Time And Materials vs Fixed-Price—Which Is Best for Software Development?

Due to the expensive nature of software development, affordability can seem like a far-fetched idea. However, finding a healthy balance between quality and cost is possible based on your unique needs. When it comes to pricing and billing for custom software development, there are two main options: time and materials vs. fixed-price agreements. 

In this article, we’ll explore the differences between time and materials vs. fixed-price, give you the pros and cons of a time and materials vs. fixed-price agreement, and help answer some of the most commonly asked questions related to these two options in a software project.

What Are Fixed-Price Agreements? Fixed Price Meaning

Fixed-price agreements are a type of contract where a software provider and client define a scope of work together and then deliver that exact scope of work at an agreed-upon price.

What Is a Fixed-Price Agreement in Software Development?

A fixed price agreement in software development is when a client defines project requirements to a software provider and the provider commits to delivering the specified features and functionality at a set price. This model provides budget predictability and assurance that the provider will complete the project within a defined scope and budget.

What Are the Pros of a Fixed-Price Agreement?

As a software product owner, getting software delivered in a fixed price agreement has several advantages, including: 

• Knowing Upfront Costs: In a fixed-price agreement, the total project cost is agreed upon before the work begins, which allows the client to budget accordingly without worrying about unexpected expenses.
• Scheduled Payments: Payments in a fixed-price agreement are typically tied to milestones or predefined schedules, helping both parties manage cash flow effectively.
• Less Financial Uncertainty: Fixed-price agreements eliminate the concern of runaway costs, as the price is locked in from the outset. This reduces financial uncertainty for the client, who doesn’t have to worry about costs increasing if the project takes longer than expected.

However, a fixed-price agreement 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 don’t 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.

A fixed-price agreement requires a well-defined scope with minimal ambiguity. Larger projects are feasible but carry higher risks of scope creep or unexpected challenges. There’s a greater chance for unknowns to pop up the larger the project or if the requirements are not fully defined.

What Are the Cons of a Fixed-Price Agreement?

If a software provider commits to a fixed-price agreement on a 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.

In a fixed-price agreement, software providers must account for their profit margins while developing the software application. This may lead to conservative approaches in the face of unanticipated challenges.. You could pay more for the project for the benefit of a known price, or the software provider may lose profit. When one of those scenarios occurs, someone loses.

What Is a Time and Materials Fee? T&M Meaning

A time and materials (T&M) fee, otherwise known as a time and materials agreement, is a payment option where you pay for the actual hours worked by the development team and the cost of materials or resources used during the project.

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 throughout the project timeline.
• The client wants flexibility to modify the scope or change features while the project is underway.

What Are the Pros of T&M?

Here are some of the most significant pros of T&M:

• Flexibility: During software development, you can adjust requirements, incorporate user input, swap out features, and change direction to get the exact product you want.
• Prioritization: With T&M, you can prioritize tasks based on changing business needs and market demands. This allows for agile development, where the development team can adapt to evolving requirements and focus on delivering the most valuable features first.
• Speed: Time and materials agreements often leverage a sprint-based approach, enabling faster project initiation and flexible adjustments. Fixed-price agreements may also use sprints but often require more upfront planning.
• Less Risk: If a project or provider isn’t meeting your expectations, T&M contracts offer greater flexibility to adjust or terminate the engagement as necessary.
• Accountability: T&M contracts show full transparency in how the development team uses time and resources. This makes it easier for clients to progress projects efficiently and for development teams to demonstrate the value of their work.

What Are the Cons of T&M?

• Variable Payments: Due to the nature of T&M contracts, there is variability in the total project cost. However, you can mitigate volatile costs by actively participating in decision-making throughout development. You just have to use vigilant and effective communication to align the project with the intended scope and objectives.

Tip: 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.

• Changing Project Scope: With T&M, both parties must actively manage the evolving project scope and costs. For example, without careful monitoring, additional feature requests may unintentionally push the project beyond its intended goals.

Is Time and Materials a Fixed-Price Agreement?

No, a time and materials contract is not the same as a fixed-price agreement. In a fixed-price agreement, you and your software development team agree on a set price for the entire project before the work begins. In a T&M, you pay for the project based on the actual time and resources spent on the project.

Time and Materials vs. Cost-Plus Contract: How Are They Different?

While both T&M vs. cost-plus contracts involve billing based on the actual expenses incurred during a project, their structure and risk distribution differ.

• Time and Materials Agreement: Under a time and materials agreement, the client pays for the actual time spent on the project (hourly or daily rates) and the cost of materials used. Again, It is often used when project requirements are not fully defined upfront or when development needs to be adaptable.
• Cost-Plus Contracts: In a cost-plus contract, the client agrees to cover the actual costs incurred during the project, plus an additional fee that represents the contractor’s profit margin. The fee typically represents the contractor’s profit margin and can be calculated as a percentage of the project’s total cost or a fixed amount. Cost-plus contracts are usually seen in industries like construction or government projects, where long-term and complex project requirements can make it difficult to estimate costs accurately upfront.

What Is the Difference Between Time and Materials and a Fixed-Price Agreement?

The primary difference between these models lies in the payment structure. 

• Time and Materials Agreement: Based on actual hours worked and materials used. 
• Fixed-Price Agreements: Predetermined payments regardless of the time and materials used throughout the project.

Time and Materials vs. Fixed-Price Agreements: Final Thoughts

Time and materials vs. fixed-price agreements are two models for pricing work in the software development industry. A client or software product owner might like the idea of a fixed-price agreement because it is a lower-risk option. But, choosing the best model ultimately depends on the type of project or work you are doing.

If you’re unsure about managing a time and materials vs. fixed-price project, a good software partner like SOLTECH will work with you to provide the processes and transparency you need. Contact us today to get help making cost- and value-based decisions on your software and learn how to make adjustments during the delivery process.

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We want to help every project begin on solid ground, so we created a guide to do just that. In The 6 Non-Negotiable Items When Building Software, we share six steps that are a must when creating your software.

Download the guide below and share it with your team!