A time and materials contract vs fixed price contract has different terms. In a fixed price model, the pricing depends on planning that's rigid. Both the vendor and client need to agree on a predetermined price of the project and define explicitly what the other's responsibilities are before the project starts.

What is a Fixed Price Contract?

In a fixed price agreement, there is one sum that's agreed upon when the service provider finishes the project for the price that both parties agree to in the contract. This is a smart method to use when the specifications, rates, and requirements are highly predictable. Otherwise, the cost isn't constant. The client must be able to share their vision of the product with their developers so it's clear and they get the final results that they want.

You should use a fixed price contract in the following situations:

  • When there is a fixed or limited budget
  • For MVPs
  • When there are hard deadlines and clear requirements
  • For smaller projects that have a limited project scope

A fixed price contract specifically defines the services provided and sets one price for that project, no matter how much expense the company incurs or how much time it takes. This type of contract is often paid in installments, which starts with a down payment and has several other payments over the contract's length with payments paid out at different points. This includes a final payment once the contract is complete.

Having a fixed price contract is good for a consulting firm when the client has work that needs a quick turnaround. This could include creating websites from pre-existing templates, where much of the work has already been done before the contract lands. A client may like having this type of contract since it's easier to budget for projects like this. However, it's a problem if you and the client cannot reach an agreement about the specifics of the work.

The key features of a fixed price contract include a set amount of work, a fixed budget, development rates that are higher, not being able to make additions or changes after the contract gets signed, and potential compromises about the product's quality.

What Are the Pros and Cons of Fixed Price Contracts?

Fixed price contracts have some benefits to them, but they also are risky. They're not the best for outsourcing software development, which is constantly changing and not predictable at all. Some people still prefer this approach, however. With a fixed price contract, you know exactly what the total cost of the project will be so you won't have any extra expenses after you make a deal. There are strict deadlines, so your team knows it's important to reach them quickly. You'll also know the project's status since it's already been planned.

However, the disadvantages include likely overpaying by up to 40 percent, as there are some risks associated with it. There isn't much flexibility either since the terms have already been fixed. Unforeseen extra features or changes that are harder to implement since there isn't any room for maneuvering with the fixed price strategy as well. There is also a longer preparation stage, which can slow the process down. If there is poor communication, the final results might not meet your expectations.

The pricing structure for fixed-price contracts is usually productive for both the company and clients, however. Communication is essential though to make sure you'll get the most from your decision to outsource.

The Art of Budgeting and Estimating

Those who agree with fixed-rate contracts will often point out that it's hard to budget for a time and materials contract. This is true since there are many situations where companies outsource the development work and get quoted a price that is lower than what the work actually ends up costing. Using a pay-as-you-go structure for payment doesn't mean it will go to plan. You don't need to worry if the company you work with has strong communication skills and a solid reputation. If you are uncertain about what to quote a client for a fixed-price contract, consider using a time and materials contract until you know what goes into a fixed-price quote.

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