The best contract with software services provider – Fixed Price vs Time and Materials

On our blog, we’re consistently sharing with you the following intricacies of establishing valuable cooperation with software services provider. Yet, due to the complexity of this subject, we’re still walking our walk to cover each and every step of the way on our blog.

This time we want to shed some light on the 2 most popular agreements – the Fixed Price and the Time&Materials. Which one works when? Is a certain one always a better choice? Or even what are the differences between these two? For ease of reference, we will describe each type in general, compare these based on the same 4 aspects, and finally sum up the conclusions in form of a short table. Keep reading to learn everything you should know about these agreements and choose the best one for your project upon your knowledge rather than a gut feeling.

The Fixed Price

Let’s start with a contract that usually seems tempting for the first-time outsourcers, which yet have many flaws that often remain unnoticed. What is the Fixed Price model? In general, it’s exactly what it sounds like. Signing such a deal fixes the budget and thus tasks to be performed by the provider, so no matter how many manhours it would eventually take to finish the agreed work, the amount you would have to pay won’t change. This budget cap is exactly what attracts people to this type of deal, yet there are only a few scenarios in which the Fixed Price contract is a good choice. So, without further ado let’s dive into the strengths and weaknesses of the Fixed Price model.

Engagement

The Fixed Price contract might be a good choice if you want to negotiate the terms, sign the deal and then almost lose sight of the project until it will be finished. It’s true that once the works start your active participation won’t be as essential in the Fixed Price model, yet the initial stages are much more time-consuming than in the case of Time and Materials. Since to establish the final price each step of the work has to be meticulously planned to estimate the final costs, this phase is not only considerably longer but also requires a lot of engagement from both sides. Completing the planning before reaching out to a potential partner reduces the required engagement, yet the time needed to start the work would still exceed the same process in the T&M since your provider will have to carefully inspect all the assumptions to decrease the risks related to the minimum.

Flexibility

Have you ever heard of the software development project that went from start to finish without any changes? Or even more – without any surprises? Yep, we didn’t too. And that’s the main downside of the Fixed Price projects – once the scope of work is agreed and estimated any changes cannot be made. In today’s world, flexibility is one of the biggest competitive advantages that a company can have, and regular pivots are frequent in software development – that’s even one of the reasons that made Agile methodologies so popular. But let’s not simply theorize and illustrate what the problem is with real-life examples that are highly possible to happen. Your business environment changes, and your product requires adjustments – the Fixed Price will make it impossible to adapt. You’ll notice some potential field of improvements in the concept – you’ll need to thoroughly discuss the additional scope of work and costs related and add the Change Request to the main deal. A feature that didn’t appear to be critical during negotiation now is a game-changer, essential for your business – once again, you can’t do it without negotiating an additional deal and building a second team or waiting till developers are done with what was agreed in the first place. The complete lack of flexibility is the biggest problem of Fixed Price deals, making it almost useless in a complicated, innovative projects.

Read also: Types of outsourcing contracts 

Small vs Big project

As you already know, to calculate the quote for a Fixed Price project every step of the work must be planned and described. This is only possible in the case of small projects with extremely clear scope – like adding a singular feature to an already existing system, or budling a small solution to solve a simple problem. If you want to delegate such tasks, then Fixed Price truly might be a good choice. At the same time if your project on the other end of the line, you should lean toward the Time And Materials. As the size and complexity of a project increases, the likelihood that a plan prepared at the outset will not need to be revised decreases. Since the financial cap makes it impossible to implement any changes in the scope of work, working under the fixed price in a project that due to its complexity requires an iterative agile approach is pointless. We won’t spill the beans saying that it would be either highly ineffective or extremely costly – and that leads us to the following aspect.

The Cost

At the first sign, some of you might perceive the Fixed Price as a cheaper option – you have a defined budget for a particular work, so how can it be more expensive than a project with almost no limits? Well, it can, and often is. When working under the Fixed Price software providers almost always add a safety buffer – in the offer they calculate not only the basic cost of work but also an additional amount for the unexpected difficulties. Even if the scope of work is as clear as possible, and any changes are out of the way, there’s always a possibility that something will go sideways. Since your provider is accountable for the final result only, they have to be prepared to deal with unforeseen obstacles. Obviously, rather than using money out of their own pockets, this risk should be covered by the mentioned safety buffer. The more complex your project is, the bigger this buffer will have to be, making the work more and more expensive. What’s more, the costs of dealing with the unforeseen problems might exceed the agreed buffer, which may lead to a decrease in quality, creation of technical debt, or may negative impact the relation between client and vendor, so that’s an additional risk one should perceive when choosing this kind of deal.

If we were to find a silver lining related to costs in Fixed Price projects that would be the safety guaranteed by having a maximum amount that you will spend on the development. When you’re about to delegate a project that fits the requirements of being “small and clear”, and the ability to secure the complete budget before the development even starts is crucial, you can choose the Fixed Price and benefit from this element.

Time and materials

To deal with all the limitations of the Fixed Price deal, the Time and Materials was created. This kind of agreement is the best choice for a project with a scope that can’t be precisely predicted and estimated beforehand, making it a perfect alternative for all the innovative projects run in agile methodologies. Yet it will also work flawlessly well with small, simple projects. What you pay for in Time and Materials? As its name suggests you pay for the hours spent on work over your project and materials used. Combining this with an iterative approach to software development and engagement from the Client creates a real synergy and allows to work over the project until all stakeholders are satisfied with the results instead of having a limited number of hours to finish the previously described tasks only. Long story short – time and material allow to mitigate most of the risk of the Fixed Price while adding several benefits. So how the key elements of this contract compare to the previously described one?

Engagement

As we said, the Time and Materials assume that the direction of work would be chosen iteratively, allowing you to benefit from a short feedback loop. Thus, you will need to be engaged and cooperate with your external partner on the strategic level presenting the direction of development and verifying if what the team delivers meets your standards and requirements. Maybe now you wonder if signing such a deal will result in management overhead rather than being a time-saving decision? Don’t worry – you might still leave the day-to-day project management to your external partner, who would take leading the ongoing work off your shoulder. As result, you would be able to spend precious time focusing on the most important part – strategic goals and ways of reaching them.

Being involved in the process would allow you to make the utmost out of cooperation with an external partner and end with a product that truly serves its purpose. If you wonder how to do it if your company doesn’t employ anyone experienced in the Product Owner role, or even no one from your team had any experience with IT that shouldn’t be a showstopper. We cooperated in such scenarios, and the blend of technical and managerial knowledge of our specialists and managers combined with domain expertise from the Client representatives is more than enough to benefit from all the other T&M advantages and achieve the goals you’ve set for the cooperation.

Flexibility

If one cares about flexibility, then Time and Materials is simply a slam dunk. The main reason to choose this type of contract is to maintain adaptability and manage the work in an Agile manner. Since you’re paying for the time and materials spent on your project, you can direct the work accordingly to changing conditions, and end with a product that perfectly fits what your customers’ needs. What’s more retaining flexibility doesn’t mean you will only expand the scope of work and spend more and more resources. Time and Materials agreement also enable limiting the scope of work if some of the features planned beforehand turn out to be unnecessary. What’s more this contract allows to mitigate the risks of maintaining big teams of developers, since with the Time and Material you can always ramp down the team to lay low during a stormy period, and the once your situation would be safe and sound again, expand the team to accelerate the work.

Small vs big

The bigger and more complex the project gets, the harder it becomes to precisely estimate the amount of work necessary to finish it and identify all the potential risks. We’re positive that if you have experience with complicated projects, you know that it’s near to impossible to plan everything so the choice should be obvious. But what about a small project that has a bigger chance to be meticulously estimated and have a reasonable level of risk? In our opinion T&M would still be a better choice – if everything goes well, you’ll pay less than with the fixed price (there would be no need to add the cost of “the safety buffer”), and if eventually, something goes sideways you will retain a chance to direct your project into safe shore in the way you want, rather than in the cheapest way possible due to the financial cap while retaining all other T&M benefits.

Costs

This matter had been permeating all the previous ones so let’s cut to the chase. In general, even if we would assume that the whole work can be planned, the scope won’t change, and the progress might be described with a Radiohead song title “No Surprises” still Time and Material is a better choice. Firstly, you won’t be charged for the “safety buffer”, but most importantly the flexibility of T&M makes it much better investments – the adaptability highly boosts the chances of achieving more than satisfactory ROI. Software Development is expensive, so you should spend your resources wisely – and flexibility is one of the pillars upon which you should plan your work. No one can predict what would happen in the months to come and we’re positive that if the environment alternate you would prefer to be able to adapt your project, rather than pay for something that would require immediate changes or even prove to be not as useful as you planned.

Last but not least, we want to address the common concern about T&M – that the dev teams in this model won’t be as committed and won’t work at full effectiveness. Best what you can do to mitigate this risk is to select a trustworthy provider able to provide what you lack and start with the Proof of Concept – i.e. a singular part of the whole forthcoming work, during which the external team would be able to prove their value in real.

After reading this article you might conclude that the benefits of the Time and Materials highly outrun not only its downsides but also the benefits of the Fixed Price. We won’t beat around the bush – that’s true, and if your provider suggests choosing this option, they simply want to ensure that whatever happens during the project life span you will end up with valuable results. There are some scenarios as repetitive projects like subsequent system implementation done by an experienced team, or crafting a singular, really simple feature in which Fixed Price might work, but these are highly limited and when you weigh up the pros and cons, remember not to fall into the trap of the illusory security provided by a fixed budget.

And if you want to learn more about effective cooperation with a software services provider, be sure to check out our other resources on the most popular outsourcing destinations, the biggest risks related to delegating software development, the process of establishing cooperation remotely, onboarding outsourced developers and many more or simply use the contact form below and ask us the questions that are running through your head.