How to settle accounts with an IT company? Financial issues are always a sensitive topic when buying any type of product or service. It is no different when settling accounts with a software development company.
In this chapter, we want to present different billing models (because each has its pros and cons) to help you make the best choice.
Let's start with the simplest and most intuitive form of billing.
The fixed price model is simply a fixed price for receiving the ordered software.
A good analogy is the purchase of a specific car model with personalized equipment configuration. We know the exact specification and the amount that we will have to pay for the finished product.
Advantages and disadvantages of the Fixed price model
Undoubtedly, the biggest benefit of this form of billing is that we know exactly how much we will pay at the end. So, if we have a specific budget and very specific needs, this may be a good solution for us.
The main downside of the Fixed price approach is that it is difficult to change specifications during the course of the project. There is a saying “The only thing that is constant is change”. If an IT project lasts more than a month - the need to change the specification, the business assumption or the end result will be almost certain. In practice, this means a risk of friction between us and the supplier, whether this change is something additional and should be accounted for in the price or additionally.
The second disadvantage of this approach is that usually the IT company, with the Fixed price approach will estimate the time-consuming tasks so that, even in a pessimistic variant, we will not pay extra for the project. So we will finance the security buffer, which results from the difficulty (even inability) of accurately estimating how much time will be needed to perform specific tasks.
An example of a 3-month project valuation for the implementation of an order management platform in the form of Fixed price:
The project will take 500h x EUR 50 / h, which translates into the amount of EUR 25,000.
When to choose the Fixed price model?
- We have high confidence that our order will change to a minimum extent.
- We need to know the final cost of software development.
A variation of Fixed price is the “Price Brackets, i.e. estimating each subtask of the project in the form of a fork from-to or even in 3 variants (optimistic, realistic and pessimistic).
Advantages and disadvantages of "Price Backets"
Thanks to this approach, we get a more reliable valuation, without safety buffers. (The pessimistic variant is its equivalent) and if the work goes smoothly, the project cost may be lower than in a rigid Fixed price approach.
This approach also allows you to choose the complexity of the task / module later, when we have more data. At the beginning, we can assume that a given functionality will take from 16 to 40 hours, and as we get closer to this task, we will be able to decide what variant will be needed or how much budget we have left.
With this approach the total amount of the pessimistic variant may be deterred, but in practice we oscillate around a realistic amount with a small deviation in one direction or the other.
An example of a 3-month project valuation for the implementation of a price brackets based order management platform:
The project will take us between 350h and 550h, which, at a rate of EUR 50 / h, gives us an amount of EUR 17,500 to EUR 27,500 per project
When to choose the “Price Brackets” model?
We recommend this approach when it is difficult to estimate the vendor how long it will take to perform given tasks. Due to unknowns in the code or the need to integrate with other systems, which often takes more time than expected (e.g. when the documentation is not fully correct).
We are more and more entering the world of Agile - agile software development. With the Fixed price approach, we mentioned that the biggest problem with an IT project is the change in the project. We often do not know what will be important in a quarter or a month (or what budget we will have), so we can contract an IT company every quarter, month, or even every 2 weeks to perform a specific functionality.
Advantages and disadvantages of staged settlement
On the one hand, the phased approach gives usflexibility, and on the other hand certainty as to the cost and result that we will receive in a month (or any other period of time).
For larger approaches, we can combine the staged and fork approach to estimate the forks of each stage in advance, and with each subsequent stage, we can make the valuation of the next milestones more realistic.
An example of a valuation in a staged form:
The project will be divided into three stages:
- the first stage will take us 160 hours, which will cost EUR 8,000
- the second stage will take us between 120h and 160h, which will cost between EUR 6,000 and EUR 8,000
- and the third stage between 80h and 200h, which gives us an amount between EUR 4,000 and EUR 10,000 depending on the selected variant and the complexity of the solution.
In total, the project will cost between EUR 18,000 and EUR 26,000.
When to choose staged settlement?
If we have a large project to implement, and we want to settle in stages and have some ability to modify the order, the phased approach is definitely worth attention.
Time & material
An even more flexible form of billing is to settle accounts for every hour that the IT supplier devotes to the project. Then the scope of work goes into the background, and the priority is to provide business value - whether in the form of new functionality or the provision of technical support services.
We have described this approach extensively in the context of technical support in our article: Why consulting is important in choosing the technology for your project.
Advantages and disadvantages of Time & material
The advantage of this approach is that we pay for the actual time spent on the task. We can even access time tracking tools and we can define and change the scope of work to be performed on an ongoing basis.
We also do not need a very specific and final specification, as we are satisfied with the basic assumptions and defining what we need to start with.
The T&M approach is the most flexible form of cooperation between the client and the IT supplier, still underused in many European countries, despite many advantages - including financial savings on the project. This approach also provides us with full support for introducing changes to the assumptions, either during the project or later - in the maintenance phase.
The obvious downside is the lack of knowledge of the final full cost of implementing the project. However, we still have an influence on the tasks that we will commission, and the supplier will not add any margin of safety, because the settlement will be made only on the basis of hours worked by the team.
To protect yourself from excessive costs, you can make an appointment with the supplier on the so-called "Cap", i.e. the maximum number of hours that the team will devote to the execution of the order and will inform in advance that there is a risk of reaching the "maximum".
Of course, T&M's approach does not mean that we give up estimating. Everyone must have a common vision of the end result and the IT provider can estimate (usually by fork) the time and team needed to complete the task.
However, this is not a binding estimate, but an approximate approximation.
An example of a T&M valuation:
The project team will consist of the following people (expected team occupancy):
- Senior Full-stack developer - 80h per month, rate 75 EUR / h => EUR 6,000 / month
- Regular Front-end developer - 80h per month, rate 50 EUR / h => EUR 4,000 / month
- Senior Project Manager - 40h monthly, rate 60 EUR / h => EUR 2,400 / month
- Regular QA - 20h per month at the rate of EUR 40 / h => EUR 800 / month
The expected monthly cost is EUR 13,200, and the estimated time for completion of the project is 1-1.5 months.
It is also important for the client to have a dedicated person for day-to-day cooperation with the team (the so-called Product Owner), who will answer all questions, make decisions and supervise the team's work. The lack of such a person may cause the costs of the project to increase disproportionately and we will lose time for an extended decision-making process in the company.
When to choose T&M’s approach?
If we want flexible, close cooperation with a dedicated team, the Time & Material approach is definitely a better option than the previous methods of cooperation mentioned above.
Using agile software development techniques (Scrum, Agile) - this is one of the two (next to Body leasing) possible forms of settlements between the client and the software manufacturer.
The models described above: Fixed price, “Price Brackets”, Milestone, Time & Material are not the only forms of settlements with a software house.
Do you want to find out what are other forms of billing with a software house?
Download our free ebook about digital transformation and discover 4 additional billing models.
Is there the best billing model? Basically no. But for a given client's situation, for a specific project, we always find and choose the best solution.
Many companies stick to one form of cooperation (e.g. large software development companies cooperate only on the basis of T&M or body leasing), but it is worth being flexible in this matter. We approach each order individually and depending on what is best in a given situation, we will propose the most profitable model for the client.
The choice of an IT service provider is of course influenced by many factors, but it is worth being aware of the available billing models and choosing the one that will give us the greatest security, and also allow us to be flexible at the level we need.