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Types of Contracts You Should Consider to Outsource Software Development

Two Main Models When outsourcing software development, costs and payment structure is typically top-of-mind. Clients want to have a full understanding of how they will...

Nacho De Marco

By Nacho De Marco

CEO/founder Nacho De Marco established BairesDev in 2009. He is General Partner at BDev Ventures and the author of "IT Outsourcing to Latin America."

10 min read

Group of people considering types of contracts to outsource software development

Two Main Models

When outsourcing software development, costs and payment structure is typically top-of-mind. Clients want to have a full understanding of how they will be billed, based on what elements, and how changes are handled. Most software outsourcing contracts either use a fixed-price model or a time-and-material model. Let’s take a look at what that means before we get into advantages and disadvantages.

Fixed-Price Model: This type of contract does not depend on time expended or resources used; instead, the project is billed at a flat rate. Fixed-price lists out well-defined requirements and procedures, a clearly established project, and a corresponding fee not subject to negotiation.

Time-and-Material Model: This type of contract is when a client agrees to pay for the developer’s time spent on the project at a set rate as well as materials or resources used. Time-and-material contracts are often used when the project is likely to change, scaling up or down, or if the entire scope of the project cannot yet be predicted.

Both types of contracts have advantages and disadvantages.


A deeper look at fixed-price contracts

Fixed-price is the more traditional type of contract used for software outsourcing, though this is changing. Clients often use fixed-price models when they have a precise budget or for a small project limited in scope. The most prominent benefit to this contract is that clients know exactly how much they will pay; there are no surprises when the bill comes. Since fixed-price contracts typically have strict deadlines, management is usually relatively straightforward.

The main reason clients are moving away from this model, however, is there is no flexibility. Often in software development, the scope of work must scale (whether up or down), and this model does not allow for that. Clients then have to take on any required changes or updates needed during the project. There is also usually less reporting with fixed-price models, which can be frustrating for clients looking for regular updates on project workflow.


A deeper look at time-and-material contracts

Time-and-material contracts, on the other hand, are extremely flexible, which is why companies that are working on a large-scale software development project often go this route. Clients have the ability to increase the workload, adding more developers onto a project, or stop work altogether if they hit a snag with funding. Furthermore, when the scope of work changes or if updates or revisions are needed, it does not complicate the contract in the slightest.

Often, companies don’t know the full scope of work but are ready to start elements of the development process, and time-and-material agreements allow for this, following the agile methodology. Clients also enjoy more reporting so they can understand how much time and resources are spent by each team member on each feature of the project.

The drawback to time-and-material is that clients do not have a fixed cost at the start of the development process. If working with an unreliable outsourcing partner, this can be trouble. Time-and-material usually requires more involvement in the process, which can be good or bad for clients, depending on wants and needs. However, this pain point can be alleviated if working with a transparent outsourcing team that consistently reports on costs.


Deciding between fixed-price and time-and-material contracts

Before deciding on which type of contract works best, consider the project scope. If the scope is not completely set or subject to change, then a time-and-material might be a better option. If the project is smaller and set in each feature needed, then it’s possible to use a fixed-price contract. Talk to your outsourcing partner to see what they offer and how each works within the confinements of the project, and then decide which option works best for the work ahead.

Nacho De Marco

By Nacho De Marco

Nacho De Marco is the founder and CEO of BairesDev and General Partner at BDev Ventures. Beginning with bootstrapped investments, he led the company to become the largest and fastest-growing software corporation in the world. He is also the author of “IT Outsourcing to Latin America.”

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