Fixed Price vs Time and Materials: How to choose the most cost-effective approach for outsourced software development
If your organization doesn’t have its own in-house coding team, you need to rely on outside developers. But managing some outside developers could be a challenge, especially managing project costs.
So if you outsource your software development, managing your costs should be a top priority. (But don’t forget, you also have to produce a great product!)
You might think that a fixed-price contract — with a predefined scope and a hard cap on costs — is the logical way to go.
Fixed-price software development can sometimes make sense… Fixed pricing works well if:
- The software project is small
- The project requirements are 100% defined (and absolutely will not change)
- The development will not require flexibility
- The developer has done exactly the same type of project before
But in our experience, the vast majority of custom software development is impossible to predefine completely. The best software products inevitably require flexible thinking, tweaks to requirements, and shifts in scope. And the larger the project, the more changes you can expect.
(That’s why a “discovery stage” is vital to define exactly what you need to build — and the best way to build it.)
Here’s what really happens with most fixed price outsourced software developer contracts:
● The developer adds as much as 50% to the true cost estimate to cover “scope creep” contingencies. So if the actual changes to project scope require less than 50% more work, you’ll end up overpaying for your software.
● The developer lowballs the cost estimate, figuring that scope creep will force you to issue change orders to cover the higher actual development costs. When that happens, you’ll end up spending time on redefining requirements, justifying budget increases, and getting approvals — instead of just making a great software product.
A fixed-price contract forces the outsourced developer to expend energy on managing profitability instead of focusing only on delivering the best solution.
Why hasn’t it been more common to outsource to software development companies in the past?
When software was less complex, fixed-price development was more effective and less risky than it is today. But software complexity has grown exponentially.
Today, to be a market leader, your software needs the most user-friendly front end, the best backend functionality, and the most efficient use of AI. The time & materials development process, including the discovery phase, ensures that your product will be the best it can be.
Also, these days, many internal software teams want to engage more deeply in their outsourced development projects. The T&M approach enables more collaborative give-and-take, greater solution flexibility, and ultimately a better product than the traditional fixed-price approach.
Real-world advantages of T&M over fixed-price contracts for cost-effective software development
It may seem counterintuitive, but paying for software development on a time-and-materials basis is usually best for both cost management and product quality. Why?
● Unit labor costs are known, fixed, and transparent, with cumulative costs reported frequently and billing set to meet your cash flow needs. You don’t have to risk an initial cost overestimate or suffer the headaches of changing orders to a fixed-price contract.
● T&M gives you the flexibility and agility to deal with the scope changes that always come with complex software development. For example, to meet shifting requirements, a developer might have to add an engineer with specific expertise. That’s easy with T&M, but under a fixed-price contract, that requires a change order and a new cost estimate.
● T&M lets both you and the developer focus on the quality of the solution, not on managing budget approvals or billing.
In short, because time-and-materials costing is grounded in reality, it is almost always the most efficient and cost-effective way to develop software.
And if your software development project is large or complex, has requirements that are not fully defined, or has to allow for modifications or new features then a time and materials contract is really the only way to go.
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