Pricing models: Fixed price vs Time and Material

Nowadays, many businesses need to find ways to price their products and services accordingly. It’s an important part of running a business and financial management, so having the correct pricing strategy can even help with your long-term success. Whether you’re offering high-end or low-end goods, you need to choose pricing models accordingly.

There’s a lot of thought that goes into having to come up with your prices, which is why different companies use different pricing strategies as well. This article will talk about the time and material vs. fixed price models, how they work, and when you should use them.

What Is a Pricing Model?

Pricing models are methods that you use to price your products or services. You use these types of financial models to determine how much your target market is willing to pay for what you have to offer. It’s used by many businesses to know whether they’re pricing products or services properly.

Pricing Model Examples

Marketers and analysts can use a variety of methods to price their products. Some of the most popular ones include conducting pricing surveys, looking at competitor prices, and examining the average prices in the industry.

With this said, pricing models also offer another way to determine the cost of your product or service. Two of the most popular types of pricing models used nowadays are fixed-price contracts and time and material contracts (t&m contracts). Both of these pricing strategies have varying advantages and disadvantages, making it difficult to determine which one is better for your company. Let’s take a better look at both options down below.

What Is the Fixed Price Model?

The fixed price model determines the final price by calculating how much it will cost to manufacture all components and features together. You should have a list of what you need to produce the item as well as how many hours are needed to create it. When determined, there will be a set fee for the package, regardless of what was involved in creating it.

How Does the Fixed Price Model Work?

As mentioned above, the fixed price model works with a fixed price. There is an estimated fee determined at the start of creating the product. So when it comes to software development outsourcing, for example, you’d have to factor in how long it will take to build software from the ground up. A fixed-price contract example will include brainstorming ideas for the software, designing it, and finally deploying it.

When to Use the Fixed Price Model?

In general, fixed price pricing models should be used when you’re sure that there will be no changes in the process of creating a product. It’s recommended for projects that have standard designs, restricted budgets, and short deadlines. Because the fixed price already tells you how to determine cost based on fixed components, you won’t encounter any surprises along the way.

Pros of Using the Fixed-Price Model

Clear Structure

With a fixed-price model, you already have a clear structure of how everything will go. The plan is straightforward, and it’s easy to combine all the estimates for a set fee. This set fee makes it easier to close business deals and secure proper funding.

Simple to Understand

If there’s one thing a fixed price model can guarantee, it’s simplicity. There are no other things to worry about with this strategy, so customers will also appreciate the simple transactions. Customers won’t have to worry about paying too much or too little since you can show them how much was really involved in the process.

Provides Established Processes

When you already have an overall estimate for a product or service, everything else will follow. Fixed price models provide established processes that make it easier to follow a certain workflow.

Cons of Using the Fixed-Price Model

Scope Creep

A scope creep is what happens when there are changes after you’ve already set a price. This is a common problem when using the fixed-price model, so it’s recommended to state in the contract that further changes should be prohibited.

Hidden Costs

In some cases, you may fail to account for certain costs. Some costs such as overtime work or additional materials can pile up and surprise you. This can affect your overall process since the final bill can differ from what you’ve initially billed your customer.

What Is the Time and Material Model?

Now, let’s move on to the time and material model, also known as the t&m contract. In this pricing strategy, customers will separate each component of the production process. They will then pay according to the units of work.

How Does the Time and Model Contract Work?

The time and model contract works by setting a price for each part of creating a product or providing a service. It’s based on the idea that no two actions are the same, so all of them should be evaluated separately. This method is also called the pay-as-you-go model because customers will provide funding as the production moves forward.

When to Use the Time and Model Contract

You should use this kind of pricing technique when you want to appeal to customers that have flexible procedures and agile project executions. When it comes to time and material vs. fixed-price contracts, businesses that want to be flexible as possible in the production process should be using this pricing model.

Time & Material Contract Pros

Flexible Pricing

The first advantage of this pricing model is its flexibility. Since customers pay for each unit of work, they can have a more active role in the overall production process. Customers will have more freedom to integrate changes in the final product or service.

More Transparency

Because T&M contracts are required to show what’s involved in different levels of production, it, therefore, requires more transparency. There’s also a better chance that your customer understands what they should expect in the final stage.

Time & Material Contract Cons

Allows Room for Mistakes

While room for mistakes should be accounted for in all kinds of pricing techniques, the time and material provide more leeway. This can be an advantage, but this can also pose risks for unforeseen complications in the project. Developers can sometimes make mistakes that can end up costing more money.

Difficulty in Expense Tracking

The nature of the time and price model makes it difficult for some businesses to track all expenses. Some may miss certain expense changes, affecting the budget for the entire process. This can also end up in discrepancies in the final payment.

How to Choose the Right Pricing Model for Your Business

Always remember that there’s no one-size-fits-all when it comes to pricing models. It all boils down to what’s appropriate for you and your client’s needs. There are different pros and cons to certain types of financial models, and you should always consider these factors before choosing which one to use.