Each company starting cooperation with a software house has to make a critical choice regarding the best contracting model. Two cooperation models most often used in software development are “Fixed Price” and “Time & Material”. Because they are significantly different, you should understand their specifics to be able to choose an option that will allow you to adjust the budget and work schedule to the specifics of the project.
The decision on which pricing model to choose is of key importance not only in the financial aspect but also affects the building of positive and long-term business relationships between the software house and the client.
In this article, we will discuss the differences between these models, the pros and cons for the client depending on the type of project, and the factors that must be considered when deciding on one of the contract models.
What is the Fixed Price pricing model in cooperation with a software house
Contract in the Fixed Price model is based on setting the price in advance for the complete product or its part. Most often, it is used in a situation where the client is able to specify how exactly the created product should look. Fixed Price contract requires the preparation of precise functional specifications and business requirements, as well as a strictly defined schedule, that is necessary to start working on the project and is used as a base to determine the project budget.
A few important factors to consider from the customer’s perspective, unique for Fixed Price contracts:
- Projects contracted in the Fixed Price model are easier to manage for the client because they do not require him to be constantly involved. In many cases, the biggest effort is needed before the contract is signed, to specify all the requirements, and later to control the final delivered product.
- Cooperation on the project in this model requires the most accurate estimation of the scope of work to avoid a situation in which the software house will underestimate or overestimate the final budget, unable to calculate all costs precisely enough.
- Knowing the exact project budget, the client can plan expenses in advance. This is crucial for projects where the budget is limited and cannot be easily modified, for example in the case of many projects in the public sector.
- Any modification of the project scope during the works requires amendments to the contract and an update of the budget.
- In order to properly define project requirements, the customer must have specialist knowledge regarding the creation of digital products, or use the services of consultants who will help in the preparation of the detailed specification.
The main pros and cons of the Fixed Price pricing model for the client, which are worth considering, include:
|Advantages of the Fixed Price model||Disadvantages of the Fixed Price model|
|budget is determined before the start of work||lack of flexibility in the software development process|
|a strictly defined schedule that allows planning expenses during the entire project||few software houses want to agree on the Fixed Price model for long, complex projects, which may make it difficult to find the right partner|
|requires little to no involvement on the client’s side after the project launch||the need to provide precise requirements before starting work on the project|
|the customer knows from the beginning what product he will receive, based on his requirements||if the requirements are incorrectly specified, the final software may not meet the customer’s expectations|
Depending on the specificity of the client and the project, the advantages and disadvantages of the Fixed Price model will have different significance. For example, the ability to set an accurate budget before the start of the cooperation will be crucial for customers from the public sector, while companies operating in other industries can afford greater flexibility in this aspect. Because of this, when looking for software suppliers, they can also consider starting cooperation with a software house based on the Time & Material contract.
What is the Time & Material pricing model in software development
In the case of this contract type, the Customer bears the costs of the team’s hourly rates and additional resources necessary to build the software. Since a full project specification is not necessary to start cooperation with a software house, the Time & Material model is often chosen by customers who, for various reasons, cannot determine the final shape and all functionalities of the ordered software so early.
Before starting work, the client knows the estimated cost of the project, and the final price may change, depending on how the scope of the work changes.
A few important factors to consider from the customer’s perspective, unique for Time & Material contracts:
- Projects contracted in the Time & Material model require the client’s active involvement throughout the entire process, not only to the extent necessary to best plan the final functionalities of the product, but above all to assess the effects of work within each of the completed billing periods.
- The software development process in the Time & Material model is very flexible, and allows for ongoing modification of the scope of work and implementation of new functionalities. This affects the cost of the project and the time of its development but does not require changes in the agreements binding the client and the software house.
- The possibility of avoiding the need to specify the full scope of work within the project at the beginning allows for its faster start, which may be important for some clients.
- The Time & Material model allows for dynamic project budget management and adjustment of current expenses to the client’s capabilities.
- High flexibility can be a risk when the client’s team lacks a person who can verify what modifications and functions are really unnecessary because they will not translate into business results. In such a situation, a reliable software house will be invaluable support, by giving advice, not just adding new tasks to the list.
The main pros and cons of the Time & Material pricing model for the client, which are worth considering, include:
|Advantages of the Time & Material model||Disadvantages of the Time & Material model|
|the ability to start cooperation quickly, without the need to prepare a detailed specification||requires a lot of commitment on the part of the client and competencies allowing for the assessment of the delivered effects|
|possibility of dynamic budget planning depending on the current situation of the customer||starting works based on an estimated cost makes it difficult to plan the budget in the long term and may result in a higher final cost resulting from decisions made during the works|
|high flexibility in adding new functions in the course of work and reacting to unforeseen changes on an ongoing basis||uncertainty as to the date of product delivery, depending on the changing scope of work|
|the ability to continuously monitor the progress of work and provide comments on an ongoing basis|
The same as in the case of the advantages and disadvantages of the Fixed Price model, in the Time & Material contract, what for one client will disqualify a software house may be of much less importance for another customer.
If you have a problem with assessing which model will be the most optimal in the case of your project, we encourage you to contact our consultants who will advise you on the most optimal solution.
Detailed comparison of Fixed Price and Time & Material pricing models
One of the characteristics of the software development process is the inability to predict and plan all the variables. There are so many factors at play, both on the part of the client and the software house, that there is no single, universal contract model that would fit every project.
Simply listing the most frequently cited advantages and disadvantages of cooperation in the Fixed Price and Time & Material models might not be enough to determine which will be the most optimal for your project.
A detailed comparison of both models of cooperation, which we have prepared based on our experience, may prove helpful in this respect:
|Fixed Price model||Time & Material model|
|Software requirements specification||Necessary to start work, it does not change during the project and is the basis for the final budget calculation||It can be created as the software is developed, it is not permanent and evolves with the development of the project.|
|Software development cost||Determined on the basis of a closed specification, it cannot increase during the project, except in strictly defined cases, specified in the contract.||It is not precisely defined at the beginning of the project; it changes depending on the amount of work required at each stage. It may exceed the estimated budget when the final product significantly differs in terms of functionality and complexity from the initial assumptions.|
|Project timeframe||Strictly defined in the contract, both as a strict deadline for final product delivery, and in the case of division of works into stages. They are binding and cannot be modified without the consent of both parties and amending the contract.||The final deadline is estimated and it ultimately depends on the direction of project development. The works are divided into billing periods, the length of which is agreed upon individually between the supplier and the customer.|
|Project size||Any, but in medium and large projects, it is more difficult to find an experienced software house to properly estimate the risk margin without overestimating the budget.||Any.|
|Project start||Delayed, subject to the collection of all information necessary to prepare detailed specifications and budgets.||Immediate, thanks to the ability to define the scope of work during the project.|
|Type of necessary involvement of the client during the project||The client is involved in the project by specifying the requirements and acceptance of the completed works, however, he does not need to have knowledge about the work methodology and task prioritization.||High. The client actively participates in the work, both by accepting the results delivered in individual iterations and deciding on the scope of work at subsequent stages. At the same time, he must have knowledge of the manufacturing process and task prioritization.|
|Ability to make changes to the project||Limited. Each change requires consultations on both sides, preparation of a new valuation, and amendment of the contract.||Significant. The customer can decide on major changes at virtually every stage, and the only limitation is the amount of additional billed hours that he is willing to accept.|
When looking for a software supplier and analyzing the offers received, we should focus on those software houses that are willing to adapt the project contracting model to the specificity of the customer.
Often, during consultations with our clients, we hear that many suppliers are not even willing to consider projects in the Fixed Price pricing model, proposing cooperation only in the Time & Material contract. While in the case of some projects this may actually be the best contracting model, it is certainly not universal and for some industries or types of software, it is not optimal from the customer’s point of view.
One of the reasons for such favoring of the Time & Material pricing model by the software house is, especially in the case of large projects, the lack of experience in optimal estimation of the risk margin. As a result, the project budget may be too low to protect the supplier in the event of unexpected complications or too high from the client’s point of view when the margin of error is overestimated.
For this reason, it is common to believe that in the case of a Fixed Price contract, the client does not receive the lowest possible offer, while in fact less control over the budget in the Time & Material model may result in a much higher final cost of the project.
Thanks to many years of experience in software development projects both in the Fixed Price and Time & Material models, regardless of their size, we are one of the few suppliers able to guarantee the client that the method of pricing proposed by us will be the most optimal for each project.
This is possible thanks to our commitment as a partner supporting the project, not just a contractor. We approach each inquiry individually, taking care to get to know the specifics of the client’s business, in-depth analysis of his needs and limitations, and understanding of business goals. Thanks to this knowledge, we are able to propose the most fitting project pricing model in a given situation.
Contact our consultants to find out what type of pricing model will be best for your project.
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