Fixed price vs. Time & Material: What is worthwhile for me and my project?

Your decision is made: You need an external development team. After a short period of research, you have found an ideal partner. The idea and rough planning are soon communicated and both sides are motivated to start a new project. But one question remains: Time and material or a fixed price model after all?

Both models have their advantages and disadvantages and suit different project requirements. In this article, we will take a closer look at both approaches and work out their relevance for the project process in (hardware) development. In the end, you will be able to decide which model is best for your project.

At cost with cost estimate

When paying on a time and material basis, the external development partner usually discloses the hours spent, including a list of what was worked on. As long as the work was carried out within an agreed budget, invoicing is undisputed.

Nevertheless, a cost estimate is often drawn up and represents a more or less detailed list of the expected costs for a project based on the requirements. This is often an estimate that can be flexibly adjusted between the external development partner and the client during the course of the project.

This flexibility pays off in particular when unforeseen changes or challenges arise during hardware development. This offers the option of reacting individually to new requirements. At the same time, it provides a comprehensive overview of the anticipated costs and can help to identify potential cost drivers at an early stage.

However, as it is only an estimate, the actual costs may end up being higher than initially thought. This may be due to technical problems or changes to the project as described above, for example. These require repeated coordination, which can slow down the progress of the project.

The fixed price model

The fixed price model is a fixed price agreement between the client and service provider in which the entire scope of the project is implemented at a defined fixed price. The advantage of this model is that the price remains the same regardless of unforeseen events or additional work.

This means that there are no surprises for your budget at the end of the project. This can be better planned in advance and remains within the mutually agreed framework. This provides both client and contractor with a clear financial framework from the outset, which makes planning and implementation easier.

However, as the price is fixed, there is little scope for additional requirements or changes during the project. Change requests can lead to significant additional costs and the service provider bears the risk if unexpected challenges arise. This can lead to the contractor calculating more conservatively and quoting higher prices from the outset to be on the safe side. Changes by the client that lead to additional work automatically result in a new coordination process, which can also slow down the progress of the project.

What is worthwhile in which project phase?

To understand which model is better suited to your project, let's look at the typical project phases and their potential challenges:

• Requirements analysis:
  The exact requirements for the hardware project are defined in this phase. With a fixed price model, very detailed planning must already be carried out in this phase, as subsequent changes could be expensive. A more flexible model can therefore be worthwhile, especially if such changes are more likely.
  
  
• Prototype development:
  This is where the first drafts and prototypes are created. When billing on a time and material basis, any adjustments and iterations can be handled more flexibly. With the fixed price model, all adjustments should be calculated in advance and discussed in detail.
  
  
• Test and validation:
  In the test phase, the prototypes are put through their paces. Should unforeseen problems arise, billing on a time and material basis could offer the opportunity to implement necessary adjustments to the project quickly and easily, whereas the fixed price model often requires contractual changes in order to continue the project.
  
  
• Series production and market launch:
  When the project goes into production, the costs are already fixed with a fixed price model, which ensures predictability. If billing is based on time and effort, additional costs could arise in this phase and jeopardize the profitability of the project.

Which model suits which project?

• Complex hardware developments:
  If the project is highly complex and involves many unknowns, it is worth billing on a time and material basis. Here, the requirements can be flexibly adapted without incurring high additional costs.
  
  
• Standardized projects:
  The fixed price model is ideal for projects with clearly defined requirements and a low risk of unexpected changes. Here, companies have clear cost control and know what to expect from the outset.
  
  
• Startups vs. established companies:
  Startups often prefer billing on a time and material basis, as they often have to make adjustments and iterations during the project. Established companies with clear processes and specifications, as well as complex internal approval procedures, tend to rely on the fixed price model.
  

Our experience

Ultimately, the aim of outsourcing development services is often to shift the technical risk of product development to the external development partner. The latter can provide support with its expertise and usually assess and manage risks better than the client.

However, when billing on a time and material basis, the technical risk is not shifted, or not completely shifted, but remains with the client. Depending on how the project progresses, this can give the client the impression that they are not only still responsible for the market risk of the product to be developed, but also continue to bear the risk of errors in the development despite outsourcing.

Our many years of experience have shown that customers prefer to place orders in phases for large projects or projects with considerable technical feasibility risks. In this way, the disadvantage of the fixed price, the pricing in of risks, can be kept to a minimum. In this way, the project is not unnecessarily inflated and can be optimized in an agile manner.

The Teleconnect recommendation is therefore to use the fixed price model as often as possible. In doing so, both parties have an equal interest in the swift and careful processing of the project.