone goal.
Advantages:
- Control over the scope and progress. In this type of pricing, a client knows exactly what piece of functionality is being developed and what results to expect at the end of each milestone.
- Results-based payments. A client pays only after the milestone goal is achieved and the results are approved.
- No risk of the wrong estimation. Like in the T&M model, all payments are calculated based on the actual time spent on development.
Disadvantages:
- Unfixed budget and deadlines. A client doesn’t know beforehand how much time and money the development of each piece of functionality will take.
- Risk of disputes. If the criteria for a milestone goal are poorly defined, there is a high risk of disputes between a client and a software development company.
All things considered, Scope Based model may be applied to the development of complex solutions which are to be built gradually. It’s also a good fit for agile development processes. However, the mandatory prerequisite must be long-term and trusted relationships between a client and its IT outsourcing partner.
When can you choose a fixed-price contract?
Your organization should choose a fixed price model in the following cases:
- A project is small or medium-sized, or you want to build an MVP
- You can clearly determine your needs and expectations and explain them to software engineers. Thus, you have to outline the user’s path appropriately and understand how to write user stories.
- A fixed-price project is an option when your requirements will not change.
- You do not have enough time to conduct meeting sessions with developers.
- A fixed price model is perfect when there is a low risk of development issues. So, your development team can control all the services provided.
- Your company has a limited budget, or you should have to approve your project budget in advance.
- You have no interest in the required time, only in deliverables. Thus, projects with a fixed budget can often finish faster. However, compared to the time and material contract, you have to pay the estimated amount for your service provider.
When should you choose a T&M contact?
After considering the time and materials contract pros and cons, you can select this model in the following scenarios:
- Your organization works on complicated or long-term projects;
- Compared to the fixed price and time model, you have only a basic description of your future product. Actually, you do not understand its full scope, so it is impossible to define a final payment.
- Your requirements will likely change, which is typical for larger projects. Thus, you should be ready to pay additional costs.
- Analyzing fixed price vs t&m, the second option means that you aim to control your product creation and development process.
- Your company requires maximum possible flexibility.
- Comparing fixed cost vs time and materials, the second option will make you pay for spent time only.
Comparison: Time and Material vs Fixed Price vs Scope-Based
So, you have already learned all the critical pros and cons of available models. Here, we will provide a brief comparison of fixed fee vs time and materials vs scope-based approaches.
Software requirements
- Fixed price contract. The requirements are defined at the beginning of the project. So, all estimates are made depending on them.
- Time and materials contract. The requirements for the minimum viable product (MVP) are defined at the start. You can break the MVP down thanks to User Stories. Also, the requirements may evolve during the software development process.
- Scope-based contract. In a scope based contract, milestones are defined iteratively. Thus, clients and dev teams discuss and plan a new milestone after completing the previous one.
Resource estimation
- Fixed price contract. The resource estimation for the whole project is performed beforehand. Depending on the designed Wireframes, the client and the development team define the number of resources at each project phase.
- Time and materials contract. The resource requirements can be different depending on the user stories and emerging changes. Comparing time and materials vs fixed fee, the first can have extended resource requirements due to a complex delivery.
- Scope-based contract. Compared to the fixed price contract and time and material contract, the resource estimation in a scope based model is also conducted iteratively.
Budget
- Fixed price contract. Using a fixed price contract, the amount of money spent on the entire product development is estimated after defining requirements. But the cost can be revisited when introducing changes.
- Time and materials contract. Analyzing the time and materials contract vs fixed price, the client’s budget estimation in the first case depends on the efforts and resources estimation necessary to complete each user story.
- Scope-based contract. Comparing a scope based model vs time and material vs fixed price, the first requires clients to approve the deliverable when each milestone is completed and make a relevant payment.
Development model
- Fixed price contract. Compared to the time and materials contract, a fixed price model prefers a standard Waterfall methodology. That is because it provides the required predictability. But in some cases, iterations can also take place.
- Time and materials contract. Considering fixed price vs time and materials, the second one can work with either a Waterfall model or Agile.
- Scope-based contract. A scope based model is a perfect match for Agile software development processes.
Change management
- Fixed price contract. You cannot accommodate changes with this model. But some companies can initially agree on the cost of each potential change.
- Time and materials contract. In the time and materials contract, change requests are accommodated easily. That is because resources and timelines are flexible enough, so you can adjust them depending on the required course.
- Scope-based contract. Comparing a scope based model vs time and materials vs fixed price, the first and the second options have similar features. Here, you can also accommodate changes easily.
Timelines
- Fixed price contract. In a fixed price contract, the timelines for a software development process are predefined. So, the development firm has to follow them since it is required by the contract.
- Time and materials contract. In the time and materials contract, the company and its client define timelines for each individual iteration.
- Scope-based contract. In the case of a scope based approach vs fixed price vs time and material, the first option means that clients do not know beforehand the amount of time necessary for developing each function.
Putting it all together
The choice between time and material vs fixed price vs scope-based models must always depend on the nature of a project. In short, the Time and Material model should be your default option. Fixed-price contracts fit well only a limited number of short-term software projects when all the payment terms may be determined in advance. And Scope Based Model will bring the expected results only if you trust your developers and have established business relationships with them.