Why a Fixed-Price Contract Is a Bad Idea for Your Project?

A fixed-price contract means that a client and an outsourcing company agree on the final budget, deadlines, and scope of a project in advance. The high level of predictability has created a popular misconception that this type of cooperation model is the most advantageous for the client side. Yet, it’s not quite true.

Calculating all costs upfront makes sense for some short-term projects. But it’s often just a guessing game when it comes to building more complex solutions. In this article, we’ll outline fixed-price contract pros and cons. In particular, we’ll discuss the main risks of fixing the price in software development and talk about the key reasons why businesses choose this type of contract.

Benefits of fixed-priced contracts

Like any other contract type, fixed-price contracts have both advantages and downsides. Let’s take a closer look at benefits businesses expect to receive when they go with a firm fixed price in software development agreements:

• Fixed scope of work. If you opt for a fixed-price project, you’ll agree the scope of work with a development team at the beginning of your cooperation, and it won’t be subject to any changes later on.
• Foreseeable total costs. In a fixed-price contract, you know the exact contract price at the moment the agreement is signed. You don’t have this advantage in a time and material model, where you can control costs as the product development process progresses but don’t know the total amount till the product is released.
• Well-defined process. When choosing a fixed-price contract, you get the full roadmap showing how developers will perform the work from the moment the first line of code is written to the moment a full-fledged product is delivered to you. It means you’ll know all deadlines and milestones, so project management will be much easier.

While fixed-price contracts offer certain advantages over time and material agreements, they certainly have many drawbacks as well. So let’s talk about the reasons why signing a fixed-price contract with a development team is a bad idea.

Many clients insist on setting the budget before a project starts because they know exactly how the final product should look like. Or, better to say, they think they know it. But, in fact, it’s a mere delusion. In software development projects, there is always a factor of requirements volatility. It means that market conditions and user expectations will inevitably change. And if the feature prioritization is not adjusted to these changes, the project will likely fail.

Problems with fixed-priced contracts

As mentioned, a fixed-price contract provides a high level of predictability. However, the disadvantages of this type of contract significantly overweight its benefits. Here’s why this cooperation model is much worse than time and material agreements.

No flexibility

Many clients insist on setting the budget before a project starts because they know exactly how the final product should look like. Or, better to say, they think they know it. But, in fact, it’s a mere delusion. In software development projects, there is always a factor of requirements volatility. It means that market conditions and user expectations will inevitably change. And if performing a contract is prioritized over market demands and the features are not adjusted to these changes, the project will likely fail.

At the same time, the parties are usually reluctant to amend a fixed-price contract since most new terms require signing another agreement and lead to additional costs. That’s why developers usually try to build a product that was defined at the very beginning rather than the best product possible. As you may guess, such an approach rarely ends up with project success.

Not a fair price

A fixed price doesn’t mean a fair price. In a fixed-price model, programmers must estimate the work when they have minimum knowledge about a product. So even if a coding team acts in good faith and does its best, odds are their quote will be unrealistic. For instance, it will be hard for developers to accurately quote the functionality that is unknown to them. Neither is it possible to provide the estimation for the changes which will be required due to some future circumstances.

Basically, this means that the price mentioned in a contract won’t be fair either way. Specifically, if it takes developers less time to complete the work than it was originally expected, a client will overpay. On the other hand, an outsourcing company may earn nothing or even have some financial losses if it underestimates the project. In such a case, a client will suffer as well – a product will doubtedly have a high quality since it is created in a rush.

Long time to market

As nothing can be changed during the process, programmers need to get a clear vision of a product before they start coding. That’s why even the smallest aspects must be discussed in advance. Ideally, all features should be also described in a written form in software requirement specifications (SRS). Such planning activities usually significantly prolongate the time to market.

To compare, parties to the Time & Materials contract, another popular pricing model, should only agree on the first piece of product functionality. Since the requirements may be tweaked at any time, developers may commence the work right away.

Costly maintenance

You can buy utensils once and then use them for ages. But software solutions aren’t anything like this. New technologies are evolving at a rapid pace so websites and mobile apps need constant maintenance. This, of course, refers to all digital products created under different cooperation models. However, the solutions built according to a fixed-price arrangement will require updates faster and they will probably more expensive.

The reason is obvious. As we’ve already mentioned, such solutions are developed according to predefined requirements without taking into account current conditions. To become relevant, they have to be upgraded not long after the initial release. Also, if the quality was compromised due to a wrong estimation of the project, further maintenance will be more complex and, thus, more expensive.

Ineffective cooperation

To complete a project successfully, a client and a development team must be on the same page. But it’s not the case of a fixed-price contract. Every party in this type of arrangement has its own interests which often contradict the interests of another party. In particular, a client wants to receive a top-notch product at the price fixed in a contract. At the same time, developers usually just want to tick the boxes on the feature list.

As all the participants of a project treat it differently, a fixed-priced model doesn’t work well in terms of transparency, communication, and overall cooperation. A coding team isn’t interested in disclosing to a client any issues discovered during the development process. At the same time, a client is motivated to get as much as possible without increasing the price.

Putting it all together

Many clients like fixed-price contracts because they think setting all terms upfront brings them a lot of benefits. But, in practice, there are more cons than pros in this type of cooperation model. Specifically, it doesn’t allow for flexibility so a client cannot change the requirements after the agreement is signed. In addition, the unfair price may result in overpricing or compromised quality. Along with the long planning process, ineffective cooperation, and expensive maintenance, these downsides make a fixed-price model not the best choice for software development.