Time & Material vs. Cost Plus Pricing: Which is Better for Your Software Outsourcing Project?

Nowadays, 60% of tech companies outsource at least a part of their application development. It is expected that the IT outsourcing industry will increase up to 5% in the next few years and reach a $425.19 billion market value by 2026.

Companies, leveraging outsourcing services, can reduce their expenses by up to 40% on average, but only by choosing the right pricing model. I suggest comparing two popular models to get to know which pros and cons they have, how to minimize the drawbacks, and which one fits your business better.

What is a Time & Material pricing model?

It is a contract where you don’t know the total cost of a project until it is done. Instead, the hired software development company provides you with a fixed hourly or monthly rate for each specialist. You can alter the requirements and scope of work in the process. The final cost will be calculated de facto according to the number of people assigned to your project and the hours they spent delivering your product.

Usually, the Time & Material (T&M) model is used in line with Agile methodology.

Advantages of a T&M pricing model:

• You can start the project quickly because you don’t need detailed specifications. You can assign the first task to the development team and prepare the next one in the process. It helps you avoid downtimes;
• You agree on the rates at the beginning of cooperation, and they remain unchangeable. You don’t pay sick leaves and holidays, the contractor cares about that.

Disadvantages of a T&M pricing model:

• The final cost can be much higher than your estimates and budget.

  
  

  How to avoid it? You can ask the contractor to assign you a skilled Project manager and Business analyst that will create as detailed project requirements as possible in cooperation with your representative. The more thorough the project description will be, the less risk of wrong tasks you have.

  
  

• The T&M model is a result-centered approach. You can fully rely on the manager from the contractor's side and even don’t go deep into what happens in the development team. As a result, there are frequent cases when high-level specialists can be exchanged for the less experienced because of turnover, and you might not even know about it.

  
  

  How to avoid it? Interview and approve each key professional personally. Then, discuss with your contractor that it takes the responsibility to retain the core talents during the project.

I recommend the T&M pricing model in software development for:

• Startups with expertise in IT.
• Medium or large businesses where decision-makers are experienced in handling staff remotely and realize how to work with dedicated teams.

How does Cost plus pricing work?

Imagine that you have a long-term project for 1+ year. You may have or do not have the in-house software development team, but you need extra resources and want to get them quickly. You contact an outsourcing software development company to hire dedicated tech specialists. They become your part- or full-time employees with fixed salaries and fully control de facto, but de jure, they stay being the staff of your vendor. So, such a cooperation model goes ideally with the Cost+.

When you select the Cost+ pricing model, you provide a monthly payment that includes: a fixed salary for each specialist according to the market rates in the vendor's country; the overhead to a contractor like insurance, rent, utilities, and other expenses.

This approach fits well with Agile, Kanban, Waterfall, or other methodologies depending on the specifics of your project.

Advantages of a Cost+ model:

• Choosing the vendor, for example, in Eastern Europe, you can cut the expenses for fees without sacrificing the development quality. In comparison with the US, UK, Israeli markets, the savings could be up to 40%.
• Your development team starts working as a united team from day one, and it tends to be really high-performance. Such specialists mostly already have experience of working in dedicated teams and perfectly know all pitfalls and tips.

Disadvantages of a Cost plus pricing strategy:

• If you already have an in-house team, hiring the outsourcing specialists may cause some issues. The managers can face difficulties communicating and handling a dedicated team. The in-house employees could feel the competition and have doubts about their future in the company. The reason is the lack of such an experience.

  
  

  How to address this issue? Arrange a meeting to explain to your company’s employees why you’ve decided to scale the team. Focus on mutually beneficial working, exchanging the experience and speeding up. Ask your contractor to assign you a professional Project manager that introduces the dedicated team to your in-house one and answers all the questions. Present the communication and management tools like Jira, Slack, Microsoft Teams that help interact smoothly and transparently.

• You have to cover sick leaves and holidays and take on the same level of responsibility as with your company’s staff. Also, you should be confident that you ensure constant workload for your outsourcing team, otherwise, you waste money on downtimes.

  
  

  How to address this issue? Ask your vendor to provide you access to employees’ contracts and financial documents to see all fees transparently. Before the beginning of work, discuss with your contractor the possibility of scaling up or down your team quickly to avoid overloading or pauses in the development process.

I recommend a Cost+ model in outsourcing for:

• The startups where the decision-makers already have experience with outsourcing cooperation.
• For medium and large businesses, typically product companies, that already have an in-house team. They need extra resources when their employees are overloaded or don’t have specific expertise.

Conclusion

For mutually fruitful and smooth cooperation, your contractor has to examine particularly your case to suggest the most appropriate pricing model.

For that, your vendor might consider several factors, such as:

• size and specifics of your business;
• availability and expertise of your in-house software team;
• your knowledge and experience in IT workflows.

This approach stops both client and vendor from unexpected expenses and streamlines the product delivery.