Software Development Outsourcing: The Best Pricing Models in the IT Industry

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March 8, 2023 Web development

Pricing models in outsourcing

At the initial stages of cooperation, a customer and an outsourcing company agree on a pricing model. It determines the terms of app development: time, resources, control the customer has over the process, etc. There are various pricing models in the IT industry. Which one should you select?

Overview of pricing models in the IT industry

As the IT sector evolves, different methodologies and new ways of cooperation between IT vendors and customers emerge. Let’s examine some pricing models in the IT industry.

1. Fixed price

This model provides fixed terms of cooperation. By signing a contract, an IT provider undertakes the fulfillment of a strict scope of requirements within a deadline and budget. Moderate projects with a clear methodology and stable requirements can benefit from this.

2. Time and materials

Every so often, you cannot foresee the ultimate custom software development pricing at the initial stages. To be on the safe side, a software provider and a customer agree on a pay-as-you-go basis.

This gives them more flexibility than the first option. It is good for projects with frequently changing or vague requirements. Pay-as-you-go allows you to create a solution without risks. A project can be divided into several tasks, and the manager prioritizes them by complexity, implementation method, and cost. The client can choose when and how to implement more complex, expensive functionality.

Thus, the customer pays for employees’ working hours. The duration of the project doesn’t matter here.

3. Dedicated team

It works as a specialized service provider for a specific period. The ultimate software development pricing includes salaries and a fee for administrative work.

There is a monthly payment, it depends on the team size and the overheads. Projects with a floating scope and frequently changing requirements can use this model. On such projects, outsourcing teams make up for the customers’ lack of competencies.

4. Product development services

This model means partnership and transparency and is convenient for both parties. A customer receives services from a development company, the parties jointly plan the budget, and the client pays monthly for the outcomes they see. The custom software development company like Andersen flexibly changes the scope of work with the needs of the partner in mind. The result is a top-notch product with detailed documentation and transparent Agile processes.

5. Money for nothing

This model provides flexibility within a fixed-price contract with equal terms for both parties. The contract specifies a software development price per hour, partly using a relative estimate.

The customer can modify the requirements or even request a new solution with the same scope. In any sprint, they may terminate the contract if they believe that its cost will be higher than its value. Here, the client pays the developer 20% of the remaining contract value. But if the customer knows what they want to implement within the framework of the project, and the IT company understands how to achieve this, the project is usually successful.

There is also the so-called Joe’s Bucket model: the parties agree to create a cash reserve (customer buffer, supplier buffer). If the customer does not use it entirely, what’s left over is deducted from the price. If the supplier takes a share of the stock, it is added to the project cost. And if costs exceed the agreed buffer, the vendor pays themselves.

Some projects may use the epic collaboration model. Here, the criterion is success, not effort. Penalties may be imposed for the lack of results or delays.

The pay-as-you-go model is also used. The customer pays for the implementation of functions or a story (a description of a separate use case). The cost of a project can be agreed upon based on the try-before-you-buy model, which is a combination of pay-as-you-go and fixed price.

There are at least five more pricing models in the IT industry. As a rule, the above are the most common and widely used. For example, the fixed price model and product development services. Let’s consider the difference between them and determine which one to choose.

Fixed price: strictness and stipulation

As we have mentioned above, this model implies strict requirements, costs, and delivery dates. The customer knows exactly how much money they will spend. The supplier of software development services will only be able to change the price with prior approval. The team commits to doing the agreed scope of work on time. The client only controls that the team follows the specified roadmap and considers everything needed with each release.

Usually, this model is used when a project is small and short-term, all the necessary documentation has been prepared, and the client is absolutely sure that the specifications will not change. For example, when you need to build a website according to exact technical requirements in two months, and the customer wants to stay undisturbed during this period.

As a rule, this pricing model is not suitable for projects on which a flexible methodology is used. If the client needs to implement changes, these need to be documented, approved and signed. This can cause release delays. If developers have an idea for a useful feature or solution, there may not be enough time and budget to implement it.

The fixed price model implies careful planning. So, developers shouldn’t make a mistake in estimating the project; otherwise, problems will arise. Thus, to meet deadlines and fulfill a contract, engineers may not pay attention to quality. In this case, the final product may simply not be usable or show vulnerabilities.

For the team, this model can cause stress related to risks. The PM, of course, regularly monitors risks and strives to mitigate them, but additional challenges may arise. For example, if the estimation is wrong, the project timeline and price may change.

Product development services: flexibility and transparency

The product development service model implies cooperation on the principle of transparency and joint budget planning.

The benefits of custom software development are that both parties can adjust planned work monthly, and the budget can be updated and agreed upon during each iteration.

Developers get an in-depth understanding of the app, which increases their performance. The customer receives regular reports with metrics on the software status. Thus, parties enjoy agreement and mutual understanding. There are no strict deadlines and requirements limiting employees. Any recommendations for improvement can be discussed and agreed upon with the customer, and the quality of the software will not suffer.

Fixed price vs. product development services

The product development services model is a modern form of collaboration with flexible scope, budget, resources, and full transparency. The client sees regular reports and practical results. They pay for the successful completion of tasks and receive an exceptional digital solution.

Although customers like projects with fixed-price projects and the fact that the supplier takes full responsibility, this model is difficult to apply to modern projects using Agile methodologies. Even if all work is carefully planned, unforeseen situations can affect the software quality.

With strict deadlines, the team has difficulties making changes or putting reasonable ideas into practice. So, the product may turn out exactly as specified, but it is not the best version possible. A flexible model removes these limitations. Thus, IT experts can build better software.

Conclusion

There is no such thing as an all-purpose pricing model in the IT industry. The choice of a specific type depends on the size of a project, documentation, deadlines, and sometimes on the methodology and the goal. A custom software development company you plan to cooperate with can give you valuable advice concerning this.