Which billing model is best for cooperation with a software house? Time and Materials, Fixed Price, or maybe Hybrid?
Here is the right answer to the difficult question: it depends! In this article, you’ll find out:
● what the Fixed Price model is,
● what the Time and Materials model is and what advantages and disadvantages to expect,
● what are the differences between those two approaches,
● what the hybrid model is and when to use it, and
● which model will be the best for you and why.
When you decide to create or develop software or accelerate its testing, you may have insufficient resources to do it on your own. For this reason, you probably will decide to cooperate with an external company.
Choosing the right supplier takes time. You have to consider factors, such as:
● the competencies of the team,
● their experience in implementing similar projects, and
● references from other satisfied customers.
However, there is always a moment for you to decide how you are going to pay for the provided service.
It is good to start by learning about the billing models used by software companies, based on the example of Solwit. It is important to know the meanings of both Time and Materials, as well as Fixed Price.
Know the total cost — Fixed Price
Let’s start with the definition of Fixed Price: it is a procurement model, in which the objective is to deliver products that meet the proposed requirements of quantity and quality within a budget that’s defined upfront.
The bright side of this solution is that you know the total cost of the project from the beginning — on the condition that you are clear and consistent regarding the requirements. The software house takes the responsibility for the scope and the deadline. But that limits the flexibility in the case of any changes cropping up. However, you actually can do modifications to a Fixed Price project. Any changes can be introduced via a Change Request. This request will be priced separately and implemented outside of the original schedule and budget.
But is Fixed Price really always the most beneficial billing model?
A lot depends on the complexity of your project. If it is complex and you choose Fixed Price, you have to be prepared to have the supplier include a buffer to cover any extra costs that may arise as a result of unexpected circumstances or complications during the development.
Defining all project requirements at the beginning of cooperation can often be difficult. Adding new features at a later time may force the supplier to reduce the specifications, in order to keep the same price. So, it comes down to a “quid pro quo” situation, which is never comfortable neither for you as a customer nor for the supplier who wants to deliver the results you expect. Negotiations take time and the whole situation becomes unnecessarily emotional.
When is Fixed Price the right choice?
Fixed Price is perfect when you know exactly what you want and how you want it from the very beginning. You have clear requirements, precise specifications, and a deadline.
The diagram below shows what a typical process of cooperation in the Fixed Price model with a typical software house looks like:
● project management is the contractor’s responsibility, you simply verify the effects.
● low flexibility,
● a limited possibility of influencing the process after the scope is accepted.
Choose it when the project assumes:
Be flexible — Time and Materials (T&M)
Let’s have a look at the meaning of T&M and what a contract of this type is. In this model, billing is carried out at pre-approved hourly rates of each member of the development team (based on the time and materials’ pricing), allowing you to flexibly change the pace of implementation and control the cost of the project. In this typically agile approach, work takes place in sprints. After each sprint, you can evaluate the effect of the work and modify the initial project assumptions on the fly.
If you choose the Time and Materials contract, you settle the accounts monthly, or in other periods agreed to before the start of work, depending on the number of hours the development team spends on your project and what materials are used (dedicated licenses, hardware, etc.).
Specification and time to deliver
The greatest value of T&M contracts is that you don’t need to know all the assumptions from the beginning. They can be added during the process. Most importantly, work on the project can start immediately because there is no need to wait for the full specs documentation.
What’s more important, a Time and Materials contract will require more commitment from you. It is you who controls the course of work and verifies the effects. You should also have the appropriate knowledge to verify the quality of the sprints and their results.
T&M works best when you want to immediately start a complex and long-term project. Or you may already have a development team but need additional resources. T&M gives great flexibility to adjust the project to your evolving expectations. Although it may seem more expensive, in this case, the costs of a T&M project will be lower than that of the Fixed Price model. A project settled according to the T&M model may be shorter and much easier to manage because everything can be modified on the go.
Maybe you’re wondering what types of projects can be done in this model. The development project for railway safety systems performed by Solwit may prove a good example to demonstrate this.
Choose it when you need:
● start the project “immediately”,
● modify the scope freely,
● validate results in real market conditions faster.
● the need for constant budget control,
● requires the product owner’s considerable commitment and competence.
Why not both? — The Hybrid model
You don’t always have to choose between one or the other. It may happen that the best method is a mix of solutions — the Hybrid model.
The driving force behind this solution is the fact that we focus on the business effect as a result of the project implementation, regardless of the initial assumptions. The analysis becomes the framework of the project and not the one true source of knowledge. With this model, you can influence the shape of the project at any time.
We assume that a rigid T&M or Fixed Price may not meet your expectations. Therefore, after the initial conversation about the project idea, we choose the elements from both models that best suit your situation.
The starting point is the analysis, which we usually perform with the client in the Product Design Sprint formula.
Our experience at Solwit shows that the client usually knows what they want to achieve, but needs support in choosing the path to reach their goal. We help to set the main project assumptions and, with the client, define the detailed scope of work. Based on the analysis, we estimate the workload for individual functionalities, which is the perfect time to decide which model will be used for the next stages of the project.
We have already defined the risks, thanks to the preparatory phase, and we can remove the buffer for unforeseen circumstances, which is usually the reason for the higher cost of the Fixed Price model.
An example of the Hybrid model is the case of performing the design phase in the T&M model, due to its flexibility and possibility of carrying out the development in the Fixed Price formula.
The greatest advantage of the Hybrid approach is that you have the freedom to combine billing models, depending on the stage, type, and specificity of your project.
Let’s have a look at the comparison:
Which model should I choose?
Our experience shows that clients with a fixed budget (are you one of them?) tend to choose the Fixed Price solution, even if the project that complies with their requirements would cost more. They want a guarantee that they will not exceed their budget.
Time and Materials will be chosen more often by those who have their own resources and only need us to help them achieve their goals.
In the turbulent business environment, the scope and functionalities of the project may change dynamically. The original expectations for the final product change to better meet the needs of the market. Technology is changing as well, so you can flexibly use the possibilities it offers. If you are creating an innovative product, the iterative approach is essential to reach its full value. This is exactly what the Time and Materials and Hybrid modes give.
Think what’s best for you
Analyze your project, and think about whether you want to take an active part in it. Consider if you have the ability to do so. It is also worth consulting the supplier, as they will give you the best idea of which model will work for your project. Now you know what to expect, depending on the model you are recommended.
Already have an idea for a project and need a valuation? Drop us a line and arrange a free consultation!
Written by Solwit Team.