Pricing models in software development
Best contracts and pricing models secure both customers and software development providers. Unfortunately, we don’t have one pricing model that fits all projects, so let’s see how we can choose a pricing model that matches our situation.
Most common pricing models in software development
In software development, we used to follow one of two different pricing models, time and material or fixed-price contracts. In time and material contracts, we define the price for resources used to build the software; usually, it’s just an hourly or daily rate. On the other hand, for fixed-price contracts, sometimes called project fee contracts, we define a definitive price for the built application described in the specification. Of course, those pricing models have many variations. For example, we can put different hourly rates depending on achieved goals or maximum total price on top of hourly rates, but still, the base rules on how we should choose the pricing model for our project are intact.
How to choose the pricing model for our project
First, we need to understand the nature of uncertainties and risks in your project. If you have a clear vision of the application and are sure it will solve your problem and bring value to the business, then a good idea may be to prepare a detailed specification (if you have not done it yet) and use a fixed price model. Building applications to support or optimise already existing processes in the business is a perfect example. Moreover, preparing a detailed specification is an excellent exercise to confirm that our vision for an application is consistent. This approach will also help us know the project's cost upfront and allow us to compare different service providers' offers more easily. But, if the application you want to build is a part of a new business model, new business processes, or there are a lot of unknowns that can block achieving the value from the application, then the iterative approach to building a web application makes much more sense. We can adjust the plan to changing environment through a robust discovery process and by making small steps. In that case, I suggest following time and material contracts as you get total flexibility with the project scope changes.
Is one pricing model cheaper or more secure than the other?
Unfortunately, no. Regarding cost, in fixed-price contracts, service providers will add risk value to the calculations, which, based on risk estimation and real difficulties in the project, can result in prices higher or lower than in the time and material model. A fixed-price contract, in theory, should secure the development cost of the application described in the specification. However, in practice, specification completeness, reliability and accuracy are never perfectly defined. We heard many times about service providers that developed the application focusing only on the requirements from the contract (that never are perfectly defined), resulting in an application built within the budget but still not fully functional and struggling to bring real value to the business.
On the other hand, it’s easy to lose focus on main project goals affecting final costs in time and material projects without a proper discovery process. Time and material also make it harder to compare service providers, as the hourly or daily rate does not say about experience and performance - that is why we should ensure that we choose freelancers or agencies with expertise, maximising the value delivered in time. Still, the correctly chosen pricing model makes project success more likely.
