Fixed Price vs Time & Materials: Which Pricing Model Won't Burn Your Runway
Fixed price or T&M contracts for software development? The wrong choice can inflate costs by 30% or leave you with unusable code. Here's how to decide.
January 8, 2025 12 min read
27% of software projects run over budget on average. For startups, that overage can mean missing your next funding milestone or running out of runway before launch.
The pricing model you choose for agency development determines whether budget overruns destroy you or whether you have the flexibility to build something users actually want. Fixed price and time & materials contracts solve different problems. Pick the wrong one and you'll either pay a 15-30% risk premium for flexibility you don't need, or you'll lock yourself into rigid scope when you need to pivot.
Here's how to choose the model that protects your runway without handcuffing your product.
What Fixed Price Actually Means
Fixed price contracts specify total project cost upfront, regardless of actual time and resources spent.
You define the deliverables. The agency quotes a price. You pay that price when the project delivers. Simple.
The appeal is obvious: budget certainty. You know exactly what you'll spend before committing. No surprises. No expanding invoices. Your CFO can forecast precisely.
But fixed price doesn't mean fixed scope. It means fixed price for fixed scope. Any scope change triggers a change order with additional costs. The question becomes: how accurately can you define scope before starting?
For predictable projects with well-defined scope and low odds of mid-development changes, fixed price delivers real value. The rule of thumb: choose fixed price for straightforward custom software development projects where requirements are clear and unlikely to change.
Small projects with basic features that don't exceed three months work well. MVPs with limited budget requiring only basic features initially fit this model. If you can write a specification that fully describes what you need, fixed price protects you.
The Risk Premium Built Into Fixed Price
In fixed price contracts, the development partner absorbs nearly all risk associated with project unknowns: unforeseen technical complexity, estimation errors, requirement ambiguity, technology changes.
Stop planning and start building. We turn your idea into a production-ready product in 6-8 weeks.
To compensate for this transfer of risk, vendors build a substantial contingency buffer into the price. This risk premium can inflate project cost by 15% to 30% or more.
The client pays this premium regardless of whether risks ever materialize. If the project proceeds smoothly, you've simply overpaid. You're buying insurance against estimation errors, paying upfront for problems that might not occur.
The premium makes sense when you can't absorb cost uncertainty. If your board approved $50K for this project and $51K means you don't make payroll, paying a 20% risk premium for certainty is rational.
But if you have flexibility in timing or budget, you're paying for protection you don't need. The development agency pockets the premium when their estimates prove accurate.
The Rigidity Problem with Fixed Price
Fixed price contracts are inherently rigid. They depend on meticulously detailed scope of work defined before the project begins.
Yet modern software development is a dynamic process of discovery. One analysis suggests 90% of projects require changes during the development phase.
Users don't know exactly what they want until they see it. Technical constraints reveal themselves during implementation. Competitive landscapes shift while you're building. Your understanding of the problem evolves as you solve it.
Fixed price punishes this evolution. Every change requires a change order. Change orders trigger renegotiation: timeline impact, cost impact, scope impact. What should be a quick decision becomes a formal process.
The overhead of change orders creates perverse incentives. Teams avoid beneficial changes because the coordination cost outweighs the value. You ship the thing you specified three months ago, not the thing you now know you should build.
Worse, agencies operating under fixed price have incentive to resist changes. Every change introduces risk to their margin. They're motivated to interpret requirements narrowly and push back on anything not explicitly specified.
This creates adversarial dynamics. You're fighting over whether a requested change is really a change or was implied in original scope. The partnership becomes transactional.
What Time & Materials Actually Means
Time and materials contracts bill based on hours logged and resources used.
Unlike fixed price, T&M contracts don't set total cost upfront. Cost depends on hours and resources poured into the project. You pay for the team's time at agreed hourly or weekly rates.
The model allows projects to pivot based on incoming insights and changing circumstances. Projects evolve through continuous collaboration between client and development team, with scope divided into smaller, manageable phases.
After each phase, teams can revisit priorities, adjust scope, and drop low-value tasks. This pricing model doesn't require solidifying project direction and scope from day one.
T&M is ideal for projects with evolving or ill-defined requirements, complex or innovative solutions involving research and new technologies, and projects using Agile or Lean methodologies that support iterative development, continuous feedback, and adaptive planning.
You know the hourly rate. You don't know the final bill. If the project takes longer than expected, you pay more. There's no cap.
For risk-averse organizations or those with rigid budgets, this uncertainty is unacceptable. How do you forecast spending? How do you get board approval for an undefined amount?
This forces a different conversation. Instead of "what will this cost," the question becomes "how much budget should we allocate." You're planning investment, not purchasing a deliverable.
The uncertainty cuts both ways. If development goes faster than expected, you pay less. If you decide to cut scope mid-project, you stop spending immediately. You're not locked into paying for features you no longer want.
T&M works when you can think in terms of team capacity rather than project cost. You're essentially hiring a development team on flexible terms. You allocate budget for their time and adjust scope to fit available budget.
The Control and Involvement Difference
For time and materials to realize its benefits, clients must be actively involved during development.
Regular feedback, progress reviews, and timely decisions are required. Project success depends on client commitment to communication and collaboration.
If you can't dedicate time to weekly sprint reviews, daily async updates, and ongoing prioritization decisions, T&M becomes expensive chaos. The team needs direction. Without it, they'll build based on their own assumptions.
Fixed price requires involvement too, but concentrates it at the beginning and end. You define requirements upfront, then step back until delivery. T&M distributes involvement throughout the project.
This difference matters for founder time. If you're stretched thin, fixed price lets you hand off the project. If you're deeply engaged with product, T&M lets you steer continuously.
When Fixed Price Protects You
Fixed price contracts work best under specific conditions.
Small, well-defined projects. Building a landing page with clear design. Implementing a specific API integration. Migrating from one platform to another. Projects with obvious requirements and minimal interpretation benefit from fixed pricing.
Limited budget with no flex room. If you've raised a small angel round and every dollar is allocated, cost certainty prevents runway surprises. The risk premium is worth the sleep you get at night.
Low complexity and minimal innovation. The more routine the project, the better agencies can estimate it. CRUD applications, standard e-commerce implementations, and well-trodden technical paths suit fixed price.
No internal technical leadership. If you can't provide ongoing technical direction, fixed price forces the agency to own that direction. They can't come back with questions because scope is locked.
Short timelines with clear deadlines. Projects that must ship by specific dates benefit from fixed price commitment. The agency owns timeline risk along with cost risk.
Complex products with emerging requirements. Building an MVP where user research will inform features. Developing innovative solutions involving new technologies. Projects where you'll learn what you need by building.
Ongoing product development. SaaS platforms that ship features continuously. Products that iterate based on user feedback. Situations where "done" is a moving target.
High founder involvement. When founders want to be embedded in development, steering daily decisions and reacting to what's built. T&M rewards that involvement by converting feedback directly into product evolution.
Budget flexibility with timeline pressure. If you can spend variably but need to move fast, T&M removes the overhead of change orders. Make decisions at speed without renegotiating contracts.
Startup uncertainty. The earlier your stage, the more your understanding will change. Pre-product-market-fit companies need flexibility more than cost certainty. T&M provides that flexibility.
Some agencies offer scope-controlled or capped T&M models that blend both approaches.
You set a maximum budget cap like fixed price. Development proceeds with T&M flexibility. When scope decisions arise, you adjust features to keep the project within budget.
The budget cap protects against runaway costs. The T&M approach maintains flexibility to change direction. Scope becomes the variable that absorbs uncertainty instead of cost or timeline.
This works well for MVP development. You know you'll spend between $50K-75K. The agency knows they can't exceed that without renegotiation. Together, you adjust scope to deliver maximum value within the budget.
At NextBuild, we typically use this model for startup MVPs. Fixed budget, fixed timeline, flexible scope. We prioritize ruthlessly to ship the most valuable features within constraints.
The Real Cost Comparison
Cost-effectiveness depends on project type and execution.
For short-term projects with well-defined requirements, fixed price may be more economical. You avoid the coordination overhead of ongoing involvement. The agency's efficiency gains from clear scope benefit both parties.
But for complex, evolving products, T&M often delivers better long-term value. You avoid costly change requests that inflate budgets. You enable ongoing optimization that fixed price discourages.
Consider a $75K fixed price project that encounters significant mid-course changes. Change orders add $20K, bringing total to $95K. Timeline extends by 6 weeks due to renegotiation overhead.
The same project under T&M might cost $85K but ships faster because changes flow through normal sprint planning. No change order paperwork. No scope renegotiation. No adversarial dynamics.
The difference: $10K and 6 weeks of speed. For a startup trying to reach product-market-fit before running out of money, that trade-off favors T&M.
Red Flags for Fixed Price Contracts
Certain situations make fixed price dangerous.
You can't write detailed specifications. If you're saying "we'll figure it out as we go," fixed price will hurt. The agency needs clear requirements to price accurately. Without them, they'll either overcharge for risk or underdeliver to protect margin.
The technology is novel or experimental. New frameworks, bleeding-edge APIs, or innovative technical approaches introduce unknown complexity. Agencies can't price unknowns accurately without massive contingency buffers.
Your market or user needs are evolving. If competitive pressure or user research might change direction mid-project, fixed price handcuffs you. You'll pay twice: once for the original build, once for the change orders.
The project timeline exceeds 3-4 months. Longer projects accumulate more change. More change means more change orders. Fixed price becomes Swiss cheese scope by month six.
Red Flags for Time & Materials Contracts
T&M creates different risks.
You have no time for ongoing involvement. If you can't dedicate 5-10 hours per week to sprint reviews, feedback, and prioritization, T&M projects drift. The team needs direction. Without it, they'll build the wrong things efficiently.
Your budget is truly fixed with no flexibility. If exceeding budget means business failure, T&M's uncertainty is existential risk. The potential savings aren't worth the downside.
You don't trust the agency. T&M requires trusting that developers are working efficiently and honestly reporting hours. If you'll spend energy micromanaging timesheets, fixed price removes that overhead.
The agency has no skin in the game. Some agencies prefer T&M because it shifts all risk to clients. If they're not committed to efficient delivery, T&M becomes a blank check.
Choose based on your specific constraints, not generic best practices.
Assess your requirements clarity. Can you write a detailed specification that fully describes what you need? If yes, fixed price works. If no, T&M gives you room to discover.
Evaluate your budget flexibility. Is cost certainty worth 15-30% premium? Or would you rather optimize for efficiency and pay only for value delivered?
Consider your involvement capacity. Can you dedicate time to ongoing collaboration? T&M rewards involvement. Fixed price minimizes it.
Account for timeline pressure. If speed matters more than cost predictability, T&M removes change order overhead that slows fixed price projects.
For startup MVPs specifically, T&M or scope-controlled models usually win. You're optimizing for speed and flexibility. Your understanding will evolve. User feedback will change priorities. The ability to pivot mid-course is worth more than cost certainty.
For later-stage feature additions or well-understood migrations, fixed price makes sense. Requirements are clear. Changes are unlikely. Cost certainty helps with planning.
Key Takeaways
Fixed price and time & materials contracts solve different problems.
Fixed price provides cost certainty at the expense of flexibility and a 15-30% risk premium. It works for well-defined, low-complexity projects with clear requirements and minimal expected changes.
Time & materials provides flexibility and efficiency at the expense of cost certainty. It works for complex, evolving projects where requirements emerge through building and user feedback drives direction.
Most MVP development favors T&M or scope-controlled hybrid models. Startups need flexibility more than certainty. The ability to change direction based on what you learn is worth more than a fixed price.
For later-stage, well-defined projects, fixed price removes coordination overhead and provides budget predictability.
The wrong choice doesn't just cost money. It creates dynamics that prevent you from building what users actually need. Fixed price makes changes expensive, discouraging beneficial pivots. T&M without involvement creates drift and wasted effort.
Match the model to your situation. If you're uncertain, that uncertainty itself suggests T&M is the right choice.
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