Time and Materials vs Fixed Price Contracts

There are two main software development contract pricing models, namely the time and materials (T&M) and fixed price (FP) contracts. These types of models are ubiquitous and used by all companies, regardless of the business model they chose to operate. Be it a startup, a small-to-medium business (SMB) or an established enterprise — all of them have to decide between these two main approaches to project management during their software or mobile development.

What are these two types of project management approaches then? We will take a closer look at both time and materials and fixed price billing contracts, their pros and cons, and the types of software development projects they are best suited for.

Fixed Price Contracts: pay for the work listed in the specification

This pricing model is the older one and was used for decades with Waterfall and other popular software development models. The project specifications hold the list of all the needed product features and deadlines for their development and implementation. All the software development lifecycle stages are laid out in an organized timeline and evaluated beforehand. This approach to billing ensures the safety of mind for the customers, as they can check the development milestones and see if the things are going according to plan. However, this project management paradigm has both pros and cons.

Pros of working under fixed price contracts:

1. Clear and exact final cost of the project. The customer is on the safe side after the contract is signed and any extra work goes without payment or under an additional agreement.
2. Strict deadlines are set from the get-go. When the customer has a clear understanding what features they are after, the developers can come up with a clear plan with milestones and deadlines, so everybody knows what work will be done at a certain time.
3. Predictability of the development process. When everything has been discussed and planned beforehand it’s easy to monitor the status of the software development project and predict if the work will be completed on time.
4. Little to no managerial overhead. As all the project details are already described in the contract, the project management takes little time and effort, so little to none regular supervision is required.

Alas, there always is a flip side of the coin…

Cons of the FP contracts:

1. The rigidity of the terms. Exactly as the Waterfall model implies, the project cannot be adjusted after the start. If the market conditions change and some feature is not needed anymore, or a totally new one is needed, adjusting the project scope and content is literally impossible. You’d simply have to start over from scratch.
2. Excessive costs. Developers cannot know for sure when they will complete the task, so they ask for around 40% extra time to be able to always meet their deadlines. For the customer, this means paying up to 40% extra for no actual work. You do always get what you want — it just costs you a bit more than you expected.
3. Long and laborious planning. Fixed price contracts demand a long and in-depth planning stage in order to execute smoothly. Every detail should be accounted for and every action should be foreseen and kept in mind.
4. Failed promises due to miscommunication. If the specifications are not crystal-clear, there always is a risk of misunderstanding, leading to the developers delivering not exactly the product you were hoping for. This can also be affected by the lack of precise monitoring, as described above.

What projects is the fixed price development approach good for then? It is great for short-term software development tasks, pilot projects aside from the main development flow, or one-time products requiring little to none maintenance during the software lifecycle. This includes most of the scope of mobile development including games, various apps with just a bundle of functions, various little tools. Interestingly enough, such pricing model works best for the projects aimed at the healthcare industry, like writing the software and drivers for medical equipment, as the architecture and the functions there are stable and predictable.

Time and Materials: pay as you go for the work hours spent

The T&M pricing model is best described as the agreement to pay for the job done, based on the number of work hours spent. This approach assumes the developers have much less commitment to the specifications and work iteratively, adding more and more product features as they go. Such project management approach works best for customers who hire a remote software development team to complete the project using Agile or any other of modern software development models.

The T&M pricing model has multiple benefits:

1. High flexibility of the requirements. As the work is done in rather short sprints and always results in a working MVP (Minimum Viable Product), the features can be added or removed easily. This results in the project that always corresponds to the customer’s expectations.
2. Precise spending. Only the actual development work is priced, so there are not excessive payments (unless the time was spent on a feature that was later discontinued).
3. Highest product quality. Repetitive iterations and thorough testing allows polishing the product and delivering high-quality software.
4. Process transparency. As the developers are paid only for the work accomplished, they have to present transparent reports on what they were doing. This helps to monitor the work in progress with ease.

However, nothing is perfect, and time and materials billing model also has its cons:

1. Deadlines can change drastically. Any project adjustment affects the final deadlines, so the product might be very overdue.
2. The budget cannot be predicted. The spending evaluation can only be approximate, as the timeframes for designing, developing and implementing the features are quite flexible.
3. The tight grip of the process is needed. As this pricing model expects higher independence for the developers, it also involves more control from the product owners.
4. Sometimes hard decisions must be made. By stating this we mean that during the development process it sometimes becomes obvious that certain features are no longer relevant or a design overhaul is required to better meet the changed market conditions. This ultimately means the work and resources invested in said features or design are gone to waste.

All in all, the T&M pricing model is great for working with a custom software development team working according to any type of Agile methodology. This approach works great for developing feature-rich products, building MVP’s quickly to test the ideas or when the final list of requirements is simply not known in the beginning and will become obvious only during the software development process itself.

Mid-to-large scale apps that evolve over time, regular releases of new feature packs to an existing app or producing DLC’s and expansions to popular games based on ongoing feedback from the players are the examples of a perfect match for applying this project management type.

T&M or FP: when to choose each?

Let’s assume you need the project to start as soon as possible to seize the window of opportunity and deliver an MVP quickly (to take part in a startup accelerator, for example). T&M would be the obvious choice, as it requires little time on planning and ensures the results are produced fast enough and can be adjusted on the go.

On the other hand, let’s assume you need to produce a bunch of typical apps using the same architecture, coding language and possessing a similar set of features (let’s say these would be chapters for a mobile game or service packs for a long-serving app, including mostly bug fixes and performance improvements). This type of projects fits FP approach best, as the final requirements are known in advance, so the timeline and budget can be planned.

Yet another example — you need the app to be perfect and smash all the existing competition, meaning its software development lifecycle will involve many rounds of rigorous testing. As the final state of the product cannot be predicted from the start, same as the time needed to reach it, opting for a T&M approach would be the wisest choice.

Choosing the appropriate project management approach can help avoid multiple issues across the software delivery pipeline and lifecycle, save you lots of time and nerves and ensure receiving the top-notch quality of your software products.

If you have any questions regarding what pricing model is right for your particular project — feel free to contact us, we are always glad to provide help and advice. Please share the article if you found it useful or entertaining and stay in touch for more interesting stuff!