Home 9 Sean Whitley 9 Understanding and Selecting the Best Software Outsourcing Payment Model

Understanding and Selecting the Best Software Outsourcing Payment Model

While software outsourcing does sound straightforward (and, indeed, it can be), it's important to consider the potential costs. Here we'll discuss different outsourcing pricing models and help you pick the right one for the development phase of your project.
Daniel Zacharias

Sean Whitley

July 18, 2023
payment model

Software development tends to be a complex affair. You must deal with architecture, designing, testing, deployment, performance analysis, and more. The solution? Outsourcing!

In other words, it’s all about passing some of your tasks to another team. The benefits range from lower costs to improved efficiency and receiving personalized services on demand. It’s a supremely flexible strategy. Furthermore, the revenue in segment IT outsourcing could hit $587.30bn by 2027. Everyone’s doing it.

While it does sound straightforward (and, indeed, it can be), it’s important to consider the potential costs. Here we’ll discuss different outsourcing pricing models and help you pick the right one for the development phase of your project.

The best outsourcing pricing models

If you’re reading this, chances are your aim is to create a solid foundation for your customized technological solution. The development phase is about to start and you need to outsource some of your operations. You also want to get the most bang for your buck.

All this is perfectly understandable. The list below outlines the benefits and challenges of six unique pricing options.

1. The fixed price model

When it comes to outsourcing pricing models, this has got to be the most straightforward option. The fixed price model is a great solution if your project already has a precisely defined scope. It fits well within a stable set of requirements that aren’t likely to change over time.

You work out the rules with your outsourced team, define the deliverables, and negotiate the price. The development phase begins. That’s all there is to it. It’s widely used in medical, governmental, banking, and military projects.

Pros: cost predictability and easier long-term planning, reduced client effort, and more straightforward contracts.

Cons: offers limited flexibility which makes ad hoc changes difficult, and tight deadlines can lead to poor quality.

2. The time and materials model (T&M)

This option offers greater flexibility than the fixed-price model. You pay for the actual time spent on the project, as well as the cost of materials and resources utilized. T&M is a good pick if you’re hiring a smaller team or individual specialists. It has extensive application in the ever-evolving fields of fintech, blockchain, and eCommerce.

Pros: dynamic resource allocation allows for adjustments and additions throughout the project’s lifecycle.

Cons: cost uncertainty and limited budget control can make it more difficult to plan ahead.

3. The incentive-based pricing model

This model is all about going that extra mile. In it, a part of the outsourcing provider’s compensation corresponds to hitting certain targets or achieving predefined performance metrics. Some companies also use penalties for underperformance but that’s rarely a good idea.

You can use the incentive-based option as a stand-alone solution, or as an add-on to other, more robust outsourcing pricing models. Just make sure you provide clear guidelines and benchmarks.

Pros: promotes an alignment of interest and a results-oriented approach in achieving desired outcomes.

Cons: complex performance measurements and potential misalignment due to poor incentive structure.

4. The shared risk-reward pricing model

The fourth entry on our list is partially related to the incentive-based model. What sets the shared risk-reward option apart is the fact that the participants enter it as equals. They share the costs and benefits associated with a venture. In essence, the parties involved take part in both the potential risks and rewards of a project.

Pros: direct involvement in the decision-making can serve as a powerful motivator and breed innovation.

Cons: you may need to hand over a lot of the decision-making to your service provider, more than you are comfortable with.

5. The profit-sharing pricing model

Here’s another of the outsourcing pricing models related to the incentive-based option. Unlike the previous entry, it’s all about profit-sharing and being focused on the project’s outcome. Service providers receive rewards if they increase the value of the company. The model is an excellent option for clients that wish to create strong ties with their outsourcing partners.

Pros: it brings about greater freedom which, in turn, can help strengthen the sense of trust between the two parties.

Cons: it can be a challenge to agree on what constitutes an accomplishment so clear communication remains essential.

6. The dedicated team pricing model

The last on the list is the one to choose if you want direct involvement in the development phase. The dedicated team model lets you control the budget, the scope, and the completion time. It also allows you to assemble your own team, member by member. It’s almost like building an in-house, self-sufficient team — without the long-term commitment.

Pros: full control over all operations, including interviewing and selecting team members, assigning tasks, monitoring performance, etc.

Cons: it involves monthly payouts which, in turn, can make it difficult to project end costs.

Factors to consider

So how do you pick among so many outsourcing pricing models? Ask yourself a few of the following questions and the right choice may become a bit more obvious.

  1. What is the scope of your project? If you clearly define its reach, complexity, and deliverables, you’ll be halfway there.
  2. How much control do you wish to have? Do you want everything to be predefined, or do you prefer to find solutions along the way?
  3. How much money have you got? More importantly, how do you like to manage it?
  4. Are you a risk-taker or prefer to play it safe? Risk allocation and management are essential to consider.

Your software development contract

Whichever model you choose, remember that it’s important to have it all in writing. Clear communication is only half of the solution. A strong and detailed contract will keep you safe and get rid of ambiguity. 

Make sure you don’t skip any of these steps:

  1. Clearly define the services provided and corresponding deliverables.
  2. Agree on the project duration and costs.
  3. Establish quality standards and milestones.
  4. State the type of testing required.
  5. Don’t forget the terms and conditions related to intellectual property rights.
  6. Include a confidentiality section protecting all relevant information.

The final word

As you can see, there are plenty of paths to success. If you’re looking to select the best outsourcing payment model, you should make a choice based on a few factors. These include your project’s scope, budget, the level of control you wish to have, and the risk you’re willing to take.

Will you select an incentive-based or a fixed method? Another option altogether? Ultimately, it will depend on what you wish to achieve. Remember that this is but another tool to meet your software or web development needs.

Get the best of Code Power News in your inbox every week

    You may also like

    What Is Data Engineering?

    What Is Data Engineering?

    Let's say you meet someone and reach the point of the conversation where you ask them what they do for a living. They tell you they are a data engineer. Not wanting to look silly, you act as if you understood what that meant. If that led you here, don't be ashamed:...

    Web3: What Is It and Why You Should Care

    Web3: What Is It and Why You Should Care

    Where would we be without the internet? Well, for one, you'd be searching for this information in a book! The ability to "Google it" has been a remarkable development of the modern world, although there is no shortage of critics.  But with critics comes...

    Get the best of Code Power News in your inbox every week