Why Hourly Rate App Development Beats Fixed Price
Choosing between Fixed Priced and Hourly Rate (also known as Time and Material) contract is an important decision you need to make when starting a project. Some development agencies offer both types, while others agree on one of the two. There are many discussions on which contract type is the best for software development and design.
Let me explain why at EL Passion we decided to bill by the hour. In this article I’ll try to compare the two types of contracts, so you can make an informed decision which one fits you best.
Flexible Scope gives you freedom to create and pivot
There are two main software development approaches — Agile and Waterfall. The choice between the two should already help you decide which pricing is best for you. Agile works best with time and material while Waterfall mostly on fixed price.
Being Agile means being flexible in the scope of work. Nobody has all the answers before an MVP is launched and feedback gathered. You want to deliver what’s best for the market you’re aiming for, learning while you build. Agile allows you to align the new goals with additional information. You don’t have to pay for anything upfront.
Waterfall on the other hand keeps the time and scope fixed to predict the total price upfront. It assumes the Product Owner knows exactly what needs to be built. This is usually not the case in software development and dynamic startup nature.
If you want to easily adjust the requirements and focus of your product, working with a team that charges by the hour might be your best option.
Start with a simple contract
Time and material contracts are most often really short and simple. There are a couple of things that they usually include: the hourly rate, the Intellectual Property ownership clause (stating you are the owner of the code) and terms of payment. You don’t need an army of lawyers to understand the contract. As an example, our contract at EL Passion is only one page long. These contracts do not include the scope of work. You, as a Product Owner, are free to change the scope during the project without any paperwork. You communicate with the development team and decide on the priorities of tasks.
Fixed priced contracts, due to fixed project scope, require extremely detailed description of what has to be delivered. You need to be really careful to cover everything you want and include it in the scope. Any changes usually result in time consuming renegotiations of the contract, estimating additional requirements and changing the price.
If you prefer to invest your time and budget on actual software development instead of lawyers and contract negotiations, the time and material contract might be your pick.
With hourly rate the contractor has no incentives to lower the quality of your project
Working on time and material means that the contractor will be reimbursed accordingly to how much time they spend on the project. They have no incentives to take shortcuts and let the quality suffer. They realise it is important to keep the code quality high and deliver exactly what’s needed. You as a Product Owner decide if speed or quality is key for the project.
In fixed price projects, the contractor will receive a fixed amount of money, no matter how much time they spend on the project. The less time they invest the higher the profit. This can result in poor code quality and deliverables not matching your expectations. The product specification attached to the contract usually has space for discussion, no matter how precise it is. Keeping the code quality high is hard to include in the specs.
If you want to align your goals (be it speed or quality) you should decide on a time and material contract. This is the only option that does not incentivise the contractor to invest the least resources possible to maximize their profit.
Pick what’s good for your budget
With a time and material contract, taking care of the budget is the responsibility of the Product Owner. Most app development agencies will provide you with an estimation of the time required to deliver your project based on the initial scope. The requirements at this stage are usually preliminary and so is the estimation. It should give you an idea of what to expect in terms of time and budget needed, but at the end it is all up to you.
You as a Product Owner are in frequent contact with your dedicated development team. You plan each sprint together and modify the scope to fit your priorities. If keeping the budget is on the top of your list, you will decide with the team what you can do to deliver within the specified budget. You decide on the tradeoff between scope and cost. No matter what decision you make you will only pay for the time spent on the project.
With fixed priced projects you know the budget upfront. As development projects are impossible to predict accurately, the vendor has to include the risk of project taking longer than expected into account when proposing a quote. This means you pay a premium for agreeing on a fixed fee for the services.
Fixed price may seem like a better choice concerning the budget, however someone must cover the costs of the risk of project taking longer than expected. Keep in mind that it’s usually the client. If you prefer to only pay for the actual time spent on the project choose a time and material contract.
Fair and transparent development process is key
Transparency is key in time and material projects. You need to know what the invoice covers and what has been done during that time to be sure the amount stated is fair. Most development companies working on time and material will provide you with a report stating how much time was spent on each task.
At EL Passion we give our clients access to an internal tracking system, where our developers note what they are working on. Working Agile, you additionally get an update on what has been done every day during standups with the dev team. You also see the progress after each weekly sprint, so you are always up to date.
Fixed price contracts do not require reporting the time spent on tasks. You are paying a fixed fee, so it is up to the contractor to make sure the project is profitable for them. Often the product will be developed for a longer period of time, after which you will see the deliverables. This increases the risk of going in the wrong direction, as the Product Owner is likely to be excluded from the process. The team will build what they understand is described in the requirements and only present the end result.
Don’t get locked-in with a contract
Time and material by definition means that you only pay for the time spent on the project. Contracts that includes an hourly rate most frequently have no start or end dates. This gives you flexibility of ending the contract whenever you decide. This gives the contractor incentives to perform at their best. You can build the initial version of the project with a contractor and later hire a team in-house.
Fixed price contracts are usually signed for a longer, specified period of time. Changing the contractor can prove difficult and involve financial penalties. If you decide to terminate the contract before the product is delivered you can also end up with no ownership of the code and a lot of wasted time.
Only time and material contract gives you flexibility in how long the relationship will last. Additionally it motivates the vendor to do their best to keep you as a client.
Conclusion
I present you my conclusions in a table, so you can easily compare the two contract types. Hope i helped you in choosing the best option for your project!
What’s your experience with hourly rate contracts? Do you think fixed price projects offer better conditions? Let me know what you think in the comments below.
