Fixed Price vs. Time and Material Contract: Which One to Choose?

Posted 22 Mar by Pavel Gorbachenko

A key consideration in the software outsourcing process is determining the right contractual arrangement to use. 

This choice can potentially affect the client-vendor relationship, alter financial bottom lines and ultimately affect the final deliverable. While doing so, it is also crucial to note that the contract model aligns with the organization’s business requirements and corporate processes.

The two mainstream software development pricing models are - Fixed Price and Time & Material contracts. 

These two models involve making different assumptions regarding the project and take different approaches to the software development process. The fixed price model approaches product development in a linear, sequential manner, while the Time & Material model considers it as an incremental and iterative process.

Each model is best suited for specific software development projects with its own benefits and limitations that this article will discuss.

Fixed Price Model

In a fixed-price model, the client company defines business requirements and expectations, that the software development vendor uses to create a detailed project scope, while estimating deadlines and costs for the project. 

This estimation forms the basis of a fixed-price contract as a billing arrangement, where the software development company (vendor) explicitly outlines the work scope, cost, and timelines of a project through its quotation to the client. 

The payment schedule can be in installments with an initial down payment, several payments spread across project phases or milestones, and final payment on project completion. 

The vital thing to note is that the total payment price is fixed and determined upfront.

When to Use?

A fixed-price model is ideally suited for the following software projects or scenarios:

1. Developing a Minimum Viable Product (MVP). 

Such projects require developing a specific and sufficient subset of features to field-test a product idea to attract early-adopter customers. It is the most bare-bones version of a software product that exists and solves a business need. Typically, this is a one-time job with no provision for future improvements or maintenance.

2. Outsourcing projects with a quick turnaround time of one to three months. 

Such projects may include:
  • Landing pages development
  • Development of CMSs websites with pre-existing templates
  • Plugins or Extensions
  • Minor bug fixes
3. Projects with a limited scope and fixed budget.

Benefits

  1. Minimized budget risks: As the entire project cost is decided at the beginning of the project, both client and vendor get a clear budget projection.
  2. Predictability of outcomes: Having a fixed price, explicit requirements, and establishing a specific timeline can ensure that the project is completed on time and within budget. However, this is usually only possible for small-sized projects with detailed requirements, a clear scope, and short delivery timelines.
  3. Easy Management: Predetermining project requirements and payment schedules helps to streamline project management. Besides, a fixed-price model also reduces the client-vendor interaction by avoiding routine compliance and milestone checks at each stage of the project.

Limitations

  1. Absence of flexibility: Project requirements are set initially, with little or no room to adjust the scope at any point in the project. Extending the project scope usually may attract extra charges at the discretion of the contractor.
  2. Lengthy planning phase: The time taken to create detailed project specifications, perform comprehensive risk analysis and plan project features can take weeks or months depending on the project complexity, thereby leading to slow project launch. This is because both the client and vendor need to ensure that there are no gaps, leading to a loss of both reputation and money.

Time and Material Billing Model - A more flexible approach

The Time and Material model addresses the fixed price model’s limitations by introducing a flexible contractual agreement between the client and the contractor to eliminate the need for a drawn-out planning phase.

In a Time and Materials model, the software development vendor charges the client based on an hourly cost of the time spent towards development efforts and cost of materials. This contract typically includes an hourly, weekly, or monthly price of resources, terms of resource procurement, and timeline agreements.

A T&M model also considers software development intricacies like dynamic requirements, software upgrades, and unscheduled maintenance as unknown variables of the project. 

As this contract allows dynamic changes to be included in an already agreed scope, the T&M model is usually preferred by both clients and vendors over a fixed-price model.

When to Use?

A Time-and-Material model is ideally suited for the following software projects or scenarios:
  • Medium to large-scale software projects with evolving requirements.
  • Projects with a scope that is not yet fully known.
  • When working on projects where you want the flexibility of modifying project scope or workloads.

Benefits of a Time and Material Contract

  • Faster project setup. The client does not have to specify the entire project scope and set of requirements initially. Therefore, the project can start much quicker.
  • Flexibility: The client can extend the project scope, add new requirements, incorporate user feedback to modify or add new features, or even pivot the project in a different direction.
  • Improved Control and Quality Assurance: The client is more involved in the decisions taken during the project, thus, has better control over the development process. The client can continuously test the product to verify that it meets the specified requirements.
  • Retains Trust: This model is often known as a contract which is built on a client-vendor relationship. While the client shows trust by agreeing to such a working arrangement, the vendor needs to deliver as per the scope to maintain its reputation.

Limitations

A Time-and-Money contract involves a collaborative process that often requires full involvement on the part of the client. 

Budgetary and timeline inconsistencies can also be a cause for concern, however these can be addressed by setting up KPIs to measure progress and ensure regular releases. 

Conclusion

The contract model chosen for a software project depends on different factors like the size, scope, and allocated budget. 

The fixed price model works for small-sized projects with a clearly defined scope. However, the intricacies of a software development project are such that it is rarely possible to determine total effort precisely. To help with this, a Time and Materials contract allows the flexibility of revising scope with enhanced transparency of effort. 

Though use-cases may vary, projects of large budgets, high complexity, and considerable unknowns, a Time and Material model is usually the preferred choice over a fixed price model.
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