Understanding Software Development Pricing Models
A software development company may use various pricing models to bill their clients. The choice of model often depends on the nature of the projects, client preferences, and the relationship between vendor and client.
In this article, we will explore six commonly used models. Each model has their own advantages and disadvantages to help you understand and choose the best vendor for your budget and project.
Time & Material Model (T&M)
The T&M model is pretty straightforward. Vendors usually bill their clients for the actual time spent by their development team, usually on an hourly basis. The hourly rate varies based on seniority and skill set of resources.
| Pros | Cons |
|---|---|
| Flexibility to adjust scope and requirements | Lack of budget predictability for the client |
| Transparent pricing based on actual effort | Potential for cost overruns if not managed properly |
| Suitable for projects with evolving requirements | Requires close monitoring and communication |
Example Scenario:
- 2 developers working 200 hours each
- 1 designer working 80 hours
- 1 tester working 30 hours
You’ll pay:
- Developers: RM 250 × 200 hours x 2 person = RM 100,000 (USD 22,000)
- Designer: RM 250 × 80 hours = RM 20,000 (USD 4,400)
- Tester: RM 250 × 30 hours = RM 7,500 (USD 1,650)
FIxed-Price Model
A fixed-price model, on the other hand, is agreed upon a well-defined scope of work. The estimated effort required for the project determines the cost. Vendors will usually bear any risk of extra costs.
| Pros | Cons |
|---|---|
| Budget predictability for the client | Less flexibility for changes in scope or requirements |
| Clear expectations and deliverables | Potential for a mismatch between client expectations and the delivered output if not scoped properly |
| Reduce financial risk for clients | Higher upfront cost for the development company |
Example Scenario:
If you’re a corporate client building an HR management system with clear requirements, you’ll want predictable costs. The development company might quote a fixed price of RM 230,000 (USD 50,000).
-
Requirement Study (5%): RM 11,500 (USD 2,500)
-
Project Management (10%): RM 23,000 (USD 5,000)
-
Development (70%): RM 161,000 (USD 35,000)
-
UI and UX Design (5%): RM 11,500 (USD 2,500)
-
Testing (10%): RM 23,000 (USD 5,000)
If your requirements remain unchanged, you’ll pay a flat amount and receive the completed system. However, any new features added later will require a new agreement.
Dedicated Team/Dedicated Resource Model
This model involves vendors billing clients a fixed monthly cost for a team dedicated exclusively to their project.
Unlike Fixed-Price models, the scope and deliverables aren’t locked. Hence, clients have more flexibility to adjust the team’s size and composition based on evolving project needs.
This means clients can scale resources up or down, prioritise specific tasks, and shift focus without renegotiating the entire contract, offering greater control over the development process and flexibility to adapt to changing priorities.
| Pros | Cons |
|---|---|
| Flexibility to scale the team as needed | Higher long-term costs compared to Fixed-Price model |
| Allows for long-term planning and roadmap | Requires effective communication and management |
| Fosters a close working relationship | Potential for underutilisation of resources |
Example Scenario:
If you’re an e-commerce company with a constantly evolving platform, you’ll need continuous development and maintenance.
The team size, however, can be adjusted based on the project’s roadmap and changing priorities. At the start of the project, you may need to hire more resources due to the high workload:
- 3 developers at RM 23,000/month (USD 5,000/month) each
- 1 project manager at RM 29,900/month (USD 6,500/month)
- 1 QA engineer at RM 20,700/month (USD 4,500/month)
-
Developers: RM 23,000 × 3 = RM 69,000 (USD 15,000)
-
Project Manager: RM 29,900 (USD 6,500)
-
QA Engineer: RM 20,700 (USD 4,500)
During periods where there is lesser workload, you might not need up to 3 developers, so you have the flexibility to pay for 1 developer instead.
Retainer Model
As for the Retainer model, clients often pay a recurring fee to secure a certain amount of the development company’s time and resources. This model is usually used for ongoing maintenance, support or small enhancements.
| Pros | Cons |
|---|---|
| Predictable monthly costs for the client | Potential for scope creep if not managed properly |
| Guarantees the availability of resources | Requires clear expectations and regular communication |
| Suitable for long-term partnerships | May not be cost-effective for short-term projects |
Example Scenario:
When a company engages with a software company to develop a Reward and Loyalty solution, they can continue to engage with the original developer on a retainer basis for continuous support and perform minor enhancements.
The team is always available within the agreed hours if you need urgent fixes or updates. However, you will still need to pay for the unused hours as they still cost the same.
Value-Based Pricing
| Pros | Cons |
|---|---|
| Predictable monthly costs for the client | Potential for scope creep if not managed properly |
| Guarantees the availability of resources | Requires clear expectations and regular communication |
| Suitable for long-term partnerships | May not be cost-effective for short-term projects |
Example Scenario:
If your financial services firm expects to save RM 2.3 million/year with a new fraud detection solution, the vendor might charge 20% of your annual savings.
- 10% × RM 1,000,000 = RM 100,000 (USD 23,000)
Outcome-Based/Risk-Reward Model
| Pros | Cons |
|---|---|
| Aligns the interests of the client and vendor | Difficulty in quantifying the value delivered |
| Focuses on outcomes rather than the outputs | Requires a deep understanding of the client's business |
| Potention for higher profits for the vendor | May be challenging to negotiate and agree upon |
Example Scenario:
Let’s say your retail chain business often experiences stockouts and overstocks due to poor inventory management, so you decided to collaborate with a vendor to develop inventory optimisation software that uses predictive analytics to optimise inventory levels, tackling your challenge of lost sales and excess inventory.
If you agree to a base fee and an additional incentive, then you will be billed for every 10% reduction in stock mismatches
For example, if results are delivered:
- Base Fee: RM 120,000 (USD 26,400)
- Incentives: RM 50,000 × 3 = RM 150,000 (USD 33,000)
Total Cost: RM 270,000 (USD 59,400)
Find out how to choose the right software development company for a long-term partnership!
Conclusion
Each model has its own strengths and weaknesses. When choosing a software company, it is best to go for the vendor that understands your project requirements and bills you based on the right model. By understanding the pros and cons of pricing models, your business can make better-informed decisions.
It is also important to note that not every software development company offers the same pricing models or will accept the model that you prefer. Hence, be sure to clarify the charging model during the vendor selection process so that your business and the vendors can align and work effectively.
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