If you’re new to building a customized software development from scratch, you might feel confused by the many contract types available to choose from.
But fear nothing: I’ll explain to you what are the three most popular contract types in software development, how they work, their limitations, and how can you decide which one best suits your needs.
Fixed Price
Suitable for: Startups and businesses with a limited and defined project scope.
How does it work?
The most popular type of contract in software development is the fixed price.
Once contacting a potential IT partner, a first call will happen to have a high-level understanding of your project’s goals and needs. Usually, a technical expert and a representative from the tech company will conduct the meeting to help you to translate your business idea into the technical requirements.
With that information, the tech partner will build a rough proposal with a range of the potential cost to build the software. At this stage, It is hard to give you a concrete price because all the technical details haven’t been discussed yet. Once you both agree to work together, you will move to the Discovery Phase.
The Discovery Phase is a series of meetings where you and the development team will deep-dive into small details of your software. Often you will need to pay a fee to start this phase.
This happens because some design and technical work start at this point. For example, during these meetings you will establish together user journeys, build a design prototype, technical architecture, and defined the UX/UI.
With a clear picture of how your software will look like, your IT partner is ready to refine the quotation. The edited quotation will take into account the entire project scope: design, software development, testing, deployment, and maintenance.
It will also include a detailed description of the total estimated hours of development work, developers’ hourly rate, and responsibilities of both parties involved.
If you don’t expect any major changes in the future, they will send you a final quotation with the total fixed price for the entire software development work based on the timelines and functionalities you both clearly defined.
The payment can be agreed upon in different ways: an upfront payment to start the work (e.g. 30% of the total cost), several small payments based on work milestones, or two-week sprints agreed beforehand between both parties, and final payment for ongoing maintenance if needed.
The advantage of this type of contract is that you are guaranteed that the total price for the entire project signed off won’t change or increase if there isn’t any major change in the scope of work in the middle of the way.
If you decided to add new features, e.g. a mobile payment integration, that wasn’t included in the initial brief, your IT partner will create a new quote and charge you separately. This will enable you to have more control over your budget and avoid unexpected technical debts.
Pro-tip
Ask your software development company to quote you with a markup of 30% of the total fixed price.
It is not unusual that customized software development projects face challenges or bugs during the coding phase that could not be foreseen in the planning phase. To avoid unnecessary costs and disappointments, don’t forget to include a safe markup to the total fixed price.
What are the limitations?
Because we’re dealing with a type of contract that has fixed price, timelines and the amount of work originally quoted cannot be changed once the development work starts.
As explained before, if you want to alter or add phases along the way, your tech partner will create a new quotation instead of including it in the original quote.
Is this model the right one for me?
If you are clear on your project needs and deadlines, or if you have a limited budget, this model is best suited for your business.
Time & Material
Suitable for: Small & medium-sized businesses.
How does it work?
This second popular type of contract is based on regular agreed payments. Instead of quoting the entire project at once, the quotation is divided into milestones.
Before each milestone, both parties (client and the software development company) agree on a particular scope of work, a timeline of completion, and a budget.
After a milestone is completed, If the client is satisfied with the work, an invoice will be raised. The next milestone can have a different scope of work and timelines based on the client’s feedback and top priorities.
Otherwise, If the client is not happy with the result, he can stop the work and terminate the partnership immediately and all the data will be deleted as per agreed on the NDA.
This type of contract is beneficial for both parties because It is extremely flexible and low risk. It also helps to plan ahead the next steps, smartly allocate budget and resources, and better manage timelines accordingly to client needs and IT partner’s workflow.
Pro-tip
If you are building an MVP to test a new product-market fit, this type of contract can help you plan ahead to the next iteration and allocate resources based on ongoing customer feedback.
What are the limitations?
This type of contract project requires constant collaboration and feedback between the client and the software development company during each milestone. Expect to maintain communication on a daily basis or 3–4 times a week minimum.
Is this model the right one for me?
The time & material contract is a popular and flexible solution that can suit many scenarios: complex and long-term projects; evolving projects currently in the testing or bug fixing stages; MVPs, or ongoing projects needing maintenance or support.
Dedicated Team
Suitable for: Enterprises and big companies.
How does it work?
This third popular type of contract is the dedicated team format. It best suits long-term projects like ERPs, digitalization efforts, and optimization of internal processes, supply chain, or financial operations.
For these highly complex and demanding projects, it is best to with a trustful, dedicated team working on a full-time basis.
Your software development partner will quote the full development work necessary to build your solution and the monthly or annual costs to hire a dedicated team.
This contract can have two different formats: the allocation of a dedicated team that will accompany you since the project briefing until ongoing maintenance and update of your software solution.
Or, If you already have an in-house team of developers, your tech partner can supplement your team with specialized developers who will work exclusively with you.
Pro-tip
If your timeline is longer than 6 months, and you prefer to have closer contact with the team and control of the project, this option will be the perfect fit for you.
What are the limitations?
In the dedicated team contract type, It is your responsibility to manage the developers or the development team allocated to you.
This requires high involvement on the client-side, and it implies a long-term relationship with your IT partner.
Is this model the right one for me?
If you have a big project underway that requires a team of developers working full-time, or If you need extra specialized developers in certain areas to complement your in-house team, this is the right model for your business.
Other Types of Contract
The custom software development market is a crowded place. You might find diverse contract types when you are in the phase of requesting and evaluating proposals.
However, most of the other formats you will encounter are only variations of the three most popular contract types in software development explained above.
Some of these small variations are firm fixed price, fixed-price incentive fee contracts, fixed-price with an economical price adjustment, unit price contract, cost-reimbursable contract, etc.
The types of contracts can get complex and deeply specific as many custom software development projects. You are the only one to evaluate and decide which format suits best your unique business needs.
So What Should I do?
It is advisable to stay with one of the top three contract types. It will help you not only to make a fair comparison among proposals but also decrease the complexity of payments to your financial department.
Lastly, it facilitates project delivery and management by your dedicated project manager.
The same advice we give to our clients at Appstrax. We currently offer the three most popular types of contracts (fixed price, time & material, and dedicated team) because we want to provide flexibility to our clients and make them feel safe and comfortable working with us.
