Outsourcing IT work has become a common practice. Even individual workers are quietly hiring people online to complete tasks for them, and CIOs are still spending a significant amount of money on external talent. However, Belitsoft, a custom software development firm, notes that choosing the right engagement model – firm fixed price (FFP), time and materials (T&M), or dedicated team – can make or break a project, based on its 20+ years of experience with projects of various sizes and domains. Each model allocates costs, risks, and control in different ways.
Businesses need to choose one that suits the size, difficulty, and need for flexibility of the project. Time-and-materials contracts tend to get clients more involved and provide them with more benefits. On the other hand, fixed-price contracts can be riskier if the scope is not clearly defined. The most recent Global Outsourcing Survey from Deloitte also states that outsourcing models are “maturing” towards outcome-based relationships, with a focus on cost, as well as agility and skilled talent. In practice, about 80% of executives plan to either keep or increase outsourcing.
In this article, we compare the three leading models – firm fixed price, time-and-materials, and the dedicated team (also called build-operate-transfer or extended team) – and explore how to match each to your project. We use research from the industry, surveys of the market, and expert opinions. For instance, McKinsey states that an FFP contract is best for activities that are the same every time, while a T&M contract is better suited for very complicated projects where the output is not clear.
The U.S. government also states that FFP works best when requirements are clear and can be broken down into short phases. However, if requirements are unclear, forcing an FFP would add unnecessary contingencies and increase costs. In that case, T&M or labor-hour models give the customer more control. Likewise, a peer-reviewed study of software projects found that fixed-price contracts were linked to a higher risk of failure than T&M contracts, in part because T&M allows needed changes without costly renegotiation. We will explain each model, list its pros and cons with links to sources, and then list the factors that should help you make your choice, such as how much you can afford and how big the project is.
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Firm-Fixed-Price Contracts
Firm-Fixed-Price (FFP) contracts – also known as fixed-sum or lump-sum contracts – obligate the vendor to deliver a specified product or service for one total price. In practice, the client and vendor agree on a detailed scope of work ahead of time, and the vendor agrees to deliver the product or service for a set price.
Historically, FFP contracts have been favored when requirements can be well-defined and the buyer wants budget certainty. Companies might outsource a service for less than the cost of doing it in-house if it doesn’t set a vendor apart from standard offerings. This is often done through an FFP model. One study says that startups with tight cash flow often prefer fixed-price deals to lock in costs, while very large companies with IT budgets of $10 million or more can handle T&M variability. Inflation or currency risk can also lead to fixed rates. For example, one Entrepreneur columnist says that entrepreneurs should set up a fixed-rate contract to protect themselves from higher costs in a high-inflation environment.
In a firm-fixed-price engagement, the vendor and client negotiate scope and cost up front – metaphorically “sealing the deal” with a handshake and detailed contract. If the scope is very clear, FFP puts a lot of the cost and schedule risk on the vendor, which makes budgets more predictable.
Benefits: The main reason people like FFP is that it lets them know how much it will cost and shifts the risk. The buyer knows the total price ahead of time, which makes it easier to plan their budget and can make buying things less of a hassle. The vendor has a good reason to work quickly, as they cannot charge more than the agreed-upon fee for extra hours. FFP shifts the risk to the contractor, which is what the government says it should do. It has worked well for simple tasks, such as setting software features or studies that last a set amount of time, as long as the contract is broken up into short phases (usually 3 to 6 months). In theory, competitive bidding on FFP contracts can also encourage vendors to offer their lowest possible price for the agreed-upon scope of work.
Disadvantages: However, FFP contracts impose high rigidity. They require nearly complete specifications upfront – a rarely met condition in modern software projects. KPMG states that traditional fixed-price contracts do not work well when requirements change frequently because they place more emphasis on detailed upfront requirements than on working together and being flexible. In reality, vendors expect this uncertainty and often add large risk premiums or markups to protect themselves from scope creep and other unknowns. Some consulting analyses found that fixed-bid quotes typically include a risk premium of 15-30% more than a time-based quote for the same work. CFO.com reports that when terms are unclear, companies can lose opportunities to identify how best to utilize their services, leading to wasted spend.
Project managers say that if you want to change the terms of a fixed-price deal, you need to fill out official change orders. This process costs a significant amount of time and money. Fixed-price projects also make it more difficult to make incremental improvements. Once the contract is signed, adding features or changing the direction of the project requires costly renegotiation, which penalizes the client for making necessary changes.
If the vendor does not think the work will be too hard, they might not make it a top priority or they might take shortcuts, which will hurt the quality. To summarize, FFP works best when there is little uncertainty and the scope does not change. Once an FFP contract is agreed upon, the client cannot naturally offer extra benefits or punish small delivery problems, which could cause incentives to be out of line.
In fact, empirical research illustrates these tradeoffs. Jørgensen et find that using FFP instead of T&M doubles the risk of project failure, after adjusting for project differences. They note that software requirements often evolve during development, so the rigidity of FFP can lead to poor outcomes: requirement changes do not only frequently happen but are sometimes essential to ensure successful software projects, meaning overly fixed contracts may reduce success. Conversely, their analysis shows that time and materials contracts led to better client involvement and more benefits.
When to Use FFP?
- If you can clearly define the deliverables like a well-defined software module or a simple integration
- When you value budget certainty over flexibility
- When you have a short-term project, a proof-of-concept, or work that has to follow strict rules.
It is also chosen when the client cannot or will not actively manage vendor hours – the vendor must assume the risk. Government guidance suggests using short-option FFP contracts when requirements are known. On the flip side, if the vendor is to be paid one sum, it will likely set that price to cover all risks, possibly reducing cost savings. Startup founders should be careful with fixed-price bids that seem too high because they usually have built-in safety nets for when things go wrong.
For Minimum Viable Products (MVPs) or first modules that are clearly defined and do not allow for much change, FFP can be a good model. People who work with agile most of the time say that FFP doesn’t work well with iterative development. KPMG believes that fixed-price contracts make it even harder to figure out what needs to be done, make a plan, and be ready to change quickly.
This goes against Agile’s premise of a roadmap that changes. This is not in line with Agile’s plan for how things should change. In the real world, many organizations get around this by signing FFP contracts for each sprint or short milestone. This enables them to use both fixed prices and iterative cycles.
Time and Materials (T&M) Contracts
T&M contracts, also known as T&M or “labor-hour” contracts, bill the client for the actual hours worked by project staff at agreed-upon daily or hourly rates. They also bill for any materials or fees from third parties. In short, the buyer pays for the work that is done, not a set amount of work.
According to the scientific literature, T&M is when the client agrees to pay the provider for the work they do, usually based on a set price per work hour. In practice, this typically means assembling a project team and paying them for their work on a regular basis. You could pay a developer $120 an hour and a QA engineer $80 an hour, for example, and keep track of how many hours they worked each week or month.
Advantages: The chief advantage of T&M is flexibility. It welcomes change: as the project progresses, new tasks can be added to the backlog without having to modify the contract. KPMG states that T&M is very flexible, but they also note that if the vendor does not do a good job, the customer is “carrying the can.” The risk of inefficiency now falls on the buyer. If the vendor hires too many people or takes too long, the client still has to pay.
But for IT leaders and product teams that expect requirements to change, that trade-off can be worth it. Without T&M, gaps in the scope can often cause budgets and timelines to go over. The same Jørgensen study shows that T&M projects usually have more client involvement and better outcomes. This is because clients stay very involved (by approving work each sprint or iteration), which makes it easier for them to guide the project.
In practice, T&M is often used for longer-term projects, maintenance contracts, or research and development where the outcomes are not fully known. Government audits state that agencies use T&M when “requirements are uncertain,” like when mission needs are hard to predict. In fact, federal rules even state that T&M work should be reviewed periodically to see if it can be turned into fixed-price work. If a part of the project starts to follow a pattern, the parties may later switch that part to FFP.
In agile software shops, T&M works with sprints: you just agree to do the work for the next sprint and pay as you go. Many startups and mid-sized companies with dedicated engineering managers like T&M because it lets them change the scope without worrying about being stuck with high costs. At first, T&M quotes are usually lower because they do not include a big buffer for contingencies. This means that you pay less than a set amount of money if developers finish tasks faster or better.
Disadvantages: The downside of T&M is cost uncertainty and the need for oversight. The buyer needs to have faith in the vendor’s time estimates and keep a close eye on the hours. Hours can creep up without good project management, which can lead to budget overruns. A GAO report on federal contracts states that T&M is a “higher-risk” model because contractors could theoretically bill extra hours. Because of this, agencies are encouraged to look for ways to switch to firm-fixed-price when tasks become routine. In the private sector, procurement teams worry that T&M gives the vendor less incentive to be efficient – one client’s inefficiency is still paid time for the vendor. CFO.com notes that when utilization reporting is broken up, clients might end up paying for capacity that isn’t being used or isn’t being used enough.
T&M also requires more client involvement: typically, the buyer needs a project manager or product owner to continually set priorities and approve work. A T&M project can go off track if a client does not have enough time to handle the scope and backlog. If a company does not have its own project leads, it may need a dedicated product manager from the vendor or a mix of teams. Lastly, T&M does not require as much discipline when it comes to schedules. Projects can fall behind if they are not carefully managed, because there is no set deadline for payment.
When to Use T&M: It is great for complicated, changing projects where the client wants to be able to set priorities and where requirements will change. It works well with an iterative sprint model, which is why it is popular in Agile development. Use T&M when (a) you cannot fully define the scope up front, (b) you want the ability to change your mind about what’s most important, and (c) you have project leadership to guide the work. Clients should set clear goals for each sprint or milestone and check in on progress often. Often T&M contracts will have estimated budgets or timeboxes, giving some expectation of cost, but formally they allow the client to add or remove scope as needed. If the vendor is a strong strategic partner, T&M can foster a collaborative relationship where the vendor earns trust by delivering over multiple iterations.
Industry analysts emphasize that T&M works best when uncertainties do not permit costs to be estimated with sufficient accuracy. It avoids the situation that KPMG talks about, where a supplier without built-in quality standards can still make money by taking their time with the work. With T&M, the client can see how many hours were worked and directly link pay to output. However, the client must be willing to pay for that transparency, and should negotiate caps or regular reporting.
Dedicated Team (Extended Team) Model
The Dedicated Team model, also known as build-operate-transfer (BOT) or extended team, is a combination of various types of outsourcing. Instead of paying for each project individually, the client hires a team of vendor developers who work full-time on the client’s projects. The vendor pays these team members, but they act as if they are part of the client’s in-house department. In real life, a client who needs a team of engineers to work on their project all the time will hire, for example, four developers and one QA specialist to work on their account. This team often sits beside the client’s in-house staff and shares daily stand-ups (though they may be physically remote) and can be scaled up or down as needed. This engagement is typically long-term, and the team is vetted to fit the client’s culture.
Dedicated teams offer the best of both worlds: from the vendor’s perspective, it appears as an open-ended contract (often billed on a retainer or per-month basis, which is essentially similar to time and materials), and from the client’s perspective, it feels like an extension of their business. Belitsoft states that a dedicated team functions like an extension of the client’s own department, with the benefits of retaining personnel and maintaining focus. The team is exclusively for that client, thereby accelerating time-to-market by providing ready talent with a single focus. The client has full control over daily work and priorities, but they do not have to hire and manage each developer directly.
In a dedicated-team engagement, the outsourced engineers integrate closely with the client’s organization (symbolized above by a team huddling around laptops). The external team works full-time on the client’s projects and shares processes and meetings, even though they remain vendor employees.
Pros: The dedicated team model works best for projects or product development that will last a long time and change over time. It gives you the most freedom because the team is ongoing, so you do not have to renegotiate the scope if your priorities change. One review even states that dedicated teams can handle changing priorities without having to renegotiate the scope or price all the time, which is not the case with fixed-price or one-off contracts. For instance, a startup might hire a dedicated team for six months or more to continuously release features and respond to user feedback. Knowledge builds up over time because the same people work on the project, which cuts down on the time and effort needed to train new people. The client gets “ready talent” that can be switched in and out. If a project needs a new skill, the vendor can add or replace staff on the dedicated team.
Cost control is also often better, since billing is usually on a simple monthly or hourly basis for the team. Analysts report that clients often achieve better cost control with a dedicated team for ongoing development and support compared to fixed-bid projects. This is partly because there are no surprise change orders – the ongoing rate remains constant unless the team size changes. A dedicated team removes the risk of the vendor working more hours than agreed upon in one sprint, since the payment covers all hours worked by the full team. This is not the case with time-and-materials project contracts. It can also help with “sticker shock” when getting quotes for big one-time projects. The client can stop or pause the team if their business needs change, even though they have to pay the same amount every month.
When clients do not have a lot of technical knowledge, vendors often put a project manager or tech lead on the dedicated team to help with some of the supervision. This “managed” part can keep the client from needing a lot of daily supervision. A lot of Western CIOs use dedicated teams in nearshore areas, such as Eastern Europe, Latin America, and the Asia-Pacific region, to build capacity in a cost-effective manner. These teams are like 24/7 extensions of their staff.
Disadvantages: A dedicated team also has downsides. The main requirement is long-term commitment. The client is committing to payroll for the entire time, which is usually months or years, unlike FFP or T&M engagements that end with a deliverable. It can be harder to leave if the project ends early or the relationship goes bad. There is also a chance that the vendor’s staffing can have a significant effect on how well the team performs. If the vendor sends underqualified engineers, the client has to request new ones. It can be difficult to integrate an outside team to share your processes, codebase, and company culture due to all the extra work that needs to be done. The model won’t work if the client doesn’t see them as a real part of their own business.
From a governance perspective, budgeting works differently. Rather than a fixed contract sum or estimated hours for features, the client usually pays a stable monthly fee per person. This means that the cost grows linearly with team size and time, which can be easy to predict but less so to justify to finance if requirements shrink. It also means that the onus is on the client to ensure that the dedicated team is fully utilized; some vendors argue that unbilled slack time is less of an issue with a dedicated team, since the pool is fixed. Finally, dedicated teams are essentially a form of T&M (billable hours), so if scope or workload is very uncertain, clients still need to manage expectations on when to ramp the team up or down.
When to Use a Dedicated Team: This model is best suited for long-term projects or products, such as building a new platform, maintaining a large software system running, or running IT operations on a daily basis. It is most effective when you know you have ongoing work but cannot specify all tasks upfront. Consider a dedicated team if you want a single point of contact for an outsourced workforce, if project requirements are expected to evolve rapidly, and if you have at least mid-level project management available to integrate the team. It is also favored when the collaboration requires very close integration with the client’s internal teams (e.g., sitting together during stand-ups, sharing agile tools and metrics).
Comparison of Key Models and Hybrid Models
A lot of businesses in the real world use a mix of these models. For instance, a project could start with a proof-of-concept at a set price and then move on to a full development team. A T&M contract might also have “not-to-exceed” or target budgets to keep costs down. According to Deloitte’s report, outsourcing delivery models are still getting better, and there is more focus on relationships that are based on value. This can include contracts based on results or gain-sharing, where payment is based on how well the work is done (for example, paying more when goals for user adoption or cost savings are met). These types of models combine FFP and T&M. For instance, a fixed-sprint model charges a set amount for each Agile sprint, but it requires everyone to work together to figure out what each sprint’s deliverables will be.
At a higher level, consider total cost of engagement (TCE) rather than just the hourly rate. A recent TechRepublic guide states that tech jobs in the West can pay more than $150–200 an hour, while jobs in Eastern Europe might pay $25–50 an hour. But raw rates do not take into account hidden costs such as cultural differences, communication problems, travel, or managing vendors. Deloitte says that skilled workers and flexibility are two of the most important reasons to outsource, which means that quality and speed are often more important than price. A procurement leader needs to think about more than just price. They also need to consider who is responsible for risk and how well the vendor’s incentives match the project’s goals. KPMG notes that forcing a full FFP on a project that is very uncertain can backfire because it often adds unnecessary contingency, which raises the price significantly.
Author: Dmitry Baraishuk is a partner and Chief Innovation Officer at a software development company Belitsoft (a Noventiq company). He has been leading a department specializing in custom software development for 20 years. The department has hundreds of successful projects in AI software development, healthcare and finance IT consulting, application modernization, cloud migration, data analytics implementation, and more for startups and enterprises in the US, UK, and Canada.
