Time-and-Materials vs Fixed Price: Which to Choose for Your Project?
Initial outsourcing agreements were traditionally built upon a fixed price model, though nowadays there is another abundantly used business model, namely time-and-material. Selecting the right pricing contract can become a tricky problem because it should fit your company’s operating procedure, contracted requirements and goals, as well as general expenses borne by the vendor.
These software development pricing models are the most common and time-proven; however, it is worth noting that today companies also apply their hybrids and combinations. In this article, we will review the pros and cons of time and materials vs fixed price contracts and their practical use for software projects.
Fixed price vs time and materials: the basics
The fixed-price agreement is a single-sum contract where a service provider is accountable for completing the project within the agreed sum set out in the bond. It can be an effective choice in those cases when requirements, specifications, and rates are highly predictable, elsewise the cost will be anything but constant. A client should be able to share his clear vision of the product with developers to ensure appropriate final results.
When to use a fixed price contract:
- Clear requirements and determined deadlines;
- Limited or fixed budget;
- Small projects with the limited project scope.
Time and material (T&M) contract is absolutely different. It presupposes billing clients for actual work scope based on hourly rates of labor. Customers are charged for the amount of hours spent on a specific project, plus costs of materials. The main advantage of T&M model is flexibility and opportunity to adjust requirements, shift directions, replace features, and involve users to get the very product.
When to use T&M price contract:
- Long-term projects with dynamic requirements;
- Project scope is not yet fully known;
- You want the flexibility to modify the scope or vary the workloads.
Fixed price agreement vs. time and material contract advantages and disadvantages:
Lump Sum benefits:
- Predictability is the core factor that any entrepreneur seeks for in business. Company strategy usually requires clear deadlines and figures to be transferred to the budget. Planning expenses for 1–3 months ahead can provide you with exact figures. However, if product development will last for 4 months and more, it is only natural that you can hardly foresee overall outlays and in such cases other price models are advisable.
- Transparency. With specified requirements, fixed budget and pre-arranged deadlines — there won’t be any surprises. Regular project management interaction with the contractor ensures scope compliance and protects margins.
- Ease of management. Payments to the service provider are mainly based on a percentage of work performed. Such workflow requires little involvement since expectations are transparent and predictable.
- Lack of flexibility is the major weak point of fixed-fee agreement. As a customer, you are responsible for any emergent changes that you’ve initialized or those ones that are beyond the vendor’s competence.
- Less accountability can be referred to as both pros and cons, depending upon each particular case. Such an approach doesn’t comprise regular reports and interactions between the customer and team. All the management is mainly carried out by the team member, so you don’t have to allocate timeslots for deep project involvement. Nevertheless, it doesn’t mean that you’ll be in the dark about the workflow.
- Flexibility. Unit-price contracts allow businesses to modify the volume of work, revise materials or designs, shift the focus or change features following the project implementation.
- Dynamic work scope is one of the key features within larger projects. There can be a general goal that should be achieved, however knowing how it’ll be reached is not that important beforehand. Often for startups and mid-sized companies, it is better to make decisions in the process, evolving a strategy and building custom software simultaneously. Such approach underlies Agile methodology.
- Better timing. Avoiding fixed-price bidding process helps to save time and start immediately. Moreover, blended rates allow you to see how much time the team spends on each feature and commit, and so motivate it to work more efficiently.
- Low budgeting control is the main disadvantage of a T&M contract. The overall cost can go far beyond the expected budget.
- Deep involvement is required from you to make sure that the team is delivering toward the approved scope and within the correct amount of hours.
In recent times outsourcing has grown from a fairly straightforward concept to a complicated aggregation of various options and patterns. In this complex chain, price model is just another configuration that business owners should get right and manage properly. Pricing framework that worked well for a particular organization and with a certain vendor may not necessarily be the best choice for your startup.
Considering the foregoing t&m vs fixed price model comparison, it is essential to weigh all the strengths and weaknesses of each contract type and how they can fit in your project.