Fixed vs. Time and Material Pricing Models - A Breakdown

January 22, 2021

Your startup team has its idea ready to go, you have settled on the right tech partner; it’s time to talk contracts. How do you know before you have even begun development what pricing model is best for your project? You know that you do not want any surprises or overruns or need to renegotiate a contract later as your runway is tight. This is why understanding your options upfront is so critical.

Pricing Model Options

There are two primary types of development contracts: fixed price and time and material agreements. We will discuss the differences between the pricing models, the advantages and disadvantages of each, the best applications, and questions to ask yourself and your development partner at the outset of your project.

Pricing Model Definitions

Fixed Price - A fixed-price contract is a type of contract in project management wherein the payment does not depend on the resources or the time spent. It involves setting a fixed price for the product, service, or result defined in the contract.

This particular type of contract can also include monetary incentives given to the seller, who has exceeded the project objectives. Such project objectives include the scheduled dates of delivery, technical performance, and anything that can be measured by the project managers.

This means that the seller has agreed to deliver work for a fixed amount of money. This type of contract is often used by government contractors to control the cost and put the risk upon the vendor. Thus, sellers who follow the fixed-price contracts have legal obligations to complete the contract, otherwise they must incur financial liabilities if they cannot deliver. Under this arrangement, the buyers should specify the types of products or services that they provide to set a particular fixed price for the deliverables.

Time and Materials (T&M) - Time and materials (T&M) is a standard phrase in a contract for construction, product development, or any other piece of work in which the “buyer” agrees to pay the contractor based upon the time spent by the contractor's employees and subcontractors employees to perform the work, and for materials used in the development (plus the contractor's markup on the materials used), no matter how much work is required to complete the project. Time and Materials models are generally used in projects in which it is not possible to estimate the size of the project accurately or when it is expected that the project requirements would most likely change. T&M is the pricing model most closely related to the Agile development cycle, which at its core is about understanding that many variables are part of the development process, and ultimately the budgeting process.

What Model Is For You?

Fixed Price

Advantages

  • Predictability - A fixed-price contract gives both the startup and the software development firm a predictable scenario, and it offers them both stability for the length of the contract
  • Can also provide the startup a concrete budget as they work with other funders for the next round of funding
  • For the “buyer” - they are protected from overruns if the development team does not deliver as promised
  • The development firm receives a significant payment of the fixed price upfront and additional payments as milestones are achieved, providing them consistent cash flow.

Disadvantages

  • It may drive some development providers to provide solutions as “efficiently” as possible rather than consider what is best for the client’s needs.
  • It can be challenging to make changes to the project’s scope, modify terms, and potentially increase your time-to-market.
  • Since the specifications, budget, and delivery date are fixed, the project roadmap is also usually established. This will also make managing risks difficult.
  • If the development team has a solution that might work better for your tech but does not fall within the predetermined scope, there will probably be no space for them to share these ideas with you. Because in the fixed-price model, the initial plan needs to be followed precisely.
  • There is often little personal interaction between the development team and the startup once the contract has been signed as all the “ins and outs” of a project have been identified.

Best Use Cases For Fixed Price Model

  • You have a clearly defined, short-term project
  • You have a limited budget
  • All the documentation for the project is already in place, such as technical specifications, workflows, wireframes, and user stories
  • You feel confident that the project requirements will not change in the future
  • You are comfortable agreeing on the scope of the project in advance, being hands-off, and delegating the work to the development partner
  • There is a new software development vendor that you want to work with. By working with them on a smaller project, you can determine how well you might collaborate on a larger, long-term project.

Time & Materials (T&M)

Advantages

  • Flexible - the work can be divided into short sprints, evaluated, and a determination can be made as to what constitutes an MVP (Minimum Viable Product). Features can be added or removed to meet the changing expectations of the customer or the marketplace.
  • Transparency - the T&M model ensures that your startup can monitor progress alongside your tech partner as the development team presents the work that they have accomplished.
  • Product quality – The Agile process that accompanies T&M models comprises several iterations, and each of them includes tests. This results in a well-tested product thanks to multiple iterations, resulting in a higher quality final product.
  • Communication - during the numerous iterations, your startup can communicate throughout the process with your development partner at the end of each sprint rather than waiting until the project is complete.
  • Efficiency - additionally, Agile methodologies associated with T&M models allow the development teams to run two or even more development stages in parallel.

Disadvantages

  • Potential lack of control over the project’s budget and the possibility of overruns
  • Uncertain/moving deadlines - changes made to the scope can extend the length of the project and delay releases
  • Projects can become casualties of Feature Creep
  • Solid management required - Product owners must take responsibility and be sure to manage the development process through each iteration
  • Owning difficult decisions - as conditions can often change quickly, product owners and the development team must be ready to pivot swiftly to address shifting market demands

Best Use Cases For a T&M Model

  • The project is complex and is expected to have a longer timeline - usually more than two months
  • Your startup does not know all the final requirements at the beginning of the project
  • You want to begin the development ASAP, but you do not have a fully defined timeline for the project.
  • Your tech specifications and requirements are dynamic and evolving
  • You are developing tech for a quickly evolving market
  • You want to manage the project scope and budget

How To Choose

So which pricing model is better? It depends. You need to evaluate what is the best choice for your startup, your tech, and your business goals. While a fixed price contract may provide you the feeling of safety, it may cost you more in lack of flexibility and product quality. A T&M contract will offer you transparency and agility, but without a committed product owner, your project could run over budget and incur delays.

The critical pricing model selection criteria to find what best fits your project are:

  • Project complexity
  • Project duration
  • Time to start development
  • Level of collaboration your startup expects to commit
  • Volatility in the industry in which you are developing

As you begin your discussions with software development firms, it is important to understand their views on pricing methodologies to be sure that you not only find the right skill sets, but also the right business tech partner for your startup.