Custom software development pricing strategies

2. Software Development Pricing Models Guide

Pricing Models.

Historically, organizations approached software development outsourcing as a black box where you throw away things you don’t want to do. The field is changing as the emerging markets have proved to provide quality and shown the advantages of higher dollar purchasing power.

With so much at stake, traditional outsourcing engagement models thus moved towards partnership models. So now, businesses increasingly outsource things they can’t do.

As a result, the emerging cooperation models have created numerous pricing models.

However, once you start digging deeper with your research and evaluating IT contractors’ proposals, you’ll start to see not only the big difference in total cost but also the difference in pricing models used to calculate the cost.

Ultimately, you may feel like companies are trying to take advantage of your lack of experience, and you can’t identify a potential long-term partner.

In this publication, Mad Devs Customer University addresses your puzzling questions about pricing models with clarity and transparency.

What are the software pricing factors?

Unfortunately, it can be hard to determine the exact cost of a software development project. Unlike building products from an assembly line, estimating the cost of a software development project involves taking into account various factors.

1. Human resources

The number of people who are involved in the project will have a huge effect on the cost of the project. You will need to hire a team of developers if you are not outsourcing the project. The size of the team depends on how complex the project is and how experienced the individuals are.

Your team's work environment will also affect how productive they are. Having a good working relationship with one another will help them become more efficient. There may be issues that they need to resolve, but the more projects they work on, the more they will be able to improve their efficiency.

The ability of your team to avoid conflict and work efficiently will have a huge impact on the project's budget. Make sure that everyone on the team is qualified and has the necessary skills to carry out their duties. Overworking the team can cause them to waste time and make them more prone to errors.

2. Project complexity&size

The complexity of a software application is also a factor that will affect the cost of the project. It can be very challenging to develop a complex program due to the number of steps and calculations that it requires.

The size of the software that you're developing will also be influenced by the number of screens that will be built. Having too many screens will increase the cost of the project.

3. Software functionality

One of the most important factors that will affect the cost of a software project is the functionality of the application. Having too many features will increase the cost of the development. It can also take longer to build and test a large number of applications.

4. Scope of work

The larger the scope of the project, the more expensive it will be. Although the project will likely have a fixed schedule and human resources, the scope can change over time. This is because constant stakeholder feedback will help determine the cost and the quality of the project.

5. UX/UI

The cost of a custom design depends on the features and scope of the project. Having a well-designed and engaging user interface is very important for a successful software development project. The right mix of animations, visual elements, and unique navigation elements will keep your users coming back.

6. Integrations

Another factor that can affect the cost of a software project is the integration of its features with other business applications. For example, having multiple third-party tools such as CRM will increase the cost of the project.

7. Migration

Different migration techniques and the unique requirements of different storage vendors can also add to the complexity of the process. Having a customized approach is also important to ensure that the data that you're moving will fit seamlessly into another system.

8. Extra expenses

Even though you're paying for the software, you should also consider the additional costs that the service provider might charge. These costs might not be related to the developers' hourly rates. It can be necessary if the complexity of the project increases or there is technical debt.

Aside from the hourly rate, there are also additional costs that the service provider might charge. These additional costs can pile up and add up to a huge bill.

Some businesses will also require that they pay for the licenses that the developers will need to complete the project. Others will require that they pay for the infrastructure costs associated with buying or leasing software.

Most people don't realize that there are also maintenance fees that are included in the cost of a software development project. These fees can range from minor repairs to security updates.

So when we’ve covered the major factors that influence project cost, we can move to pricing models. 

What are pricing models in IT industry?

It can be overwhelming to build software from scratch. Not only does it involve writing code, but it also involves various phases such as architecture, design, testing, and deployment.

To avoid getting bogged down by the various steps involved in building a robust software solution, companies should keep in mind that there are various pricing models available. They should also be aware of the premium options that are available for their project.

With pricing models, companies can easily understand what they are paying for and what benefits they will get from their projects. There are several types of pricing models that can help companies develop software: Fixed price, Time and Material, Outstaffing, Dedicated team, Hybrid, and Gain-sharing model.

Let’s look closer at each of them.

Fixed Price Model / Waterfall 

As the name itself implies, a fixed price model is an agreement between a business and an IT outsourcing company on a strictly predefined set of requirements to be accomplished for a predefined price.

Note: The terms “fixed price model” and “waterfall model” are used interchangeably.  

A fixed price model is an ideal mechanism for projects with a clear scope, established project management methodologies, and a stable set of requirements. For a successful collaboration, a team and a service provider should have a good grasp of project requirements and a conducive working environment in place and should be aware of each other’s skills and needs.

Clients with tight budgets and those who require absolute certainty tend to incline towards the fixed price model.

IT service providers absorb the majority of the risk. However, this risk coverage is, in fact, coming from the customers’ pockets. Keep in mind that in 100% of cases, the service provider charges a 20%-50% premium on top of the real cost because the provider must consider various risks and ensure profitability for the entire project timeline.

In the early stages of IT outsourcing, almost everybody worked using the fixed price model, and it created numerous inconveniences and issues for both service providers and clients.

Problems and pitfalls of the Fixed Cost pricing model 

The above explanation of the Fixed Costs pricing models is what you’ll commonly hear and read on the Internet. Let’s dig deeper; here is what they don’t necessarily tell you.

  1. Negotiation mess: As the contract defines the scope of the work and specifications, any deviation from this scope will create a negotiation mess. As problems and new needs emerge, it’s difficult to understand which party should absorb the additional cost. So instead of moving the project forward, both parties will be sending new additions to the contract back and forths, so a lot of time can be wasted.
  2. Undeniable utopia: Dealing with a list of clearly defined specifications and requirements, unfortunately, is a utopia. In a normal project, adjustments and alterations will inevitably be needed at some points. Unless, of course, you are required to automate a 100-year-old process that will maintain the status quo forever. Or your project is tiny.
Fixed price model.

Time and Material (T&M) pricing model

User behaviors and needs change faster than a typical software development project lasts. Often, you as a client can only predict possible intentions and perceptions of users. Meanwhile, MVP requirements can’t be defined precisely. Thus, during the development process, new product requirements and new flows will appear, and they will affect the total software price as well. 

The time and material price model provides agility. Flexibility in software development enables you to create a product that the market indeed needs and will use.

Also, this model is the most transparent one. In the fixed price models, where the probability of risk is high, IT outsourcing companies charge an extra 20%-50% on top of their real estimation to be able to absorb the risk and ensure profit. In the Time and Material model, you as a client always pay the real price without any premiums. Thus, you always know where your money goes.

With this pricing model, the service provider and the client organization normally agree upon an hourly rate. The billing is based on the developers’ levels of education and experience.

Problems and pitfalls of the T&M pricing model

  1. Uncertainty: The company operating under the time and material pricing model should provide specific processes designed for the partners to be able to control the costs. Otherwise, you might fall into a disadvantageous situation of overpaying.
  2. Deep involvement: T&M pricing models require your deep involvement in the development of a solution to make sure that the IT company is moving in the right direction and spending the correct number of hours.
Time and materials model.

How to estimate the final price using the time & material pricing model?

Answers to this question will vary from company to company. We can describe our best practices in approaching price estimation. Our methods are not unique: they can be found in other transparent IT outsourcing companies. 

At Mad Devs, we approach every new customer as a new case. We don’t send to customers proposals we’ve already used in other projects. 

Image.

    During the first meeting, we meticulously examine the clients’ vision and the users’ needs. A special SWOT analysis team consisting of senior-level developers with expertise in the required field then creates a detailed roadmap and estimates the scope of the project.

    The roadmap created by the SWOT analysis team consists of:

  1. Typical tasks (team onboarding, DevOps, test);
  2. Specific tasks;
  3. Team composition.

Total estimation for typical tasks can easily be calculated, and the SWOT analysis team creates approximate estimates for specific tasks and multiplies them by the developers’ hourly rate. 

This approach enables us to determine the right pricing and answer all potential questions regarding how the final estimate was calculated. Additionally, the clients themselves have the power to shape the final price by altering the scope of work or suggesting changes in the team composition.

Hybrid pricing model

Hybrid pricing model.

The hybrid model is a cost-effective alternative to the traditional T&M model for projects that do not have specific requirements or clear-cut goals. It allows customers to set a fixed price based on the estimate. This model has the best features of the two models - Fixed-priced and Time&Material, such as the ability to deploy resources and the well-aligned processes.

The hybrid model is ideal for projects with unclear objectives and requirements at the start. It allows for feedback and input during the early stages, but it can be refined over time to deliver the best possible results. This model is also ideal for customers who prefer to pay one-time or hourly.

It allows customers to keep their budgets flexible and avoid compromising on the quality of their product or application. It also provides a controlled environment for the service provider.

Outstaffing pricing model

Outstaffing means handing tasks over to individual specialists working for a service provider company. Organizations engage in outstaffing when they lack the expertise or capacity to complete the tasks in-house. Usually, hiring experienced developers might take a lot of time, and sometimes, you don’t have enough authority to attract the best personnel. This model provides human resources for whole projects or just parts of projects as needed.

The model is ideal for clients who are looking to hire specialists on a short-term basis. The clients don’t have to pay for recruiting, and terminating the contract is easy.

The outstaffing pricing model can use predefined rates like the time and material model or fixed price in the form of a regular salary without covering additional benefits, taxes, vacations, and coffee breaks.

And since the project is managed by the client organization, closer monitoring of performance provides more accurate cost control. To confirm the seniority level of the professionals being hired, most IT outsourcing companies let clients interview and test outstaffed team members.

Dedicated team model

This type of model is ideal for companies that need to quickly expand their software development team. The most significant advantage of a dedicated team pricing model is its ability to control the number of people that the team members are allowed to work with. You can also monitor and interview the members of the team.

Unlike an in-house team, a dedicated team model eliminates the need for hiring and training new employees. Instead, you can enjoy the services that the team provides. With a dedicated team, you can also pay the monthly salaries of the employees that you have hired.

Problems and pitfalls of dedicated team model

Before the project begins, it's important that the customer knows the exact amount of hours that the team members will be working on. This is because the hourly rate that the service provider charges is based on the number of hours that the team members will be working on.

Since you will control the whole project, you are responsible for the overall management of the team. You also need to make sure that the team members are working efficiently and effectively.

Instead of paying intervals, a dedicated team pricing model provides monthly payouts. This method takes into account the various costs associated with the project, such as salaries, administrative fees, and other fees. So, this model is effective only for long-term projects. 

Dedicated team model.

Gain-sharing pricing model

Future unicorn startups having great ideas but unable to attract the best employees and financial resources to boost their growth can pitch their product to IT outsourcing providers. 

The providers in some cases might operate as investors and become co-founders of a startup. In contrast to traditional monetary investments, the startups ask for labor expertise. It is called the gain-sharing pricing model.

However, this pricing model is usually not the most attractive to IT service providers. These pitches often come from startups that lack a solid foundation and are looking for freebies.

To those who are interested in this pricing model, we have a few recommendations:

  1. Develop a clear monetization strategy and make sure you know how your project is going to generate profit in the future.
  2. Conduct market-fit analysis.
  3. Have a clear vision of how your product is going to meet users’ needs.

Also, IT outsourcing companies never cover 100% of costs but only provide a discount. It puts the responsibility for faster success on startup founders’ shoulders, and thus they take their idea more seriously.

No matter how much Mad Devs or any other vendor is interested in supporting startups and becoming responsible partners, we can accept only a limited amount of projects under our umbrella.

After having thoroughly analyzed the various pricing models types, it's now time to start writing the contract that will best suit both you and the service provider.

What should be included in a software development contract?

1. Service should be provided

The contract should include a section that describes the services that you expect from the service provider. This section should also include the project scope and any details that you need to protect both you and the partner from disputes.

The Services section should also include a discussion about the procedures involved in making changes to the scope of the contract. This should be done in writing so that both parties can make informed decisions.

2. Project time and cost

The contract's terms should also be summarized in terms that are easy to understand. This section also includes the project's timeline and the estimated cost of the project.

In addition, the contract should also include a statement that explains the responsibility of both parties for delays caused by the project. If the parties have already agreed on partial payments, this should also be included in the contract.

3. Testing

The acceptance testing section should also include a statement that clearly states the type of testing that will be performed on both the vendor and the client.

4. Intellectual property rights

It is one of the important sections. The software that's developed as the result of a project should also be clearly stated in the contract. This section should also include the terms and conditions that govern the use of the software.

Particularly it should include:

  • source code
  • Any material that was developed during software development: wireframes, designs, plans, etc.

The development company can only reassign the rights to the software that it created. If the software was developed using open-source tools, they will remain public.

5. Confidentiality

The confidentiality section should also be included in the contract to protect the information that the development company has stored about the project.

Most software development contracts contain confidentiality provisions that are usually maintained after the contract has been completed.

Conclusion

Most IT outsourcing providers have specific preferences in certain pricing models. Fixed Price, Time & Material, Outstaffing, and Gain-Sharing pricing models are only a few of the most common models of determining the final price for your project. Some projects feature a combination of pricing models: different models are used on different development stages.

You as a client can have full control over the expenditure and choose a transparent IT partner who will explain the final price composition in detail.

Pricing Strategies in Custom Software Development.

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