Which software development pricing model to choose? Fixed price vs. T&M vs. FPSC

When engaging in a software project, it’s crucial to establish a clear payment model that outlines how the client will compensate the software development team. This model will impact the project’s dynamics, timeline, and overall success.

So, how do you choose the right pricing model for your project?

In this article, we’ll discuss the 3 pricing models:

1. Fixed Price
2. Time & Material
3. Fixed Budget, Flexible Scope

The project management triangle

The Project Management Triangle consists of three key constraints: scope, time, and cost. In the context of pricing models, each model handles these constraints differently.

• Fixed Price models typically fix all three aspects, potentially sacrificing quality or flexibility when unexpected challenges happen.
• Time and Material models keep scope and time flexible but may lead to unpredictable costs.
• The Fixed Price, Scope Controlled model attempts to balance these constraints. It fixes cost and core scope elements while allowing flexibility in non-essential features and timelines.

Understanding how each pricing model interacts with these constraints is crucial for choosing the right approach for your specific project needs and risk tolerance.

1. Fixed-price model

Scope: Fixed

Schedule: Fixed

Budget: Fixed

Quality: At risk

A fixed price model is a pricing structure where the total cost of a project is agreed upon upfront, regardless of the time or effort required. It’s said to work well for projects with very clearly defined requirements and minimal expected changes. It provides budget certainty for clients, which can be appealing. Yet, it’s main “benefit” – the fixed scope – is simultaneously its biggest disadvantage.

The problem with the fixed-price model

There are a few considerations that come with fixed price:

• Requires very thorough upfront planning and scoping
• A software service provider will often include a buffer in the price to account for uncertainties
• Leaves little-to-no space for mid-project changes
• May result in reducing quality (cutting corners) if time and budget estimates were too low

When budget and scope are fixed, quality often suffers, leading to “technical debt” that can cause problems later. Consciously cutting quality can be acceptable if done with awareness of consequences and a plan to improve later. Unconscious quality cuts often lead to issues like increased support costs or lower product ratings.

That’s why fixed-price, fixed-scope projects typically result in one of three scenarios:

1. The client overpays due to the agency’s risk estimation
2. The client underpays but faces quality issues later
3. The agency is inexperienced and loses money on the project

Fixed scope assumes perfect knowledge of user needs, but statistics show that a large percentage of product features often go unused. When it comes to the software development process, scopes always change (if it is not, you are doing it wrong). That’s why fixed-price is the worst pricing model from the buyer’s perspective.

• Learn more: The problem with fixed price, fixed scope (and dubious quality) IT projects

2. Time and material pricing model

Scope: Flexible

Schedule: Flexible

Budget: Flexible (“at risk” of increasing)

Quality: Maintained

The exact opposite of fixed price.

A time and material model is a pricing structure where the customer pays for the actual time spent on a project and the materials used, with no fixed price agreed upon upfront. It offers highly adaptable scope, allowing changes as the project progresses. The schedule is also flexible and can be adjusted based on evolving requirements. The budget is variable, based on actual time and resources used.

It’s ideal for projects with unclear requirements and allows for easy pivoting.

However, it comes with less budget predictability and may lead to scope creep.

In the Time and Material model, trust and strong client-developer relationships are crucial. Clients pay for actual work done, usually hourly or daily. This can be risky for non-technical clients who can’t easily verify time estimates or the necessity of proposed solutions. Developers might claim certain tasks “always take this long” or insist on complex, time-consuming approaches. Without technical knowledge, clients can’t effectively challenge these claims. This can lead to inflated costs or inefficient development.

3. Fixed-price, scope-controlled pricing model

Scope: Flexible

Schedule: Fixed

Budget: Fixed

Quality: Maintained

Fixed-price, scope-controlled combines the best of the two previous models, and we believe it’s the best option out there.

It offers the budget certainty of a fixed-price contract while providing some of the flexibility found in time and material arrangements. In this model, the core project requirements are set with a fixed price, but there’s room for adjustments in less critical areas.

This approach acknowledges the reality that software development projects often evolve, while still providing a framework for managing costs. The ‘controlled scope’ aspect allows for some changes without opening the floodgates to endless revisions or scope creep.

• For clients, especially those with budget constraints, it provides a clearer picture of costs upfront. At the same time, it doesn’t completely lock you into initial specifications that might prove less than ideal as the project progresses.
• For developers, it offers some protection against the risks of a pure fixed-price model, where unforeseen complications can eat into profits. The controlled scope gives them some leeway to adapt to challenges or changing requirements without having to renegotiate the entire contract.

The success of this model depends heavily on clear communication and agreement about what constitutes the fixed core of the project versus the more flexible elements. It requires careful planning at the outset to define these boundaries effectively.

Setting the scope: Product Discovery Workshop

A crucial aspect of this approach is that the boundaries between fixed and flexible elements are established at the beginning of the cooperation. This typically happens during a tailored product discovery workshop where the client and the product team meet. This workshop is a critical phase where both parties collaboratively define the project’s core essentials and identify areas where flexibility might be needed.

During this discovery process, the team works to understand the client’s business goals, user needs, and technical constraints. They then use this information to outline the fixed, non-negotiable aspects of the project, as well as areas where changes might be accommodated later. This upfront investment in planning and communication helps set clear expectations and reduces the likelihood of misunderstandings or disputes later in the project.

Learn more:

• Right things in the right way. A fintech startup case study from a Product Owner’s perspective. Read more about how user story mapping cut project scope by 90% & our Product Owner’s insights led to a $80,000 solution instead of a $15 million gamble
• Product Discovery Workshop FAQ

Fixed price, scope controlled FAQ

1. How can you guarantee that the “fixed price” won’t end up costing me more in the long run?
   The fixed price covers agreed-upon essentials. You won’t pay more unless you request significant changes outside the defined scope.
2. If the scope is “controlled,” doesn’t that mean I’m limited in making changes as the project progresses?
   You’re not limited; the “controlled” part allows for adjustments within predefined boundaries.
3. What happens if we realize midway that the initial requirements were off? Am I stuck with a product I don’t actually need?
   We define core requirements and nice-to-haves. Core stays fixed, nice-to-haves can be adjusted based on new insights we learn as the project runs.
4. How does this model ensure better quality compared to a regular fixed-price model?
   1. vs. fixed-price: Allows flexibility for non-core features, reducing pressure to cut corners on essentials.
   2. vs. time and material: Maintains focus on core requirements, preventing quality-impacting scope creep.
5. What’s the catch here? It sounds too good to be true – fixed price for me, but flexibility for you?
   No catch. It balances your need for budget certainty with the reality that software projects often need some flexibility.
6. How do you determine what falls under the “controlled” part of the scope? Who makes that decision?
   We collaboratively define core and flexible elements during initial planning. Both parties agree on this division.
7. If I’m paying a fixed price, how can I be sure your team won’t cut corners to maximize their profit?
   Our reputation is crucial. We maintain quality to ensure long-term relationships and referrals.
8. How does this model handle unexpected technical challenges or delays?
   We build in buffer for known unknowns. For major unforeseen issues, we communicate early and may renegotiate if absolutely necessary.
9. Why should I choose this over Time and Material, which seems to offer more flexibility?
   It offers more budget predictability than Time and Material, while still providing some flexibility to adapt to changes.

How to choose the right software pricing model for my needs?

When choosing the right pricing model for your software project, two crucial factors to consider are trust/relationship and the level of predictability.

Trust and relationship with your software provider

Trust and relationship with your software provider play a pivotal role in this decision.

If you have a strong, established relationship with the contractor and trust their work ethic, a Time and Material model often proves more beneficial. This approach typically involves fewer formalities, allows for more efficient work, and can result in lower costs and a better product.

However, if you’re working with an unfamiliar contractor or have concerns about trust, a Fixed Price model might offer more security. Some organizations start with a Fixed Price model when working with a new partner and transition to Time and Material as trust builds over time.

Predictability

The level of predictability in your project is another key consideration.

Examine the work you’re asking your software partner to perform closely. If the problem you’re solving is well-understood and a clear solution already exists, a Fixed Price contract might be appropriate.

Yet, if the solution is uncertain and you need flexibility, consider a hybrid approach like a Fixed Budget, Scope Controlled model. This approach can be particularly effective in navigating the uncertainties often inherent in software development, as it allows for adjustments as the project progresses while still providing some budget predictability.

Custom software development = Fixed price, scope controlled + Dedicated Team model

Fixed Price, Scope Controlled pricing often proves to be the best model for custom software solutions. It balances budget certainty with the flexibility needed in modern project development. This approach allows for adaptability at each development stage while maintaining cost control.

Complementing this pricing model, the Dedicated Team structure gives product development an additional boost by providing consistent expertise and deep engagement. When combined, these approaches create an ideal framework that let our clients address complex development needs throughout the entire software development lifecycle.

• As a software development company committed to your success, we encourage you to reach out and explore how this powerful combination can drive your project forward. Let’s work together to turn your vision into a reality; we’ll make sure that your software solution evolves with your business needs.