Fixed Price vs. Time and Materials – Which is best for a software projects?
When it comes to pricing and being billed for custom software development, there are two main options: Fixed Price and Time and Materials (T&M).
Fixed price is exactly as the name suggests. A software provider will define a scope of work with your help, and then deliver that exact scope of work for an agreed upon price. With T&M, you are billed for the time and any related costs associated with the project as they occur.
In this article, we will give you the honest the pros and cons of fixed cost vs. time and materials when it comes to a software project.
Fixed Price Agreements
As a software product owner, a fixed price contract feels warm and fuzzy. You know what your costs are upfront. You can space out payments evenly and not worry about financial uncertainty.
But a fixed price contract doesn’t make sense for every project.
Fixed-price agreements are great when:
- The scope of the project is small
- The requirements are 100% defined
- The requirements will not change
- The work is turnkey, where the software provider has done the exact work repeatedly with little to no variation
- There is no need for flexibility for the duration of the project
The reason why a fixed price agreement needs a well-defined scope that is limited in size is because it is impossible to estimate a true and fair price when there are unknowns.
The larger the project is in size, the greater a chance for unknowns popping up. If the requirements are not fully defined, then there absolutely are unknowns in the project.
If a software provider agrees to create a fixed price project with an unclear scope, they will most likely add a risk factor, or padding, to protect themselves. That padding is in effect a wager on a future outcome.
Rather than focusing fully on developing your project and meeting your needs, a fixed price agreement may distract a software provider because they are managing their own profit interests in addition to delivering your software. Either you will pay more for the project for the benefit of a known price, or the software provider will lose profit. In each chase, someone loses.
Time and Materials Agreements
Time and Materials agreements are great when:
- The scope of the project is not small
- The requirements are not fully known
- The requirements may change during the course of the project
- The client wants flexibility to modify scope or change features while the project is underway
The main benefit of a T&M agreement is flexibility. During the course of the software development, you can adjust requirements, incorporate user input, and swap out features and change direction so that you get exactly the product you want.
The concern most people have with a T&M contract is managing the variability of payments and the total project cost. Most software companies will be happy to work with you on a payment schedule to manage your cash-flow requirements. With regards to the total project cost, you have more control than you might think.
As a software product owner, you can put in place the processes and transparency you need to manage budgets with your vendor. This might mean asking for features to be estimated and approved before each phase of work. It might also mean requiring detailed invoices by feature or task so you can reconcile estimates with billed work.
There will be some additional overhead on both sides to manage the changing features and ongoing project spend. The goal is to get the software you want for a total cost that makes sense given the features and value delivered.
Fixed price and T&M are two models for pricing work in the software development industry. As a client or software product owner, the idea of fixed price or fixed cost is very attractive because it seems like a lower risk option. But the best pricing model really depends on the type of project or work you are doing.
Fixed price is a fair pricing model for small, well-defined, fixed scope work that requires no involvement from the client. In all other scenarios, a T&M contract makes more sense.
Managing a T&M project may concern you, but a good software partner will work with you to provide the processes and transparency you need to make cost and value-based decisions and adjustments during the delivery process.
The 5 Pillars Of A Successful Software Project
We want to help every software project begin on solid ground. In The 5 Pillars Of A Successful Software Project we share the five essential ingredients of every software project.
You can grab a copy of the guide below and share it with your team!