Both time and materials and fixed price contracts may end up with budget overruns, so let's stop focusing on myths.
Each contract fits a different kind of project, so most often the question isn't "which contract is better", but "which one fits your project and needs". It's also about your priorities.
Having said that, let's take a look at the opportunities and risks both contracts carry, and the list of projects that fit each one well.
<h2 id="key_differences">Fixed fee vs time and materials: key differences</h2>
Scope - In a fixed price contract, you initially spend a lot of time specifying the scope of a project. In a time and materials contracts, the scope is adapted to your business needs throughout the process.
Payment - In a fixed price contract, you pay for the whole project after the final product is delivered. In a time and materials contract, you pay according to an agreed-upon increment of work completed, with the payment determined by the hourly or daily rate of the roles involved. While some vendors opt to keep their rates undisclosed, others offer their own time and materials cost calculators, which can serve as a helpful starting point for estimating the project's overall budget.
Your involvement - In a fixed fee contract, you participate in initial meetings when you clearly define the scope of a project and needed features. Then, the team most often won't need your involvement - you'll see a product when it's finished. In a time and material contract you start faster, but then you (or someone from your company) most often involve in the whole process - by participating in meetings and giving feedback on finished features.
Control - A fixed price contract gives you less control over the quality of your product and the fact if that fulfills your vision and requirements. Working with a time and materials contract allows for more control since you often meet with a team and give them feedback when they deliver new features.
Project - A fixed price contract doesn't fit well projects with high complexity, since it's hard to determine all the requirements so specifically from the beginning. Complex projects go better with time and material contracts.
When to choose a fixed fee contract?
when your project is not complicated and its scope can be easily defined from the beginning,
when your project is small and there are no changes anticipated.
When to choose a time and materials contract?
when your project is complex,
when the duration and scope of the project are hard to determine,
when a project has dynamic requirements,
when you need more flexibility,
when you want to have more control over what's being developed and in what order.
<span class="colorbox1" fs-test-element="box1"><p>Choice between time&materials and fixed fee: checked.</p>What's next? If you're looking for a development partner, explore this ranking of top custom software development companies.<p>And if you'd rather prepare an RFP first, proceed to this free RPF template.</p></span>
Time and materials vs fixed fee - how to decide?
There are three simple questions that will help you to decide:
Do you know exactly (really, in detail) what you would like to build? If no, go with T&M. If yes, you can negotiate the fixed-price, but remember its downsides.
How much is managing the financial risk important for you? If it’s crucial, pay the extra money and go with the fixed price. If not, go with time and material and control exactly what you are developing.
How important is flexibility to you? If important, go with T&M. You’ll be able to prioritize and adjust your project scope every 1-2 weeks. If not important, go with the fixed-price model and wait for end results from your contractor.
Read on to explore fixed price and time&material contracts in detail.
Fixed price contracts in a nutshell
What is a fixed price contract?
In a fixed price contract, product requirements and costs are fixed. You are charged a total price for a project instead of for hours or tasks. A fixed price contract outlines what a vendor is required to do for a firm price.
How does fixed price work in practice?
Initially, along with a vendor you determine a specific rate for the entire project. To do that, you need to put a lot of work to create a plan and thoroughly document the scope of work.
Then, the development team proceeds to work. Every change requires agreement renegotiation.
You see your product when it's ready and make amendments only then.
When fixed price is a good choice?
It’s great for projects of low complexity.
Fixed price fits projects with a clearly defined scope when no changes are anticipated throughout the process.
It’s great when a project’s scope is easily determined from the beginning.
Pros and cons of the fixed price agreement
Advantages of fixed price contracts
The budget is firm. With a fixed price contract, you set aside a certain job and give instructions. You set a certain amount of time and money needed to perform a task.
Minimal project management is needed. Since everything is defined in a contract, you don’t need to spend time on project management - you just wait until the project is done and then check if everything was delivered according to our needs and specifications.
Disadvantages of fixed price contracts
There’s no guarantee you won’t go over budget. Any change in requirements requires budget renegotiation, and if something goes wrong, your product will need fixing and improvements, which also consumes the budget.
You can’t consult hired developers. When you plan every step in advance, you deprive yourself of the opportunity to consult with the hired team during the development process.
Less control. It may seem that a fixed price contract gives you more control, but it’s actually the opposite. The development team will deliver what’s written in the project scope, so you won’t have a chance to consult them, change plans, or give them feedback after each iteration.
Preparations take a long time. Before you can start the project, you need to analyze the market and predict what will work for your users and business. The contract needs to specify it in detail, and developers need to know the scope of work thoroughly.
Risks are involved. In software development, it’s hard to predict so many aspects upfront. You can’t have a finger on the pulse - you revise the product once it’s finished. There’s a risk connected to the quality of a product and the fact that it will fulfil your requirements, and another, connected to possible changes and challenges that may affect the budget. Plus, you need to remember that you pay for each change that wasn’t covered in a contract.
Time and materials in a nutshell
What is time and materials pricing?
In the time and materials contract, you pay for the actual amount of work, based on a daily or hourly rate. That way, you pay for the hours and days developers spend on work. The contract outlines, that you will pay a contractor for the time the team spends working on your project and the materials they use to build it.
How does a time and material contract work in practice?
Together with a contractor, you establish the estimated project’s timeline along with needed resources.
The project is split into parts. That way you establish which functionalities need to be developed first, but during each part, you’re able to make changes and additions, as well as evaluate which functionality should come next to bring the most business benefits.
Developers normally work at a fixed day rate. After selecting the functionality to build, you and your contractor establish the number of days needed to implement it.
When developers complete the tasks and make potential improvements according to your feedback, you are billed for the hours worked.
When time and materials is a good choice?
It’s particularly suitable for complex projects.
It’s ideal when the duration of the project is hard to determine.
Time and materials contract works well when the project scope can’t be precisely determined because of the high complexity or external factors (e.g. market changes).
When a project has dynamic requirements. Changing requirements may be caused by a competitive environment when competitors often release new features.
When you need more flexibility, e.g. to balance resources or cash flow.
What are the advantages and disadvantages of a time and material pricing?
Advantages of time and materials contracts
Control over the project, its direction, and results along the way. On one hand, you control which features to push first, so you can choose those that are key to end users or the ones that bring revenue quickly. On the other, constant contact with a development team leaves you with no surprises.
Budget management. In fact, with a time and material contract, you are more flexible in terms of budget management. You can scale the team up or down, and end the contract when you need it.
Quality. You're in constant contact with the vendor’s team, assessing their work and giving feedback, so you can be sure of the final outcome. With each iteration, you give feedback to a development team.
Flexibility. With time and material contracts, changes aren’t a problem. Plus, the cooperation is open-ended, so when you feel the current state should be enough for the MVP, you can end it. A changing business situation doesn’t force wasting time on contract renegotiation.
Faster start. The cooperation can start faster than in the case of fixed price agreement because you don’t need to establish every detail of what needs to be done first. Instead of talking, you start building your app.
Results are visible faster. You start the cooperation quickly, so the first results also can be seen faster. That allows you also to show the app to potential users or investors quicker.
Disadvantages of time and material contracts
Going over budget. There may be variations in the budget if you change the requirements. But the general belief that time and material contracts end up more pricey is a myth.
Not spending enough time on planning and design. The truth is, a good contractor will most likely start a project with a Discovery Phase. Therefore, you won’t need to worry about too little time spent on analyzing the functionalities and features that your future product needs. Detailed plans made before the development kicks off don’t prevent budget overruns and don’t guarantee the quality of the final outcome.
Choosing a bad contractor. It’s not necessarily a con of a time and material agreement, but rather a thing to watch out for. Time and materials contract gives you flexibility and control, but only in a package with a good vendor.
Time and material contract - management tips
Engage often. It’s important that you (or someone from your company) are a part of the project. It included taking part in meetings, giving feedback, and participating in the process of choosing priorities for the next iteration. By being engaged, you can be sure that the final outcome won’t surprise you and you’ll be able to test and comment on each feature taking care of its quality.
Don’t exaggerate with flexibility. Remember to make decisions focusing on bringing the maximum value to your business. Often simplicity will be a better choice than overfilling the backlog with various features, trying to make the perfect product. Remember that it will also impact your budget.
Time and materials or fixed price - reasons to not decide everything upfront
Does the fixed-price model seem less risky because you know the total cost of a project before its development?
Actually, it just seems that way and it does not really benefit the investor. In a fixed-price model, all business and product decisions, as well as the scope of work, must be decided, declared, and contracted before the project starts – so in the time when you know the least about your project.
In the time and materials model, the cost is based on actual time spent on a project and an hourly rate or man-day rate.
When you don't decide everything upfront, your project benefits in 5 ways:
1. The final product is better because you’re flexible
In the time & materials model, you are able to adjust the project’s requirements and shape to constantly changing business circumstances. This way, there’s no need to renegotiate the contract or conduct painful discussions with the software house to determine whether a feature was or was not in the scope of work.
In the T&M approach, the scope can be adjusted ad hoc. For example:
Do you need some additional functionality? No problem. Let’s do it.
Want to simplify the registration process? Let’s skip the unnecessary features.
Need to slightly pivot your startup? Go ahead. We’ll support you.
Choosing the right technology also helps.
2. The final product is better because you prioritize
Unlike the fixed-price model, when an investor pays for every hour of work he or she analyzes the most features in terms of ROI(Return On Investment). We see it all the time and it’s good! This mechanism helps to build things that are really important for the product. Sometimes these things are not the same as those contracted at the beginning of the project.
Also, our priorities are aligned. The development team wants to deliver the highest quality product. While in the fixed-price model, the software house naturally tends to maximize its margin thus producing the project at the least possible cost.
Choosing the right scope of work is critical in this area. For more information, check out what is a real MVP.
3. The time and material model is faster
A highly detailed analysis gives you a definition of the scope of work before the project starts. These things take time, yet practice shows that nailing all the features is almost impossible. The time & material model allows you to start fast and move at an accelerated pace while working on details along the way.
Also, contracting the fixed-price model takes longer than signing simple time & material deals. That means there’s less time spent on negotiating the paperwork and renegotiating the scope.
4. You save money
It’s not only that but with the time & material model, you only pay for actual work completed while saving time on the project.
Also, to limit the risk of changing requirements, the software house usually charges a premium for the uncertainty (the less information, the higher the premium). In time and material, there’s no reason for this overhead.
5. Time & material limits risk
You don’t know the final cost of your project, but unlike the fixed-price model, you are not committed to the business relationship with a software house until the end of the contract.
On top of that, the time & material model requires significant transparency from the software house. This allows you to track progress and know exactly where the team is at any point.
Finally, ending up with a better product reduces the business risk of your enterprise.
Learn to navigate the fixed price vs time and materials estimates
At the end of the day, most stakeholders will want to choose an option that ensures an optimal product-market fit at a fair price. For small projects with fixed scopes, a fixed price might ensure money is better spent. However, for more elaborate projects, or projects developed in uncertain circumstances, a time and materials approach will provide more flexibility when it comes to the changing product vision, roadmap, and available budget.
Estimating a project's cost is challenging and requires detailed information. However, there are free online calculators you can use to get a rough estimate of the expected costs:
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