Fixed-Price Contracts vs. Time&Materials Contracts: How to Choose the Most Suitable One
Software development business looks like a bowl full of multiple ingredients originating from virtually all areas of the economy: Science, Engineering, Psychology, Commerce, Customer Relations, Banking, Accounting etc. All these ingredients add something peculiar to the business and make it a unique blend.
One of the most essential factors in the relationship between a customer and a software development contractor is pricing, i.e. how the services and work are priced and paid.
At present, the most common pricing options are fixed-price and time&materials models.
Finding it especially important for us to choose the most suitable option, DIGIS has contacted some subject matter experts dealing with procurements, sales, and contracts in general.
Mr. Mark Beha, Senior Vice President for Hinz Consulting, provided his extended comment on the subject:
“One frequently hears the question “When should I use a Fixed Price contract type as opposed to a Time & Materials contract type?” Much has been written about the features, benefits, and risks associated with each respective contract type, but it is still hard to find a decision matrix that can help you decide which type to use in real-life situations. The decision on which contract type to use should be based on your organization’s requirements for Cost, Schedule and Performance. What are the Cost, Schedule and Performance Risks that should drive your decision? The Contract Type Decision Matrix below is not meant to be blindly used a template, but it can serve as a basis for building your own informed, situational-dependent Decision Matrix for determining the best contract type (limited to FP and T&M for the purposes of this discussion) for each procurement action to maximize results and lower risks.
If it is still unclear which Contract Type should be used, apply “weighting” to the matrix above depending on which parameters are more important to your organization for a particular procurement action. For example, Schedule may be more important than Cost considerations on a given procurement, if your ability to deliver to an important customer by a promised delivery date is dependent upon this contract action. So, in the case of this example, a Fixed Delivery Schedule may be weighted more heavily than Cost considerations.”
Mr. Anton Krawez, Capital Markets and Accounting Advisory Services Manager for PwC, shared his opinion as well:
“ I think that if a procurer knows what he wants and can specify the product very well, it is fine to go with a fixed price contract. If the requirements of the product are however not completely defined it makes more sense to work on a time and materials basis because then you don’t have to manage the budget aspects of constantly appearing change requests and new requirements.
As regards the fixed-price model pros and cons, they are:
Pros: You can optimize the price of the product and if necessary change the supplier if quality is not met. No work supervision is necessary.
Cons: It is difficult to define the product in its totality.
At the same time, time&materials model has the following advantages and disadvantages:
Pros: You are a lot more flexible and can manage new features on an ad-hoc basis.
Cons: You need to manage yourself the time and material and constantly supervize work.
If I would opt for the fixed-price model, I wouldn’t take a possible higher project cost as a disadvantage, as it is balanced by the advantage of being able to reject the project if it fails to meet the requirements.
But, since I’m doing more ‘uncertain’ kind of projects which contain a lot of changes on the way, Time&Materials works better for me.”
Let’s now define what Fixed-Price and the Time&Materials Contracts are and see how they compare.
What is a Fixed-Price Contract?
As it can be seen from the name, Fixed-Price Model means that a scope of services or works is performed by a contractor for a certain fixed price. This fixed price may or may not include a security portion to account for the risks the contractor takes.
What is a Time & Materials Contract?
As opposed to a fixed-price project, a time & materials type is when the customer pays exactly for the contractor’s time and materials spent on the project implementation. This type of relationship actually anticipates that nothing is carved in stone and that the project scope, budget, and timing can be changed en route.
Fixed-Price Model Breakdown
Time & Materials Model Breakdown
What DIGIS Thinks
Based on our experience and considering the Mark Beha’s Contract Type Decision Matrix, we have worked out our own approach as to when which pricing model should be used. Here you go with it.
When the Fixed-Price Contracts are better:
1.When You Have Precise and Clear Understanding of the Final Product, Its Development Process, Schedule, and Relevant Requirements
It means that if you have studied all possible aspects of the desired product, clearly defined all the requirements to its architecture, design, performance etc., you are free to go with the fixed-price model. The only crucial point here is to have all your requirements and instructions perfectly documented, in order to protect you in case of unexpected events.
2.When Your Contractor Is Capable of Providing You With Perfectly Detailed Estimate of the Product Development, Schedule, and Cost
Even if you are not absolutely sure what exactly you want, you may be lucky enough to find a contractor which is able to ask perfect questions to have all the aspects and details clarified and documented.
3.When Your Project is Relatively Small-Scale
If the project scope is not overwhelming and has no complicated components, it’s good to apply fixed-price approach as it will surely cost you less.
When the Time & Materials Approach works better:
1.When You Are About to Outsource A Huge Project
Huge projects mean huge scopes of work, and if you choose the Fixed-Price Model you might not be able to monitor the project development until its completion. As a result, you may obtain at the end something absolutely different from what you requested. Opposite to that, Time&Materials Model lets you divide the entire huge scope into smaller portions and easily control their accomplishment. It also lets you better plan your project budget.
2.When You Want and Have Time to Keep Hands on the Project Pulse
If you want to be directly involved in the project implementation, communicate with the project developers, be one of the first to see the project growing from an idea to something perceivable and operation, pick up Time&Materials Method. The bottleneck is that such involvement requires plenty of time. But if you have it, no problem then.
Summing up: We here at DIGIS cannot predict and instruct you on which approach to choose for your projects. This thing is very personal and depends on many different factors to be accounted for. The only thing we can do here is to recommend you to objectively analyze your idea, concept, requirements, budget and alike and them pick up the most suitable option.
Develop your own Decision Matrix and Weighting Scale to compare the importance of various factors for your project.
If you want to be more confident in that how your project will evolve, you may decide to choose the Fixed-Price approach.
And vice versa, if you want more involvement in the project and if you want to get flexibility in its course, the Time&Materials will certainly work better.
If you still aren’t sure what to choose, you may contact us, and we will help you to pick up the most suitable option for your project cost, schedule, and performance.
