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When do software development firms usually recommend a time and materials (T&M) contract?

Amit Ashwini
February 16, 2018

In the field of outsourcing particularly, a well-planned pricing model is an essential component of a successful long-term cooperation. Here, when it comes to economic evaluation, flexibility will prove to be a crucial mechanism. But sadly, pricing is perhaps one of the few aspects of outsourcing where innovation and evolution weren’t as fast as in the case of growth of technologies.

Traditionally, initial outsourcing contracts were built on the fixed price model. Today, the commonly used business model is the time-and-materials model. Picking the correct pricing contract could turn into a tricky issue since it has to fit your company’s operating pattern, contracted goals and requirements, as well as basic expenses borne by the vendor.

Does knowing the entire cost of your project before its development make the fixed-price contract appear less risky to you?

It might seem that way, but it does not come with any real advantages for you. In a fixed-price model, all product and business decisions and the scope of work, before the project starts, has to be cleared out, up front and then contracted. So if you’re starting out with a vague vision, we advocate the time & materials model. Here, the cost is based on actual time spent on a project and an hourly rate or person-day rate.

Below are the advantages of not deciding everything upfront:

  • In the time & materials model, you can adjust the project’s shape and requirements to fit the constantly changing business needs. This way, there'll be no need to conduct painful discussions with the software house or renegotiate the contract to determine whether a feature was in the scope of work or wasn't. To put it simply, the scope could be tweaked ad hoc in the T&M approach.
  • The model helps to build things that are really important for the product. Sometimes these features might not be the same as those contracted at the beginning of the project. Also, in this model both the parties priorities are aligned. Here, the development team can focus on delivering the highest quality product. While in the fixed-price model, naturally, the software vendor tends to maximize its margin, hence producing the project at the least possible price.
  • To get the definition of the scope of work, a highly detailed analysis will give you that before the project starts. This will take a considerable amount of time. However, experience says that nailing every feature is close to impossible. The time & material model will allow you to begin quickly and continue at a faster pace while figuring out details as you go. Further, signing simple time & material deals takes lesser time than contracting the fixed-price model. Meaning, there’s lesser time spent on renegotiating the scope and negotiating the paperwork.
  • In the time & material model, while saving time on the project, you only end up paying for the actual work done. Additionally, your vendor generally charges a premium for the uncertainty, to limit the risk of changing requirements, in a fixed bid model. Lesser the information, higher the premium. There will be no need in the time and materials model, for this overhead.
  • Lastly, the time & material model demands considerable transparency from the vendor. Allowing you to track progress a lot more closely and know exactly how much of the work is done at any time.

The art of estimating and budgeting

 Supporters of fixed-rate contracts will surely point out that the issue with a time and materials contract is that it can be difficult to budget for. This is a valid point because there have been situations where companies outsource development work and are quoted a price that is much lower than what the work ends up costing. However, just because you select a pay-as-you-go pricing structure, doesn’t mean this will happen to you. If the company you are working with has a solid reputation and strong communication skills, you will have nothing to worry about. A reliable outsourcing company will work with you and provide full disclosure of pricing when unexpected changes arise.

Also, it’s worth noting that these software development pricing models might be the most time-proven and common. However, today businesses do apply their combinations and hybrids. Over time, outsourcing has grown to a complex aggregation of different patterns and options, from a fairly straightforward concept. In this complicated chain, business owners should understand that the pricing contract is merely another configuration that they should get down pat and manage correctly. A pricing structure which worked great for another organization with a certain vendor might not necessarily be the best choice for yours.

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Amit Ashwini