When you’re negotiating with a software engineering partner for an outsourced project, selecting the right pricing model is crucial. You have to balance the risk and reward for both parties, laying the foundations for a successful outcome and ensuring you’re getting the most value for your investment.
Based on the Accelerance team’s expert market insights, these are the top four price models to choose from when you’re structuring your next outsourcing agreement.
Time and Materials (T&M)
Your outsourcing partner bids for the project based on your requirements, depth of scope and the amount of work that will be completed. The T&M model works really well if you’re able to communicate your needs effectively, so the development team spends less time reworking problems – shortening your project completion time and saving you money.
Be ready to build an effective project management structure to ensure work is finished on schedule and within budget. You will need to tightly track performance and avoid costly delays. Consider building in a budget contingency, should the project go over time or budget.
If you manage the team and requirements well – and are good at forecasting effort over the months ahead – the time and materials model can be the most cost-effective model for businesses looking to build long-term team extensions, and not just project capacity.
Standard fixed-price contracts can be very advantageous to projects with a clearly defined scope and a stable set of requirements. By waiting to pay until the work is completed, all of the risks are placed on the outsourcing partner – protecting your budget, as well.
Fixed-price models are perfect for long-term projects with a high value to the outsourcing partner, because they are incentivized to complete the work more efficiently so they derive more value from the contract.
Partners will request payments as they deliver on project milestones. Variations and change orders also become part of the landscape when there is a change of scope or delays caused by clients. This can cause cost blowouts and should be carefully managed.
For services that can't reasonably be quantified when the contract is signed, ensure there is provision at reasonable rates to address any emerging new requirements. A rate card is essential for resources, and the business should retain flexibility to choose to contract as fixed price or on a time-and-materials basis for the extra work. However, if you’re too rigid on terms, it may end up costing your business more in the long run as some providers will build contingency into their pricing.
A word of caution for those looking to transition current software contracts from time and materials to fixed pricing: The price will increase under a fixed-price model. Expect the software development partner to include a contingency of at least 15% for simple projects if they know you well and are comfortable with working with you. Expect higher contingency rates for custom software development engagements with new partners – a 30% contingency is not unusual for complex projects.
Often an add-on to one of the models outlined above, incentive-based pricing includes bonus payments as a reward for meeting performance goals above and beyond the standard deliverables written in the contract agreement. Incentives can make up for limitations in fixed-price or T&M models, ensuring your outsourcing partner’s motivations stay in line with your own.
Adding complexity to your engagement model means you’ll need to rigorously ensure it’s driving measurable benefits for your business. Transparency and insight into the true price and cost savings can be crucial.
Compared to more traditional models, this comes with a bit of extra flair. Like incentive-based pricing, it’s based on a flat-rate and holds additional payments until your partner achieves specific objectives. The key point of difference here is that the development of new products is jointly funded by both the client and the service provider, with your outsourcing partner sharing in the rewards for a defined period of time.
This innovative approach encourages your partners to develop ideas that add value to your business because the financial risk is shared between both parties. However, be ready to invest a detailed level of oversight. The result of your partner’s work may be difficult to measure, so you need to be prepared not only to enjoy the potential upsides (speed to market, plus the increased revenue, market share and customer satisfaction that comes with high-performing software) but weather the downsides, too (delays or a change of scope that prove costly).
REMEMBER, outsourcing is a partnership, and neither party should enter into the discussion attempting to take advantage of the other. Clearly communicating your expectations and choosing the right pricing model can go a long way to achieving success.