Although these are the most common and well-proven methods of software development pricing, it is worth noting that many modern firms also use a hybrid approach. In this article, we will look at the pros and cons of both firm fixed price contract vs time and materials agreements.
A "fixed price agreement" is a lump sum payment contract in which the main parties agree that the service provider will complete the task for a specific deposit amount or less. It is an excellent basis when you know your requirements, the rates are predictable, and you know how much it will cost. The client must provide the engineers with a detailed description of the product they see.
The difference between time and material and fixed price is that time and materials (T&M) contract means that the contractor is paid based on the actual hours spent on the job. The client pays an hourly rate for each completed task plus material costs. The flexibility to adjust criteria, change directions, exclude features, and involve end users in producing the desired product is a significant advantage of the T&M model.
When to Use a Fixed Price Contract?
Fixed price contract vs time and material has obvious advantages and is better for a range of situations:
- for specific tasks with clear deadlines;
- for smaller projects with a narrow focus;
- for MVPs;
- and for projects with fixed or small budgets.
When to Use T&M Contract?
T&M pricing agreements are outstanding for long-term projects with changing requirements because they allow a pay raise and an implementation of additional changes. The model would be instrumental:
- if you want to adjust the scope or workload of the project as needed;
- when the scope of the project has not yet been defined or established, e.g., during the initial bootstrapping phase;
- for maintenance work because it lets project owners pay only for the number of person-hours needed to finish the job, which is especially helpful when you need support 24/7;
- when a project needs to be completed quickly to meet a deadline, even with a possible risk of overbudgeting.
As soon as we discovered time and materials contract vs fixed price construction, let's dive into their benefits and drawbacks.
Fixed-price contracts, like any other type, have advantages and disadvantages. Weighing the pros and cons of each option can help you understand which arrangement is ideal for a particular project.
Your approach determines the average difference between fixed price and time and material, whether you stick to strict budgets or prioritize features.
Fixed Price Benefits
In fixed-price contracts, the contractor, not the project owner, bears the main financial risk. The contractor must perform the work within the established schedule and budget. As a result, the web development schedule and cost can be predicted with greater accuracy and confidence.
Fixed-price web development contracts have less burdensome reporting and accounting requirements for project owners than time-and-materials contracts, which require owners to invoice all costs incurred (along with supporting documents such as timesheets, expenditures, etc.).
While defining the scope of work is essential for all contracts, it is crucial for firm fixed price level of effort vs time and material, as minimizing the number of change orders is critical for the project owner to stay within budget. The total cost of a fixed-price contract is known from the outset, with a clearly defined scope of work and a minimum number of change orders. As a result, predictability and certainty are likely to increase.
Fixed Price Drawbacks
Fixed-price contracts give a software development company less administrative reporting and accounting work. Still, they sometimes offer different levels of insight into how well the contractor is doing in terms of costs.
The inability to bargain for a lower price for the same service or product narrows the range of potential outcomes. If the final project cost is less than projected, the contractor makes money on the savings. When you compare fixed price model vs time and material, you'll see that changes in the project scope are more challenging to make under a fixed-price contract because the contractor's bid is based on the timing and method of project delivery.
Time and Material Benefits
The owner benefits financially when a project is completed on time and within budget. T&M agreements provide greater transparency regarding the owner's actual expenditures during project implementation.
If you compare fixed price project vs time & material, you'll see that though the T&M project owner will need to be more active, it will have greater access to information about the progress of the project as a result.
Owners often need to move forward quickly, and T&M contracts allow them to do so by having them pay for goods and labor upfront. Fixed-price contracts require extensive bidding and scoping, and the direction of the work is often unpredictable until an estimate is determined and a work plan is drawn up.
Time and Material Drawbacks
The business owner bears all financial risks; hence no risk sharing. Comparing fixed price projects vs time and material, we see that owners are obliged to reimburse any costs that exceed the established budget in the latter. Regarding scope extensions and changes, contractors and project owners should control T&M contracts in the same way as fixed-price contracts. To avoid cost overruns and delays, ensure that everyone is informed and aware of changes made to the project.
Suppose project teams, owners, and contractors have different opinions about T&M and fixed-price contracts regarding scope definition, project control, and project execution strategies. In that case, this can lead to poor project management and budget overruns. When choosing time and material or fixed price model, you need to remember this.
In contrast to fixed-price contracts, project owners must be more involved in the administrative side to keep up with reporting and accounting. While the benefits are attractive, the cost of the owner's time can be prohibitive. The contract for the purchase of materials and time often requires additional documentation from the owner.
Due to the lack of competition, some contractors may try to take advantage of this type of contract by overestimating their expenses, knowing they will still be reimbursed.
