Choosing the right type of contract is important to both the client and the provider, since it minimizes risks and increases chances of getting a positive result for both parties. Arrangement of relations is a truly important foundation of success.
There are two major pricing models in the field of software development: Fixed Price and Time and Materials. Each type has its pros and cons; therefore, the choice between them may be a complicated task. The option that is optimal for one project may be far from ideal for another one.
Alternatively, you can compare pros and cons of a certain pricing model and choose the most suitable option depending on a specific project type. This is clearly a better option. So let us take a look at this issue in more details.
Fixed Price Contract
This cooperation model implies that the development budget is approved before the works start based on assessment of their amount, and will not be changed later. Project deadlines are also approved at the beginning.
At a first glance, it is very convenient. The customer clearly sees the amount she needs to pay and the schedule of delivery. The timeline of the entire process, its costs and functions to be implemented in the product are known immediately. Just pay and wait for the work to be completed, with minimum interference into the process.
Ideally, it should look like this:
That is, a fixed price contract means that all terms remain the same. However, we all know that it is never like that in reality. As a result, we receive the following picture:
The market is constantly changing, so you need to adapt to these changes too. Work process and entire business models are getting changed. However, you remain clamped inside the tight conditions of a fixed contract. In many cases, this may become a problem.
Among the advantages of the fixed price model, the following may be highlighted:
- Predicted budget. The customer knows clearly how much money will be spent on the project implementation, and this makes planning easy. You know the exact final price of the entire project.
- Predictable results. The list of tasks to be completed within the process, and a result that must be achieved, are agreed upon at the initial stage.
- Fixed timeline. Both the customer and provider know the timeline allocated for project implementation.
- No need for strict control. All the details are specified in the contract.
- Administrative load is minimal. You know what needs to be done at once; therefore, you will spend minimum time on interaction. You may quickly start working.
Disadvantages of the fixed price model:
- Minimum flexibility. Lack of possibility to introduce changes or additions after the contract was signed.
- Risk of overpayment. Engineers often include all possible risks of additional development hours into the fixed price.
- All changes should be agreed upon. You will have to pay for any change request or additional function that is not included into the scope of work within the contract.
- Communication risks. If you missed some details, you may receive something different from what you expected.
- Possible compromises in quality. If in the course of development additional tasks appear that are not foreseen by the budget, the provider will most likely ignore them in order to be able to finish everything on time; this will affect the quality.
Despite the above, a fixed price model may be a good choice in the following cases:
- a small project both in the scope of work and timeline;
- a list of tasks is defined 100% and probability of change is very unlikely;
- flexibility is not needed, since everything has been agreed in advance;
- turnkey approach. It is a typical solution, where only small changes are made in order to adapt to a specific customer.
In general, fixed price model has its benefits. However, it is not the best option when speaking of software development.
Time and Materials
The essence of this pricing model is that the client pays for the hours actually spent by the service provider. Depending on the client requests, payments are made after each stage, every month, every six months, and so on. Estimation of the scope of work and project deadline is approximate, the end result and its quality are the most important.
Important advantage of Time and Materials model is a high level of flexibility. In the process of software development, the customer may change requirements, disable and add functionality, i.e., do anything to get exactly the result she needs.
The development team is not limited by the tough budget and timeline, so it has a high motivation to seek and offer the most effective solution to the client. They can pay more attention to a specific field of work, if it helps to achieve the best result.
Work on the project is divided into separate stages; each of them is estimated separately (in hours). Thereafter, such estimates are agreed with the client. Once the task is completed, the customer pays for the work, and developers start assessing and working on the next sprint or milestone.
Main advantages of Time and Materials:
- Quick start. No need to think through the future product to the smallest details, which may usually take a good deal of time. The provider and the client discuss the hourly rate and estimated scope of work; this is when the work begins.
- No extra payment. You pay for the actually completed work only. You pay for the time spent directly on your project.
- Flexibility. In the course of development, you can easily make changes, change the scope of work and use flexible development methodologies (agile methodology). The reaction rate is also very high.
- Feedback, control and transparency of the performance. The customer communicates with the project manager, and the manager allocates tasks within the team. The customer has access to any required information and is continually aware of the development process.
- Practical testing of hypotheses. You can quickly create a product MVP and test it in practice, for example by releasing a test version. It enables prompt receipt of the target audience reaction and understanding what needs to be changed or improved.
- Setting priorities. Which features should be implemented in the first place? Those that bring profit quickly or those that are key for the end user? Is it better to start with simpler or more complex things? The choice is yours and you may change it any time.
This pricing model also has its flaws. Here they are:
- Undefined budget. Since only the approximate project implementation costs is known, there is a risk of exceeding the expected budget.
- Intensive communication. Communication may be both a positive and a negative factor. Everything depends on the way you look at it. Not every customer may keep in touch constantly, especially if the team works in another time zone.
- Complicated release forecasting. In the process of developing, a mind map of project tasks is changing all the time; therefore, it is complicated to forecast the time of project completion accurately.
- Administrative expenses. Time accounting, reporting, and other similar things – all of these formalities require a lot of time.
Time and Materials model is suitable in the following situations:
- requirements to the product functionality and scope of work are expected to change in the course of development;
- the customer has no clear requirements and detailed specifications or the customer simply has no time to allocate time for their preparation;
- the project is of high scalability and presupposes large scope of work;
- the product quality is of utmost importance to the customer and the customer is not discouraged by the idea of spending more resources than initially planned.
Thus, Time and Materials model is oriented on achieving a high quality product. Flexibility of the development process, readiness to changes, transparency of cooperation and close communication greatly contribute to the achievement of this goal.
Which Pricing Model to Choose for Your Project?
Each of these two types of contracts has its pros and cons. We described them in this article and hope it will help you make right decision. Even if you have already used a certain model, it is quite possible that another option will fit better to your next project.
As for software development, Time and Materials model is a better solution than the Fixed Price. This model enables dynamic response to any changes, presupposes close communication and discussion of all details, which helps receiving a project that would be just what you wanted to see. Although it might take more time, the quality is more important.
At any rate, consider the peculiarities and needs of your business. If you are not sure, which model will fit you best, we are always ready to advice you and answer any of your questions.
We have extensive experience in successful project implementation in various areas, and we are ready to help you bring your ideas to life.