Fixed-Price vs Time and Materials: Software Project Pricing Models Explained

How you price a software project shapes risk, flexibility, and alignment between client and vendor. Fixed-price and time-and-materials (T&M) are the two dominant models, each with distinct trade-offs. This guide explains how each works, when to use them, and how to structure contracts for enterprise software development in 2026.

How Each Model Works

Fixed-Price

With fixed-price, the client and vendor agree on a set scope, deliverables, and total cost upfront. The price does not change unless the scope changes through a formal change order.

| Element | Fixed-Price | |---------|-------------| | Cost | Agreed total, regardless of hours | | Scope | Defined in SOW, functional spec, or user stories | | Risk | Vendor absorbs overruns; client pays same amount | | Flexibility | Low without change orders | | Change process | Formal change request, revised quote, approval | | Payment | Milestone-based (e.g., 30% start, 40% midpoint, 30% completion) |

Example: A client commissions a customer portal for $150,000. The vendor delivers the agreed features; if development takes longer than estimated, the vendor absorbs the cost. If the client requests new features, a change order is issued and the price increases.

Critical success factor: Fixed-price only works when scope is sufficiently defined. Vague statements like "build a portal" invite disputes. A fixed-price SOW should include functional requirements, acceptance criteria, technical constraints, and explicit exclusions. The more detail upfront, the fewer change orders later.

Time and Materials

With T&M, the client pays for actual time (and sometimes materials) at agreed rates. Scope can evolve; cost scales with effort.

| Element | Time and Materials | |---------|---------------------| | Cost | Hours multiplied by rate; varies with effort | | Scope | Fluid; prioritized backlog, iterations | | Risk | Client bears cost overruns; vendor guarantees rate and quality | | Flexibility | High; adapt priorities as you learn | | Change process | Prioritization in backlog; no formal change orders | | Payment | Weekly or monthly invoicing based on hours worked |

Example: A client engages a team at $150/hour. After 200 hours ($30,000), they've built an MVP. They continue for another 300 hours ($45,000) to add features discovered during development. Total: $75,000 for a product that evolved with feedback.

Critical success factor: T&M requires active client participation. Without clear priorities and regular feedback, the team may build the wrong things or over-build. Weekly syncs, a prioritized backlog, and defined "done" criteria keep T&M engagements aligned. The client acts as product owner; the vendor executes.

Risk Allocation

Where risk sits affects behavior and outcomes:

| Risk Type | Fixed-Price | Time and Materials | |-----------|-------------|---------------------| | Scope creep | Vendor bears cost of extra work | Client pays for all work | | Underestimation | Vendor bears cost | Client pays for actual effort | | Requirement ambiguity | Vendor incentivized to interpret narrowly | Both can refine as they learn | | Delays | Vendor absorbs cost of delays (within contract terms) | Client pays for extended engagement | | Quality disputes | Often tied to "acceptance criteria" in SOW | Vendor accountable to rate and professional standards |

Fixed-price shifts risk to the vendor; they must estimate accurately or lose margin. T&M shifts risk to the client; they must manage scope and budget.

When Fixed-Price Works

Fixed-price suits well-defined, low-ambiguity work:

| Scenario | Why Fixed-Price Fits | |----------|---------------------| | Compliance-driven project | Scope is determined by regulations; little room for interpretation | | RFP with detailed spec | Requirements are documented; vendor can estimate | | Tight budget with no flexibility | Client needs cost certainty for approval | | Small, scoped piece of work | e.g., Migration of 20 reports, integration of one system | | Client has low risk tolerance | Prefer predictable cost over flexibility | | Waterfall procurement process | Procurement requires fixed bids |

Limitations: Fixed-price struggles when requirements are fuzzy, discovery is needed, or the client expects to iterate. In those cases, change orders multiply and the "fixed" nature breaks down. Vendors may also pad estimates to protect against risk, raising the effective price. And clients sometimes resist change orders for "small" requests, leading to friction or undocumented scope creep.

When Time and Materials Works

T&M suits discovery-heavy, iterative work:

| Scenario | Why T&M Fits | |----------|--------------| | MVP or new product | Scope emerges; you're figuring out what to build | | Agile/iterative development | Sprints, backlog refinement, continuous feedback | | Complex, novel problems | Unknown unknowns make estimation unreliable | | Long-term partnership | Retainer-style engagement; priorities shift | | Client wants flexibility | Willing to pay for learning and adaptation | | Innovation or experimentation | Exploring tech, UX, or business model |

Limitations: T&M requires trust and active client involvement. Without guardrails, cost can spiral if scope is not managed. Some clients worry about open-ended spend; a cap or regular budget checkpoints can address this. T&M also assumes the client can dedicate time to prioritization and reviews. Absent that, the engagement can drift.

Hybrid Approaches

Many engagements use a blend of both models:

T&M with Cap (Not-to-Exceed)

Client pays T&M rates but sets a maximum (cap). If the cap is hit before completion, parties renegotiate or pause.

| Aspect | T&M with Cap | |--------|--------------| | Flexibility | High within cap | | Risk | Shared; vendor must deliver value before cap | | Best for | MVPs, discovery phases with budget limit | | Client benefit | Cost ceiling | | Vendor benefit | Flexibility to iterate |

Fixed-Price Phases with T&M Options

Phase 1 (discovery, design) is T&M. Phase 2 (build) is fixed-price based on Phase 1 output.

| Phase | Model | Rationale | |-------|-------|-----------| | Discovery | T&M | Scope not yet defined | | Design | T&M or fixed | Depends on design maturity | | Build | Fixed | Scope is now clear | | Support/iterations | T&M | Ongoing enhancements |

Fixed-Price Sprints

Agree on a fixed price per 2-week sprint. Scope per sprint is flexible; total engagement can be a number of sprints or left open.

| Aspect | Fixed-Price Sprints | |--------|---------------------| | Predictability | Per-sprint cost known | | Flexibility | Scope can change between sprints | | Best for | Agile clients who want some cost certainty |

Cost Implications

| Factor | Fixed-Price | Time and Materials | |--------|-------------|---------------------| | Vendor buffer | Typically 15-30% added for risk | Minimal; rate reflects skill, not risk | | Effective rate | Often higher due to risk premium | Typically lower per hour | | Client total cost | Predictable if scope stable | Variable; depends on collaboration | | Waste | Incentive to cut corners if over budget | Incentive to bill more hours | | Alignment | Vendor profit from efficiency | Vendor profit from engagement length |

Fixed-price can yield a higher effective rate because vendors build in contingency. T&M can be more efficient when both parties collaborate to deliver value without overbuilding.

Hidden costs: In fixed-price, watch for "out of scope" interpretations that push work into change orders. In T&M, watch for low-velocity teams or unnecessary gold-plating. Good contracts and regular communication mitigate both. Transparent time tracking and sprint demos help clients verify value in T&M.

Contract Structure

Fixed-Price Contract Elements

| Element | Typical Content | |---------|-----------------| | Statement of Work (SOW) | Deliverables, acceptance criteria, exclusions | | Payment schedule | Milestone triggers and amounts | | Change order process | How changes are requested, quoted, approved | | Acceptance | Definition of "done," acceptance period, rejection process | | Warranties | Bug fixes, support window | | Limitation of liability | Caps on damages |

T&M Contract Elements

| Element | Typical Content | |---------|-----------------| | Rate card | Hourly rates by role (e.g., developer, designer, PM) | | Invoicing | Frequency (weekly/monthly), payment terms | | Reporting | Time logs, burndown, or status reports | | Notice period | How much notice to reduce or end engagement | | Work order or SOW | High-level goals; not a fixed deliverable list | | Cap (if used) | Not-to-exceed amount |

Change Management

In Fixed-Price Projects

Changes require a formal process to avoid scope creep and disputes:

1. Request: Client describes the change in writing.
2. Impact: Vendor assesses effort, cost, timeline.
3. Quote: Vendor provides a change order with revised price and schedule.
4. Approval: Client approves or declines.
5. Execution: Approved changes are added to scope.

Without this process, "small" requests accumulate and the fixed price becomes untenable.

In T&M Projects

Change is continuous. Backlog prioritization replaces change orders:

1. Backlog: All requests go into a prioritized list.
2. Sprint/iteration: Team pulls top items.
3. Review: Client reviews progress and reprioritizes.
4. Repeat: No formal change process; prioritization is the control.

Choosing the Right Model for Your Project Type

| Project Type | Recommended Model | Notes | |--------------|-------------------|-------| | Website redesign with clear spec | Fixed-price | Scope can be defined | | Custom SaaS MVP | T&M or T&M with cap | Discovery is central | | Enterprise integration (well-defined) | Fixed-price | Interfaces and systems known | | Legacy modernization | Often T&M | Scope emerges during assessment | | Mobile app (first version) | T&M with cap | Requirements evolve | | Compliance module (e.g., audit trail) | Fixed-price | Regulatory scope is clear | | Ongoing product development | T&M | Continuous iteration | | Proof of concept | T&M | Exploratory |

Understanding enterprise software development costs helps you set realistic budgets for either model. Use our website cost calculator to get ballpark figures for web projects.

In-House vs Outsourced Considerations

The same models apply whether you use an in-house team or an agency. With in-house vs outsourced development, the key difference is who bears risk and how you manage scope:

• Outsourced fixed-price: Vendor owns estimation risk; ensure SOW is clear.
• Outsourced T&M: You own scope and budget; choose a partner you trust.
• In-house: Effectively T&M (salaries); "fixed-price" is internal project budgeting.

Summary

| Choose Fixed-Price when | Choose T&M when | |-------------------------|-----------------| | Scope is well defined | Scope will evolve | | Budget is fixed | Budget can adapt with value | | Low tolerance for cost variance | You want to iterate and learn | | Procurement requires fixed bid | Agile or partnership model | | Small, discrete deliverable | Ongoing product development |

The right model depends on project clarity, risk tolerance, and how you want to collaborate. Many successful engagements use hybrid approaches: T&M for discovery, fixed-price for build, or T&M with a cap for controlled flexibility.

Final recommendation: Start with clarity. If you cannot write down concrete deliverables and acceptance criteria, lean toward T&M or a discovery phase. If you have a solid spec and need budget certainty for approval, fixed-price can work. When in doubt, a short T&M discovery (2-4 weeks) to define scope often yields a better fixed-price SOW than estimating from incomplete requirements. The upfront investment in clarity reduces disputes and change orders later.

Need help structuring a software project engagement? ZTABS works with both fixed-price and T&M models for enterprise software projects. We can recommend the right approach and draft clear contracts that protect both parties.

Get a free consultation.