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Fixed price vs estimate in software development

At Meta Bytes, in our long-term client collaborations, we use a pricing model where the customer pays a fixed price every month. Together, we select areas to focus on, on a rolling basis, which can include everything from new development, infrastructure, and system improvements.

However, many customers come to us with a specific initiative in mind that has a clear end and pay a price for that single project. There are two pricing options in this scenario – fixed price or T&M (Time & Materials) pricing, generally based on an estimate. The differences between the two models may seem obvious, but let’s take a closer look at what we think about them and how suppliers can work differently depending on how the project is priced.

Fixed price – Predictable but less flexible

A fixed price means the cost is predetermined, providing security for you as a customer. The price is based on the available information at the time the price is set, and therefore, the supplier must find out everything from the beginning – and when we say everything, we mean everything. Everything needs to be planned and defined, deliverables must be nailed down, and all frameworks must be in place. This can feel like a heavy and demanding task, almost overwhelming, for many customers, when everything essentially needs to be in place at once from the start.

Extensive preparatory work with fixed price

Because the preparatory work with a fixed price needs to be so comprehensive, it takes longer to get started with the actual work. However, having as much information as possible in the beginning is often not enough when it comes to software development, as new things will almost always bubble up throughout the project. With fixed pricing, the supplier must therefore account for this as a potential risk when setting their fixed price – something that can result in you as a customer actually paying a higher price than you would with T&M pricing based on an estimate.

The supplier simply cannot take the risk of not adding a buffer to the price to handle the risk of unexpected events occurring and new information emerging that requires them to spend X number of hours more than estimated on the project.

Another thing you as a customer should be aware of is that within a fixed price project, some suppliers may take shortcuts if problems arise, all to keep the project within budget. They may feel that they cannot spend the time needed to develop a long-term solution to the problem and therefore choose the easy way out to not spend more time than the budget allows.

Fixed price = Fixed scope

With fixed pricing, the project scope is quite fixed from the beginning. Not entirely – there is still room for the supplier to work agilely – but almost. Payment usually occurs when set milestones are reached, and if something needs to change, the process for approving these changes can often become quite formal, since everything has usually already been agreed and documented.

Regardless of pricing model, we work in the agile way that has always characterized us. However, it is important to understand that when a project has a fixed price, even though there is room for reprioritization, this can entail difficulties and compromises that can negatively affect other parts of the project.

T&M pricing (estimate) – Flexible with potential uncertainty

With a variable price, the work is more focused on a goal rather than a specific specification, as with fixed pricing. At the beginning of your project, you get an estimate of what your solution will cost, and payment is generally made monthly, based on the number of hours the supplier has worked during the month.

A rough estimate where a lot can happen

The estimate you receive is not a definitive budget but is an indication of the total estimated cost of the project, meaning your final investment in the project may deviate from the number you were given. Therefore, unlike with fixed pricing where it is the supplier that takes the risk of the budget not holding, with T&M pricing, you as a customer take the risk of the total project price exceeding the initial estimate. Of course, this works both ways – if the total price ends up being less than the estimate, you as the customer receive the benefit of that.

The estimate is, just like with fixed pricing, based on the information we have when we start, but because it is an estimate, we do not do the prep work as thoroughly (though still very carefully!) and can therefore start developing your software more quickly.

Flexibility opens up opportunities

Working with estimates makes the work more flexible, allowing you as the customer (and us as the supplier) greater opportunities to change things for the better during development. You can reprioritize, suggest new features, and involve more users who may benefit from the solution being built.

The increased flexibility also leads to closer collaboration throughout the project between the customer and the supplier. This is because there must be continuous dialogue throughout as you go through bit by bit and handle things gradually as they come up, rather than handling the majority of issues upfront, as in a fixed pricing model.

What does Meta Bytes prefer?

As we mentioned earlier, many of our long-term collaborations have a completely different setup. The customer doesn't just have a solution to implement and deploy; we work continuously to digitalize the entire business. New initiatives are added, and we are constantly reviewing the digital ecosystem.

For customers with individual solutions they want in place, we usually estimate the price and then start the development work. T&M pricing is in many ways better than fixed, as it enables you to fully reap the benefits of our agile way of working. We can follow the priorities and costs that arise during the project in a way that benefits the entire project.

From experience, we also know that the software we deliver to our customers almost always looks different in the end to what they initially thought they wanted. Yes, that sometimes means it's more expensive – but then they also have a better and more sustainable solution that can be scaled and used for more than they initially thought. Enabling innovation, new ideas, and changes is something that almost always results in higher quality and better results.

What can a software solution cost?

In our article, you can see some examples of what software can cost.
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