Which Software Pricing Model Gets Me to Market with A Competitive Advantage?

Get a better understanding of software development pricing models and what they mean for your tech ROI and go-to-market strategy.

July 26, 2022
10 min

According to a recent study by Deloitte, 70% of companies are choosing to outsource their software development projects. The leading driver behind this decision is to save money.

If your goal is to reduce costs and gain better ROI, you may be tempted to go with a customized software development agency that offers the lowest bid. Nevertheless, just because the bid is low does not mean the contract pricing model or service agreement is right for you, your project, or your overall business goals.

To determine how to get the best software development pricing that meets your needs and gives you significant advantages in the market, you need to understand the following concepts:

  • Why software development agencies use different pricing models
  • Differences between available pricing models 
  • Pros and cons of each model
  • How to choose the best pricing model for your needs

Demystifying Why Software Development Agencies Use Pricing Models

Software development agencies use different pricing models for strategic purposes. Their strategies can be internal or operational based, such as choosing projects and pricing models to match the skills resources of their staff. These agencies may also choose their pricing models to better accommodate the needs of their ideal customer profile.

For example, some software development agencies, often referred to in the industry as “dev shops,” choose to serve customers who just need something basic built. The software doesn’t have a lot of bells or whistles and only solves very common business problems.

Most of these dev shops use cheaper, overseas labor to attract customers with extremely low rates, but you have to understand what you’re paying for. You are only paying to have your product built to spec. Nothing more. 

These dev shops are build-to-order businesses, not consulting agencies that provide business guidance or technology recommendations. When choosing a software development agency, you must know if the scope of work you need done is build-to-order or more complex. That will help you find not only the right partner, but also the right pricing model.

Defining Software Development Pricing Models

The following includes the most common software development pricing models currently available:

Pricing Model Type Definition of Pricing Model

Fixed Price or Fixed Bid

The contract is set at a specific price but only covers the agreed-upon scope of the project. The contract also includes the timeframe in which the project will be built and delivered.

Time and Materials (T&M)

This agreement states that customers will be charged based on the hours spent and cost of materials to build the project. While there is an initial outline in terms of budget, scope, and other factors, the contract remains flexible, and payments are made in intervals.

Mixed Pricing
or
Hybrid Pricing

Taking elements from the fixed bid and the T&M models, this agreement includes a strict scope of work with deadlines, but there is some flexibility. As a result, the price may fluctuate based on any change orders.

Dedicated Team

Instead of a software development company building your project, you’re paying to bring in their workers as a temporary staff for the duration of the build. You would be responsible for their salaries, additional admin fees, and you would manage them during the day-to-day of the project.

Managed Services

In this agreement, the software development agency and the customer define clear service deliverables and designate a fixed rate for the project. 

 

As a more quantitative method of delivering service, this pricing model often includes service level agreements (SLAs). The customer agrees to a fixed monthly rate, and through the SLAs, the agency must produce the agreed deliverables.

Outcome-based

Instead of being charged based on the hours of work to deliver a project, this model is value-focused and charges customers based on the delivered measurable impacts. 

 

In this model, both the software development agency and the customer must align toward a common goal of building the project to deliver the clearly defined impact outcomes

Cost Plus

In this model, software development agencies determine the price by calculating how much it will cost to build the product, and by adding an additional margin to the cost, which is often a set percentage. 

 

For example, the price might be the salary of the programmers involved in building the project plus a 10% margin.

Pros and Cons of Software Development Pricing Models

If budget is your main concern, you may look at these pricing models and think that the cheapest and most straight-forward ones are your best options. But before you make that decision, you should consider the pros and cons of each model.

Fixed Price or Fixed Bid

Pros:

Cons:

Everything is planned and determined upfront.

Customers lack control over making changes to the project.

Lower risk for customers.

Generally no industry guidance or feedback is offered by the provider.

Software developers are motivated to finish on time and on budget.

Quality and costs vary widely from provider to provider.

Time and Materials (T&M)

Pros:

Cons:

Straightforward pricing.

Deadlines are not always clear.

Industry and tech experts can help determine your business and project needs.

Requires extra monitoring to control the budget.

Interval-based payments can be easier on the budget.

Change orders can extend deadlines.

Mixed Pricing or Hybrid Pricing

Pros:

Cons:

Blends the best features from a highly rigid model (fixed bid) and a more flexible model (T&M).

Changes can lead to delays in time-to-market.

Allows the customer to get the most for their budget without compromising on quality.

Project requirements often shift and can lead to scope creep.

Less risk for all parties involved.

Customers lack control over the use of developer resources.

Dedicated Team

Pros:

Cons:

Simplistic program with quick implementation.

Customer must manage and motivate team members.

Less risk involved for all parties.

Team members have fewer incentives to go above and beyond the contract.

Customer has more control over the team.

Team members may not be invested in the customer’s company goals.

Managed Services

Pros:

Cons:

Monthly payments for SLAs allow for better budget forecasting.

Hiring multiple providers each under managed services contracts can become volatile if they do not work well together.

Providers are incentivized to deliver better quality to meet SLAs.

Providers may not have a full understanding of the customer’s key pain points or the project scope.

Customers can focus more on business initiatives while providers manage technology initiatives.

It can be difficult for customers to manage and handle the non-conformance of SLAs.

Outcome-based

Pros:

Cons:

Projects align directly with customer’s business goals.

Less day-to-day transparency on how tasks are completed.

Providers are incentivized to innovate.

Determining the value and cost of the service isn’t always clear.

Providers generally have more understanding of the customer’s industry, operational processes, and their business model.

The age and maturity level of the customer’s company may not work well with an outcome-based technology plan.

Cost Plus

Pros:

Cons:

More transparent contract without hidden fees.

Excessive admin duties for managing and tracking expenses.

Flexible for scaling needs of the project or team.

Unknown final costs can create tension between the customer and provider.

More management control options for the customer.

Potential for disputes over provider’s indirect costs and who covers them.

How to Choose the Best Software Development Pricing Model

The reason there are so many different software development pricing models is to match the variety of customer needs. Therefore, the best pricing model will always be the one that matches your organization’s immediate needs.

That said, there are some guidelines you can follow to determine which pricing model would work better for your needs as compared to other models.

Size and Complexity of Your Project

Most software development agencies rank projects as either small, medium, or large. Smaller projects usually take less than three months to complete, they include fewer deliverables, and the software solution delivered is not very complex.

Medium-sized projects can be completed in 3-6 months, are somewhat more complex, involve several customer stakeholders, and there is often ambiguity concerning the full scope of the project. 

Larger projects include multiple deliverables as well as subprojects. Projects of this size often impact multiple services and departments within an organization, and they typically take anywhere from 6-24 months to complete.

Based purely on the size and complexity level of the project, here are some general guidelines on which pricing models work best:

Small/Less Complex

Medium/Somewhat Complex

Large/Super Complex

  • Fixed Price

  • Mixed/Hybrid Pricing

  • Managed Services

  • T&M

  • Mixed/Hybrid Pricing

  • Managed Services

  • T&M

  • Dedicated Team

  • Cost Plus

  • Outcome-based

Timeline to Get Product to Market

In the previous section, we verified how long software development projects take in terms of months based on size and complexity. But, how do you know what constitutes a small project versus a medium-sized one? 

If you don’t have a background in technology, you have no context for what developers quantify as small, medium, or large, let alone complex. That’s why most software development agencies start every project with a discovery process.

During discovery, developers and product owners can determine which technology solutions are best suited for solving your business problems or upgrading your systems. From collecting these details, they can create a basic scope of work, propose a budget, and build a timeline for how long it will take to complete the project.

Recognize that completing the work includes a multistep process. Most projects are not something that can be done over the weekend. Software development requires designing what the product or service will look like, determining the best way for it to function, doing the actual development and technical coding, testing the product, and completing all additional prelaunch stages before it goes live.

Software developers cannot complete your build overnight, but they also recognize you have a deadline. If the deadline is feasible, they will try to make it happen, or they will negotiate project needs to deliver a more bare-bones version, such as a minimum viable product (MVP). The MVP may not have everything you want, but if you have a shorter deadline that can’t be missed, it may be your best option.

For which software development pricing model works best for projects based on a timeline, the general rule is as follows:

Timelines Less Than 3 Months:

  • Fixed Price 
  • Mixed/Hybrid Pricing 
  • Managed Services

Timelines Greater Than 3 Months:

  • T&M
  • Mixed/Hybrid Pricing
  • Managed Services
  • Dedicated Team
  • Cost Plus
  • Outcome-based

To give you even more context on how long your project might take, look at this graph below for the average amount of time it takes to build commonly requested software projects:

You can learn more about the difference between out-of-the-box and customized software here.

AltSource’s Pricing Model Promotes Partnership and Transparency

While there are several software development pricing models out there, most providers only offer one or two options based on their business strategy and ideal customer persona. 

For example, at AltSource, we value developing long-term business partnerships in which we can help customers build their technology roadmap so that they can continue to grow and scale. To match our business needs and style, using the T & M model has proven most effective, as it allows for full transparency and relationship-building. 

Likewise, T&M enables our team to be more innovative for our clients. Often, clients come to us with medium to large-size projects that are usually less defined. By leveraging a T&M pricing model, we can better provide more thoughtful, long-term consulting to identify the right solutions for our client’s present concerns as well as their future needs and goals.

For instance, when we worked with Northwest Generics, a supplier of generic prescription drugs to more than 180 pharmacies throughout the Western United States, we knew that they needed a business partner like us with the skills necessary to identify their problems and build them the right solution to align with their current needs and future goals.

During discovery, we took a deep dive into their business to identify the problems they were facing. After the discovery process and interviewing their team members, we learned that their legacy system was creating too many roadblocks and that many of their business processes were slowing them down. 

Thanks to our way of connecting with customers, our experts leveraged their industry knowledge so that we could build them a point-of-service pharmaceutical management system. Find out more details here.

If you still have questions about different pricing models or how the relationship between customers and customized software development agencies works, please reach out to our team: sales@altsourcesoftware.com