How do time and materials and fixed-price contracts work?

When we outsource a software development project, we need to know which billing agreement will best meet our needs. We have the choice between two major types of billing agreements: Time and materials and fixed-price. Each model offers distinct advantages and disadvantages. Let’s take a closer look at these two models:

First up, fixed-price agreements. Software product owners like fixed-price agreements for projects that:

• Have a small scope

• Have easy-to-understand requirements

• Have a short time horizon

• Have no need for flexibility or expansion

Fixed-price agreements don’t work so well for projects with a vague scope. They also work less well for longer-term projects. Fixed-price agreements also function less well for very large projects. Trying to  predict the scope of such an undertaking proves very difficult.

Now let’s take a look at time and materials contracts. Product owners must choose a time and materials model contract when:

• They do not know the full requirements 

• They do not know the full scope of the project

• They want flexibility to make changes

• The project is large

• The requirements might change during development

Time and materials contracts worry some product owners. The product owner may fear fluctuation in budgets and payments. They might also worry about projects taking too long to complete. Software development teams can address both of these concerns. They do this through open communication and transparency. Developers must discuss the time frame and budget with clients. This way, nobody fears massive budget overlays. Product owners don’t worry about projects costing much more than anticipated. Most time and materials contracts cost less and deliver faster than fixed-price contracts.

So, what are the advantages and disadvantages of fixed-price versus time and materials outsourcing agreements?

Fixed-price model advantages

When companies choose to use the fixed price model, they know exactly what they will pay. For projects with a short time frame and predictable steps, fixed-price makes sense. Software development teams create easy-to-understand budgets and schedules.  Product owners choose fixed-price contracts for their predictability and simplicity. They know exactly what to pay and when to pay for it.

Fixed-price model disadvantages

Fixed-price billing sometimes proves disadvantageous for both product owners and software development teams. The development team must keep strict to requirements and stop any scope creep. They must review the expected product and make a meticulous plan for the project.  Poor planning leads to budget and time over-runs, which will hurt profits. If a team underbids a fixed-price project, they cannot ask for a larger budget.

Product owners who choose the fixed-price model have less control over the project. They must also accept less ability for change and flexibility. Companies offering a fixed-price model might over-or under-bid. 

Development teams using fixed-price contracts must do a lot of research ahead of time. Teams must explore every aspect of the upcoming project to offer an accurate price. This takes up valuable development time.

Time and materials model advantages

Time and materials billing agreements usually prove very beneficial. The client and the software development team both benefit. Flexibility is the biggest benefit of time and materials model agreements. Software development teams have the power to change requirements and adjust features. They can make changes based on user testing and feedback. Project owners feel free to ask for more features or changes to existing features. Time and materials contracts work well when the software development team uses agile methodologies. Teams using agile value transparency and open communication. They estimate the costs of each sprint. They communicate with product owners. Product owners know how much each sprint will cost. Agile and time and materials contracts work in perfect symbiosis.

Time and materials model disadvantages

Some product owners may worry about cost overruns or out-of-control budgets. To mitigate this fear, software development partners give clients a rough estimate of the total cost of the project. Product owners must be more involved in a time and materials contract than in fixed-price contracts.

Think of the differences between the two models like a home improvement project. If you need a faucet replace in your kitchen, a fixed-price contact makes sense. There are few variables and the project is short-term.  But what if you need to do a full remodel of the whole house? You face many variables and possible changes. This makes the project very difficult to estimate. A company bidding for such a project with a fixed-price contract is in a tough spot. They will either inflate prices to protect profits or risk underbidding. Neither situation is ideal; for the customer or the service provider.

Software costs vary by project and business requirements. We at Blocshop understand that you might need some rough estimates before a project begins. A typical project at Blocshop takes three months and costs about $60,000. More complex projects will take more time and more resources, costing up to $300,000. Blocshop always delivers an MVP (Minimum viable product) early. This gives clients a starting point from which they can budget for future software development.  Clients can make informed decisions about what features they want to add without spending money on features they do not need. Tell us more about the type of application you need and your specifications, and we’ll get back to you with a project estimate.