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 pricing models you can choose from, and for each particular project, there is one that fits better. Each of them has its business requirements and peculiarities. However, there’s no strict rule on which pricing model to choose.
In this article, I’ll focus on the four most popular pricing models, their pros & cons, and comparison in order to help you choose the one that will suit your project best.
What are software development pricing models?
If your business is constantly evolving, you’ll have to invest in custom software development at some point. 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.
The term appeared many times already, but what is a software development pricing 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 successful IT outsourcing. It’s a type of contract that defines the spread of activities, timeline and overall cost. For example, a software development pricing 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 the type of a project and those connected with the kind of a software product.
It defines how big your project is and what the project scope is. The more sophisticated the project, the higher the price. You will pay more if the project includes research, UX prototypes, design, copyright laws, etc. The scope, among others, determines human resources – the number of people who should be involved in the project. How big should a Dedicated Team 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 to 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.
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). You can read more about software development costs in Gabriela Jarzębska’s article on that point or even find out why in most cases, estimations turn out to be improper.
Time and Materials pricing model (T&M)
Let’s explain the most important of the most popular software development pricing models – the Time and Materials model (T&M).
What is T&M?
A Time and Materials contract offers the highest level of flexibility. It enables the client to alter the project requirements easily. We estimate the approximate budget, project timeline and general scope, but everything can be changed if necessary. The Time and Materials pricing model involves regular payments for completed work.
The customer pays for the actual number of hours spent on the project and all the expenses related to the development of the software, carrying all risks related to the scope of work. The client 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.
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.
Time and Materials pricing model pros and cons
Time and Materials (T&M) contracts have many advantages, including the ability to add or remove features and change project requirements as needed. The client has direct input on the product, and there are no budget or timeframe limits, making it easier to build a successful product. Time and Materials contracts are cost-effective, as clients pay only for the actual time developers work on the project. The development process is transparent, and progress can be tracked easily. Thorough testing at each iteration improves the product’s quality. Once the project details are set, and the contract is signed, development can begin immediately.
And what about the cons of the Time and Materials model? You cannot be sure about the final deadline, as changes in the development process can delay the release. Each product iteration requires careful management, which can be time-consuming. There are many difficult decisions to make – e.g. adjustments. The budget can be ambiguous, as it’s hard to predict the software development costs that may occur at any stage of the project. However, the number of changes you require will ultimately affect the cost.
What should be included in a Time and Materials pricing model?
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 hour amount you can afford to stay within your budget, materials costs and markups, not-to-exceed clause (NTE), as well as the payment schedule.
Fixed-Price pricing model
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 model estimates project costs based on initial work estimates, providing a Fixed-Price budget regardless of actual time or expenses. Clients are assured of on-time delivery and adherence to specifications. Requirements and scope must be fully documented in the contract before development begins.
Fixed-Price pricing model pros and cons
The Fixed-Cost pricing model means you know the software development cost upfront, and it can’t be changed without notice. However, adjusting costs along the way can be difficult and time-consuming. When everything is scheduled and discussed, progress monitoring is straightforward, and the development team can manage the project. Deadlines are strict, and everyone knows what work needs to be done at each stage. This makes the model predictable and beneficial for clients.
However, a Fixed-Price contract has terms that can’t be adjusted after signing, which may delay the app’s launch if changes are needed. The planning phase is detailed and time-consuming, with a risk of miscommunication if project specifications aren’t clear. Quality may suffer as developers prioritize meeting deadlines and contract obligations over quality. Fixed-Price contracts can end up being more costly than Time & Material contracts, as they include risk margins to account for potential budget overruns due to adjustments. If you want to learn more about Fixed-Price contract risks, disadvantages and advantages, I’d advise you to read our separate article about it.
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.
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.
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 pricing model pros and cons
In Milestone-Based contracts, you pay for actual things that have been delivered and can easily control and track the results. What’s more, you can define your own criteria. However, it may take a lot of time to agree in case of a dispute, which can postpone time-to-market. Other disadvantages of Milestone-Based contracts are also unpredictable total costs and no rigid timeframe.
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.
Dedicated Team model
While discussing different types of pricing models, we couldn’t forget about a Dedicated Team model.
What is a Dedicated Team pricing model?
A Dedicated Team pricing model 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 outsourcing 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.
Dedicated Team contract pros and cons
The main advantage of the Dedicated Team 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 of the software development pricing models 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.
When to use a Fixed-Price pricing strategy?
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 to be 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.
When to use a Time and Material pricing strategy?
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 specifications are evolving, and it’s important for the client to control the whole project. It might be 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.
Fixed-Price vs Time and Material pricing model
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 Materials model in the comparison table below.
- 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.It’s better to be aware of risks and challenges that comes with Fixed-Price contracts. You can find more about it in Gabriela’s article on our blog.
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.
When to use a Milestone-Based pricing strategy?
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.
When to use a Dedicated Team pricing strategy?
The Dedicated Team billing model is a suitable choice when you have a long-term project with changing requirements and need an in-house team of experienced developers to work exclusively on your project. This model offers more flexibility, transparency, and control than other models. You should consider such a model if you want to have a higher level of involvement in the development process and adjust the team size and composition to your needs.
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).
The pricing 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 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 out my article on how to select the best company. I’m sure it will be helpful.
If you need help choosing the right software development pricing model, contact us! We’ll schedule a free consultation to help you decide which model is perfectly aligned with your business needs.
Since 2016 Mike has been helping international companies to gather and analyse requirements for their apps-to-be and guides them through the first stages of the development process. He aims to help our clients reach their business goals by focusing on their target groups.
Having such a background, Mike shares his knowledge to help companies choose the best software developer that suits their needs.