Table of content
- What are software development billing models?
- What defines the project costs?
- Time and materials (T&M)
- Fixed price
- What is the difference between a time and material and a fixed price model?
- Milestone-based model (a mixed model)
- What is a dedicated team pricing model?
- Which billing model will be the best for your project?
Creating custom software can be an exhausting and daunting thing, especially if you have a limited budget but at the same time, you have serious business needs and a sophisticated app idea.
Creating a software product is not only about writing and executing code. It’s about managing the whole project, which includes multiple aspects – business analysis, design, software architecture and development, testing, deployment, and maintenance. All the elements mentioned above are usually specified in a software development agreement (contract).
Software development contracts also specify when and how payments will be processed. There are a few major contract models you can choose from, and for each particular project there is the one that fits better. Each of them has its business requirements and peculiarities, however there’s no strict rule on which billing model to choose.
In this article, I’ll focus on the most popular pricing models, their pros & cons, and will compare them to help you choose the one that will suit your project best.
What are billing models?
If your business is constantly evolving, at some point you’ll have to invest in custom software development, and a lot of companies decide to outsource it. There’s no difference whether you’ll need an app to manage internal processes and supply chain or provide the best app possible to your customers – there’s always a contract to sign. In many cases, it’s the contract that defines the software development costs.
Even if you have prepared the well-articulated specifications, most likely you still want to avoid getting bogged down by the various steps involved in creating a robust software solution. To do that, you have to choose the right software development billing method.
The software development pricing model you choose can actually make or break your software development process. It’s crucial to choose the one that would perfectly respond to the general scope of your needs because it affects the entire development process and provides business value.
So, what is a software development billing model? Simply speaking, it’s a model of what you pay for and what benefits you will get from your project. It’s one of the crucial steps of a successful IT outsourcing. It’s a type of contract that defines the spread of activities, timeline and overall cost. For example, a software development billing model determines the number of hours spent and the end result delivered within a certain time frame.
What defines the project costs?
Each software development company has probably heard a question: why is it so pricey? Many times. In fact, there are many factors that affect the price of a software product. They can be divided into two groups: those connected with a type of a project, and those connected with a kind of a software product.
It defines how big your project is and what the project scope is. The more sophisticated is the project, the higher is the price. You will pay more if the project includes research, UX prototypes, design, copyright laws, etc. The scope, among the others, determines human resources – the number of people who should be involved in the project. How big a dedicated team should be? Is one project manager enough? Do you need a product manager on the team? Also, project complexity matters. The main pricing models are different if you only need an MVP or build a full product from scratch. Do you need integrations? Or maybe you’re just adding new features to an existing product? All those aspects affect the final cost.
Software product type
The functionality of the app is one of the most important factors in custom software development projects. How many major features will the app have? The more features your app has, the higher the overall cost and the longer it takes to build it. Do you need only a web platform, or a mobile app as well? The software product size and type are normally directly proportional to the software development cost.
There are also external factors like deadlines, as well as the vendor’s expertise, reputation and size. If you want to speed up the time-to-market of your app, the project may be more expensive than expected. If you choose a well-known, popular vendor instead of a small, local software house, the developers’ hourly rates will probably be higher (but you’ll most likely get a better final product).
Time and materials (T&M)
Let’s explain the most important of the most popular software development pricing model – the time and materials model.
What is T&M?
A time and materials model offers the highest level of flexibility. It enables the client to easily alter the project requirements. You estimate the approximate budget, project timeline and general scope, but everything can be changed if necessary. The model involves regularly paying for work completed. The client carries all risks related to the scope of work.
How does T&M work?
The customer pays for the actual number of hours spent on the project plus all the expenses related to the development of their software. They can test the product, suggest changes, approve developmental stages, etc. Such a contract provides a great deal of time, scope and financial flexibility, given that early estimates have been established. In this model, payments are to be conducted regularly.
There may be some changes in the project, mainly because of your competitors’ moves (launching projects like yours and providing your target audiences with what they need), dissatisfying design elements that lead to adjustments, improvements recommended by the development team, and simply the need for adding new features.
T&M contract advantages
There are many pros to a time and materials contract. The most important are:
- You can add or remove features and project requirements can change up to speed. The client has a direct impact on how the product will work and look. Budget and timeframe aren’t limited, which is helpful if you want to build a successful product.
- T&M contracts are cost-effective – client pays only for the actual time developers have worked on the project.
- The software development process is clear and transparent, the progress can be easily tracked up to speed.
- The product is thoroughly tested at each iteration, which increases the quality.
- Once the project details are set and the contract is signed, the development can be started immediately.
T&M contract disadvantages
And what about the cons of time and materials contracts?
- You cannot be sure about the final deadline. Changes and adjustments in the development process can postpone the release (but those are up to you, so you have a direct impact on the project).
- Every iteration of the product has to be carefully managed which takes time (but a reliable company knows how to manage the project efficiently not losing too much time).
- There are many difficult decisions to make – e.g. adjustments.
- Ambiguous budget – you cannot be affirmative on the software development costs that may occur at any stage of the project (but still, it depends on you how many changes you’ll need).
When to use a time and materials contract
Time and materials contracts are perfect for projects where the scope and requirements are hard to finalize at the beginning. They are often chosen by businesses that want to build software projects lasting at least 2-3 months with advanced project management. The time and materials pricing model works great if technical specifications are evolving, and it’s important for the client to control the whole project. It might a good choice for building cross-platform apps because of the development complexity. Consider this model if your key objective is to deliver the highest quality possible.
What should be included in a time and materials contract
If you’re just about to create a time and materials contract, make sure it includes the following: hourly rates of the members of the software development team, maximum hours amount you can afford to stay within your budget, materials costs and markups, not-to-exceed clause (NTE), as well as the payment schedule.
Now, let’s dive deeper into the equally popular software development pricing model – a fixed price pricing model.
What is a fixed price model?
A fixed price pricing model is based on an estimate of the amount of work that needs to be done. It guarantees a fixed budget for the project, no matter the actual work time your development partner spent and expenses they incurred. The client can sleep tight as they know they will get exactly what they need and on time. The key priority is to meet the terms that have been specified in the fixed price contract.
How does a fixed price model work
In this model, it’s crucial to write down all project requirements and the project scope in detail. The contract ensures that a project is done and delivered within a specific timeframe and fixed budget. You cannot enter the project development stage before finalizing the contract. In fixed-price contracts, both a service provider and a client carry some scope-related risk. However, if there are new features that weren’t specified in the contract, the client must pay extra. Such a model may make risk management a bit problematic – it’s not easy to monitor the project’s progress.
Fixed price contract advantages
These are the most important advantages of a fixed price contract:
- You know the exact software development cost right after the contract is signed. It cannot be changed by the software development company without notice. However, it can also be a minus as cutting the costs on the way may be a bit tricky – if you decide to do so, you have to waste time making changes to the contract.
- If everything is properly discussed and scheduled, it’s easy to monitor the progress.
- You don’t have to supervise the project completion, everything can be managed by the development team.
- There are strict deadlines and everybody in the software development team knows what work should be done at any stage of the development process.
- This model is highly predictable for a client.
Fixed price contract disadvantages
And what about the disadvantages?
- Terms cannot be adjusted after signing the contract. Even if there are market changes or a new feature is not already needed, it’s impossible to accommodate that unless you make changes in the contract (which delays your app’s expected launch date).
- The planning phase is long and in-depth. Paperwork takes a lot of time.
- There is a risk of miscommunication if the project specifications aren’t clear.
- It may put quality at risk – hired developers may focus more on meeting deadlines and fulfilling the contract than on quality while building software.
- Very often, a fixed price contract eventually results in higher software development costs than a T&M contract – such software development contracts include some additional amounts (risk margin) since service providers want to prevent risks associated with a budget overrun in case of adjustments.
When to use a fixed price contract
A fixed price model is perfect for you if you want to create software within a specified budget and time. It’s recommended for small and short-term projects where it’s more likely that requirements are not going to change. It’s often chosen by clients who don’t need and don’t want to be involved in the project (changes, suggestions, etc.). Such a model is perfect for MVPs or checking the capabilities of the software developer before establishing a long-term collaboration.
What should be covered in a fixed price contract
To sign a fixed price contract, you need to have all the necessary documentation for the project. It should include technical specifications, workflows, wireframes, user journey maps, etc. The contract has to include the service provider’s and the client’s duties and areas of responsibility in detail (deliver data, quality standards), as well as the budget.
What is the difference between a time and material and a fixed price model?
No software development projects are alike. Thus, you should carefully consider all aspects of your long-term project to make sure all your project requirements are met within a contract between you and a chosen software development company (choose it wisely, considering all key aspects. If you need a hand, check my article on how to choose the best contractor).
Fixed-price agreements are recommended if you have a limited budget for your custom software project and the project itself isn’t complex. It works for apps where predictability is more important than flexibility.
On the other hand, a time and materials contract is recommended for long-term, complex, or large-scale projects that should be implemented with agile in mind.
See the most important differences between a fixed price pricing model and a time and material model in the comparison table below.
Fixed price model
There are clear requirements and estimations before a project starts.
The cost is estimated once the requirements are frozen.
No changes can be accommodated (unless the contract is changed).
Perfect for short-term, small-scale projects.
Works for tight or fixed deadlines.
Time and materials model
Requirements can evolve as the software gets created.
The budget estimation is based on user stories that can change.
Resources and timelines are flexible and can be adjusted if needed.
Perfect for complex, long-term projects.
The timeframe is flexible.
Milestone-based model (a mixed model)
Finally, something between fixed price contracts and time and materials contracts: a mixed model, also known as a milestone-based model.
What is a milestone-based model?
A mixed model is based on tight and strict deadlines. However, it allows flexible changes if a client decides that they are needed. It’s often used by companies that want to release a product within certain timeframes, but the requirements aren’t clear enough.
How does a milestone-based model work
A milestone-based model works as a combination of a fixed price model and a time and materials pricing model. It allows you to alter the scope of the project and ensures as many revisions as needed. A client is billed when a software development company has implemented a specific milestone over a certain time. They pay an amount that depends on the time spent and the things achieved. Usually, there are weekly or two-week sprints that serve as the measurement of the project to some extent.
Milestone-based contract advantages
The most important advantages of the model:
- You pay for actual things that have been delivered.
- You can easily control and track the results.
- You can define your own criteria.
Milestone-based contract disadvantages
The main disadvantages are:
- The total cost cannot be predicted.
- There is no rigid timeframe.
- It may take a lot of time to agree in case of a dispute, which can postpone time-to-market.
When to use a milestone-based contract
A milestone-based model is recommended if you mainly focus on launching the product at the earliest. It works for medium size and short-term projects. You should consider such a model if you don’t need a limited timeframe and you are ready for changes. To implement such a contract, parties need to trust each other.
What should be covered in a milestone-based contract
You should clearly specify the scope of work for each milestone. Also, make sure you estimate the number of hours spent by a contractor on building your product.
What is a dedicated team pricing model?
While discussing pricing models in software project development, we cannot forget about a dedicated team pricing model. This approach is similar to building an in-house team. However, instead of recruiting, training and hiring a team you only use their knowledge and experience (if you’re not sure what is better, hiring employees or a software development team, check the pros and cons of software development).
Such an approach is flexible – your monthly cost depends on the monthly salaries of the hired employees instead of interval pay. When you manage to compose your dedicated team, you can easily predict the monthly cost of the entire project.
The main advantage of this model is a great level of control over software development projects. You have direct access to all information and the power to personally interview all the members of the software development team. You can request resumes of developers and interview them individually, as well as change the size of the team according to your needs.
On the other hand, you have to invest your time and effort to monitor the working process and team management. Also, you should know the exact time spent by each member of the team to predict the project cost.
A dedicated team pricing model is perfect for you if you want to make a direct impact on the developmental phase and if you want to tightly control the budget. It’s a great option if you have solid experience as a project manager.
If you’re about to choose the contractor for your project, check my article on how to select the best company possible.
Which billing model will be the best for your project?
So, how to choose the right one among software development pricing models? Usually, the main selection criteria are project complexity, budget and timeframe, team size and the level of control a client expects. A fixed price model will be great if there is a fixed scope and a limited budget. If the project is flexible and you can easily adjust requirements, a time, and material pricing model will be a better fit. If the parties have a trusting relationship and solid foundation, they can select a milestone-based or a dedicated team model.
So, the choice is all about budget, deadlines, trust and expectations of quality.
The billing models mentioned above are applicable to any software development project. The case is to choose the one that suits your needs best. Although the fixed price pricing model seems more attractive at the first glance, a T&M contract eventually means lower app development costs in most cases.
Before you decide on one, gather all your software requirements to be sure that you’re making the right decision according to the project’s specifications and project roadmap. If you need a hand with gathering requirements for your app, check Gabriela’s article on how to write a software development requirements specification.
If you’re comparing development teams, check my article on how to select the best company. You can also download the checklist template to make the process easier and more impartial. I’m sure it will be helpful.
If you need help in choosing the right pricing model, contact us! We’ll schedule a free consultation to help you decide which model is perfectly aligned with your business needs.