One of the key objectives of IT outsourcing has always been cost-effectiveness. In fact, an outsourcing pricing model plays a pivotal role in forming a successful relationship by aligning the interests and expectations of both the outsourcer and the service provider.
Businesses working with remote development teams are aware of the fact that technology-related projects are priced differently than goods in supermarkets, or even off-the-shelf software solutions. The cost models for outsourcing software development are universal across the industry.
Pricing models in IT outsourcing
The three IT outsourcing pricing models – Fixed-price, Time-&-Material, and Cost Plus (Open Book) – are rarely interchangeable. Each fits particular projects and conditions. We previously gave examples of how the first two align with particular IT services. So let’s briefly review them before introducing the Cost Plus pricing model in software development outsourcing.
- Fixed Price Model
Case #1: Clear path
You know exactly how to digitize your fashion business. Market research is done, roadmap devised, and detailed specification written, UX agreed on. You have a tight budget and prioritize ruthlessly. The date of the first release is extremely important. You’re ready to sacrifice some features to make it happen. An example in our portfolio is Styberry, a digital fashion publishing platform.
How it works
In fixed-price contracts, the project cost is fixed early on. It’s only possible to do with detailed specifications on the software you’re planning to develop. While freezing the cost sounds great, not being flexible with the scope of features is dangerous. Any change after the contract is signed will come at additional cost. So you might end up paying more or getting a mediocre quality software of dubious value.
Chose this model only if you have a clear understanding of the product’s functionality and a well-written specification. The fixed-price model goes well with waterfall methodology and is suitable for MVPs and small projects with:
- limited features
- clear requirements
- limited budget
- determined deadlines
Pros
Cons
- predictability
- transparency
- ease of management
- not flexible
- less accountable
- Time and Material Model
Case #2: Zero vision
You’ve got a brilliant concept of the next-gen streaming platform, but no clue how to implement it or if it will work out. You seek validation. An example in our portfolio is Join-a-game mobile app, bringing together soccer lovers.
How it works
The Time-and-Material pricing model is more flexible in terms of both budget and project requirements. The total cost of the project isn’t defined. It remains unknown until the end, depending on the time and effort used to implement it. This model allows changing the scope and the milestones on the go. Consequently, the cost of the project might differ from the initial estimates.
The T&M model goes well with agile methodology and is suitable for medium to large projects with:
- dynamic requirements
- unclear project scope
- anticipated flexibility
- significant control over a project
Pros
Cons
- flexibility
- dynamic work scope
- optimal timing
- low control over the budget
- active involvement in PM
- Cost Plus (Open Book) pricing model
Case #3: Long-term perspective
Your brilliant idea is completely validated and transitioning from MVP to a full-fledged product. You have a long-term vision as to how the product is going to evolve and need to secure resources to implement it. An example in our portfolio is the Recruitment management system, which outgrew its initial T&M model once the dedicated development started.
How it works
The Cost Plus pricing model includes the cost and a margin, which is an added percentage of the project cost agreed on by both parties. Besides developer fees (which in this case are negotiated on an individual basis), the margin comprises additional effort of the infrastructure and human resources management, project management and consultant fees for the dedicated team set up and once the change is required.
The Cost Plus model goes well with dedicated development and is suitable in outsourcing of large long-term projects with:
- evolving requirements
- agile/waterfall methodology
- full product owner control over a project
- flexible time frame
Pros
Cons
- transparent fees
- no hidden agenda
- best product quality
- client-vendor alignment
- inefficient for short-term projects
- extra fee for the local PM
Let’s look at the pricing options from the perspective of the dedicated team model.
Which pricing model is best for the dedicated team model
In software development outsourcing, one of the best practices for long-term engagement with a vendor is to switch from an early-stage T&M model to Cost Plus later on.
The simplest and most common way to outsource the software development project is based on time and material pricing model (i.e., pay per time unit of work). The hourly or monthly rate includes developers’ salaries, all taxes, overhead costs, and the company’s revenue – and therein lies the main problem with this approach. Since the rate is fixed, the contract becomes a fixed cost. That’s good in case you need a few developers for a short-term period, but if your goal is to build a top-notch development team for a long-term period, this model is rather the worst than the best.
Under this model, your service provider and yourself have the opposite interests. When you plan to increase the size of your project team, you are looking for the absolute best candidate who will meet your requirements and do the job. The service provider, on the other hand, is looking for the least expensive person who is good enough to meet your requirements.
Why? Because the salary impacts the profit directly.
No hidden fees
How to avoid this scenario?
Transparency is a key. The service provider should be your partner. A good way to achieve this is to split the cost into two parts:
- expenses
- management fees
This pricing model is commonly known in IT outsourcing as the Cost Plus or Open Book pricing model. Under this model, you agree with the service provider on a fixed or incentive (as decided by both parties) management cost per employee and you negotiate directly each employee’s salary. You negotiate it with an employee the way you would if you were hiring someone locally.
Cost Plus is a transparent pricing model. Here the service provider presents the outsourcer with a detailed cost structure, highlighting the infrastructure and software developers required to accomplish the project. This model can potentially constitute the best of both worlds by allowing you to utilize the expertise and knowledge of the service provider while maintaining overall control of the project. It allows establishing a mutually beneficial agreement in the long run.
Last but not least
If you’re looking for more information about the pricing of software development outsourcing in Ukraine try our interactive Team Builder to create your team online and estimate the monthly cost. Set the number of years of experience, the core technology, additional technologies and add specialists to the team. Team builder shows you a monthly cost of a software development team in Ukraine. Our estimate is based on the internal data and the results of continuous IT salaries surveys provided by local job sites and IT community.
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