Fixed price vs. time and materials contract: Which one to choose for your project?

Choosing the right pricing contract for outsourcing app development is one of the key decisions you need to make before sealing the deal. Does the predictability of fixed price models go well with the nature of your project, or do you need the flexibility of the time and materials (T&M) contract type to adapt to the evolving product scope? While both options have their pros and cons, the final choice hinges on your specific project variables. 

We've prepared a time and material vs fixed price comparison to help you choose the pricing option that makes the most sense for your project.

Key takeaways

• A fixed price contract works well for predictable projects with a well-defined scope and with low odds of mid-development changes.
• The time and material pricing model lends itself well to projects where requirements change, priorities shift, and the full scope is not clear from the start.
• The choice of a suitable pricing model is made based on the project specs, clarity of project requirements, and the level of involvement the client prefers.

What is a fixed-price contract? 

As the name implies, a fixed-price contract is an engagement where a client and a service provider agree on a fixed scope of work, deadlines, and payments. Contrary to popular belief, the project scope doesn't have to be completely rigid — companies can add new features to the scope if necessary. However, these additions are priced separately and can only be implemented after the original scope is completed.

How does a fixed-price contract work in practice?

The fixed-price model requires that your tech partner fully understand the task and timeline in order to provide an accurate bid. Usually, if a project is done on a fixed price basis, the vendor has already delivered similar solutions and knows how many resources go into completing such software development projects. So, they're capable of providing you with an exact budget estimate upfront, without any surprise costs down the road.

Step 1: Defining the scope

Under the fixed-price contract, your collaboration with the tech partner kicks off with a detailed requirement breakdown. The tech partner works with your team to define app features and functionalities and then documents product specifications, visual elements, and layout, acceptance criteria, and other product specifics.

Step 2: Project estimation and contract signing

Following a detailed project specification, the development company estimates the total cost and timeframe for completing the project. Once you agree on the scope, price, and timeline of the project, you sign a formal contract that clearly outlines all the deliverables, milestones, payment schedule, and change management process.

Step 3: Development and delivery 

Guided by a structured development approach, the development team builds your application according to the defined scope. Fixed-price contracts do not allow for high-level changes, while minor tweaks are possible, provided they’re technically feasible. 

Any changes to the scope are handled via a change request and priced separately. Once the app is ready, the development team delivers the final product to your team so you can evaluate it against the acceptance criteria.

What are the pros and cons of a fixed-price model?

A fixed price model is quite popular among companies due to its predictability and easier risk management. However, it's not a silver bullet, so for some projects, it can turn out to be a poor match. Below are the pros and cons of a single-sum price agreement.

Pros of fixed price contracts

Fixed budget

With a lump sum contract, a client knows the tentative budget beforehand. The final price of the project is established and locked into the contract, and the project remains aligned with the client's expectations throughout the development, allowing the client to budget with confidence.

Fixed deadlines

Fixed price contracts offer a clear project timeline from the outset, as the project's scope is set in advance. This predictability allows companies to plan post-launch activities, such as marketing campaigns or team training, well in advance.

Minimal client oversight required

Although this pricing contract doesn’t imply an entirely hands-off approach, the client’s involvement in the project is kept to a minimum, thanks to a well-documented scope and vision. The development company is in charge of allocating resources and scheduling work while the client approves deliverables at key milestones.

Reduced risks

Thanks to cost clarity and well-defined project scope, this pricing model reduces the risks inherent to the development process, such as budget overruns. Also, this contract transfers a significant portion of the project's financial risk from the project owner to the contractor.

Fixed price contract cons

Little room for flexibility

As previously mentioned, any changes out of scope require a contract modification. A fixed fee contract is ill-suited for iterative development as it's hard to incorporate new features discovered during the development process.

Slow project launch

The customer and the software development company can spend a substantial amount of time planning out the product development roadmap in detail. This time-consuming process can be a potential drawback when it comes to short deadlines. At Orangesoft, we streamline this process through workshops and pre-built templates, but it may still take a while.

Less control

Fixed-price projects may come with a high-risk profile as you don’t have direct oversight of the development team's code or daily processes. With this model, the vendor is fully responsible for the team and project management, while you can check in with them at key milestones. 

Higher project cost

To account for unforeseen technical challenges, software development companies often include a buffer in their cost estimates for fixed-price projects. This buffer provides peace of mind for both parties, but may translate into higher project costs compared to the time and materials approach. 

Scope creep is another concern associated with the fixed price agreement, as all unexpected requirements are priced outside the original agreement.

When is it best to choose fixed-price software development?

The rule of thumb is to choose a fixed-price contract for straightforward and predictable custom software development projects with a well-defined scope. Use cases for this pricing contract also include:

• Small projects with basic features that don't exceed three months in duration
• MVPs with a limited budget that require basic features initially
• Projects with tight deadlines and budgets
• Projects with a set of predetermined features

What is a time and materials contract?

Under the time and material model, clients are billed based on the time logged by the development team and resources used for implementing the software solution. Unlike fixed-price projects, T&M contracts don't have the project's total cost set in stone, as it depends on the number of hours and resources poured into the project. This engagement form also allows you to scale development up and down as and when needed. 

How does a time and material contract work in practice?

The time and materials model allows the project to pivot based on the incoming insights and changing circumstances. The project evolves through continuous collaboration between the client and the development team, with the entire project scope divided into smaller, manageable phases. After each phase, the team can revisit project priorities, adjust the project scope, and drop low-value tasks.

Step 1: Initial project kickoff

This pricing model doesn't require you to solidify the project's direction and its scope right out of the gate. During the initial phase, the development team focuses on the project's core functionalities and goals, along with a general development roadmap. Together, the team and the client establish high-level priorities for the project, creating a shared foundation before diving into detailed execution.

Step 2: Estimation and breakdowns

Based on the core functionalities, the development team prepares an initial estimate that tallies up the time and resources required for the primary development phase. As the project progresses, the team can make price adjustments to factor in new requirements or unforeseen tech challenges. However, in a well-managed development environment, those price adjustments shouldn’t swing wildly unless the scope itself changes dramatically at the client's request.

Step 3: Iterative development based on feedback 

Such an agreement supports an iterative development approach, where the development team works through a predefined set of features in each sprint. As a client, you’re closely engaged in the development process, providing feedback at the end of each sprint and prioritizing features for the next iteration. 

Throughout each sprint, you'll be billed based on the actual hours worked and the resources used to build up the functionality.

What are the pros and cons of the T&M contract model?

Time and material contracts give you the freedom you need to successfully complete projects with a dynamic scope. However, to benefit from this flexibility, you need to approach your project with clear communication and cost awareness.

Pros of the T&M contract model

High flexibility

T&M contracts give teams the flexibility to respond to changes quickly. They support a product mindset, where features can be adjusted based on user feedback and evolving priorities. The team can reprioritize tasks in the middle of the development process, add or remove features from the roadmap, and adjust the scope to focus on the highest-value project outcomes.

However, this flexibility shouldn't derail the project or lead to unchecked scope creep. To keep the project on track, a dedicated project manager must keep track of tasks, hours, and changes in real time, along with defining clear criteria for adding or removing features. The client and the team should check in frequently to assess the project and align on the priorities.

Fast project launch

The T&M pricing model is particularly favored by startups under time pressure, because it doesn't require companies to think through every detail of the project scope. The team can start with a set of core features, test them against real user needs, and refine the functionality based on the feedback. Also, planning stages are shorter than in a fixed-price project, allowing the companies to hit the ground running.  

More control over the project

Such an approach offers a more collaborative, flexible environment that puts the client in the driver's seat. As a client, you are involved in all the development phases, including sprints, iterations, and meetings where you can discuss the progress and course-correct if needed.

Also, with this pricing model, you can control resource allocation and decide which features to focus on first. 

Reduced risk

With phased development, early feedback, and close collaboration with the development team, you have fewer chances of getting a product that doesn’t resonate with your vision and real user needs. As the scope isn't fixed upfront, you can adjust your development as the project proceeds.

Cost transparency

Regular reports on time and resource usage keep the client in the loop about the project's progress, allowing them to catch cost overruns early. Also, with T&M contracts, the client can call the shots about the amount of time a team spends on a specific task and adjust the scope whenever it goes beyond the established budget range.

Cons of the T&M contract model

Uncertain budget

Unlike fixed-price contracts, the time and materials (T&M) model allows for mid-project adjustments that aren’t factored into the project budget beforehand. While this flexibility is great for perfecting the product, it also makes financial planning more challenging and can lead to unexpected costs down the road.

Uncertain deadlines

T&M contracts allow clients to start a project without a clearly defined scope. However, this also means that unforeseen requirements can increase the lead time, extending the actual release date beyond the expected deadline. 

Requires deeper involvement

Even though it seems like a big plus for some clients, for others, close involvement in the project can become a burden on top of their regular roles. Although the right project management approach can offset this drawback, T&M contracts still require significant time commitment from stakeholders.

When is it best to use a time and materials contract?

Time and materials contracts are a good mesh for projects where it's hard to pin down the final cost or the timeline of the project upfront. Examples of such projects include:

• Large-scale and long-term projects with flexible requirements
• Projects with an unclear scope
• Projects revolving around changing market needs

Fixed price vs. time and materials: head-to-head comparison

Each cooperation model has its obvious advantages and disadvantages. The flexible nature of the T&M model can cover all the unanticipated overages, while a fixed budget and deadline can help you get your well-defined projects delivered on schedule. To help you make the right call, let's compare both types of contracts head-to-head:

As you see, at the end of the day, an optimal pricing contract depends on your specific project needs and priorities. Take into account the criteria above to determine which approach brings the most value and cost-effectiveness for your software development project.

Summing up

Both cooperation models have their benefits and drawbacks, and each has its use cases. To choose a suitable pricing model, you need to understand your project scope, time, budget, and the level of involvement you want and can afford.

At Orangesoft, we are comfortable working on both a fixed-price and a T&M basis. If you need help with choosing the right pricing model or want to get an accurate estimate on your project, you can always reach out to our team.