Fixed Price vs Time and Materials: Choosing a Software Contract

You’ve found a development agency, the proposal looks good, and now they ask: “Do you want this fixed price or time and materials?” It sounds like a billing detail. It’s really a decision about who carries the risk when the project changes, and software projects almost always change.

Pick the wrong model and you either pay a large risk premium for certainty you didn’t need, or you sign an open-ended deal that drifts over budget. This guide explains how each contract type works, how change requests are handled, and which projects fit which model. It’s written for business owners and managers buying custom software, apps or integrations.

The 2 contract types in plain English

Fixed price (FP). You agree on a defined scope, a price and usually a timeline. The vendor delivers that scope for that price. If the work takes longer than they estimated, they absorb the cost. If you want something outside the agreed scope, you go through a change request, which usually adds cost and time.

Time and materials (T&M). You pay for the hours people actually work at agreed hourly or daily rates, plus approved costs such as software licenses or cloud services. You can change priorities as you learn. The vendor gets paid for effort, not for a fixed result, so you carry more of the cost risk.

The US government’s own rulebook draws the same line. The Federal Acquisition Regulation (FAR) says a firm-fixed-price contract puts maximum risk and full responsibility for all costs and resulting profit or loss on the contractor. It describes time-and-materials contracts as suitable when it isn’t possible to estimate the extent or duration of the work accurately at the start. The FAR also requires a ceiling price on T&M contracts and notes that T&M gives the contractor no built-in profit incentive to control costs, so the buyer has to watch progress closely.

Fixed price vs time and materials at a glance

Key takeaway: Fixed price buys certainty about cost. Time and materials buys flexibility about scope. You can’t fully have both, so decide which one your project needs more.

How risk sharing really works

On paper, fixed price moves all the risk to the vendor. In practice, vendors protect themselves in 3 ways:

1. A risk buffer. Experienced vendors add a margin for unknowns. If everything goes smoothly, you’ve paid for risk that never happened.
2. Tight scope language. Anything not explicitly written down is out of scope. Ambiguity becomes a change request.
3. Strict acceptance criteria. The vendor delivers exactly what the specification says, even if you realize midway that you need something different.

Under T&M, there’s no buffer, but there’s also no protection if estimates slip. Without good tracking, a 3-month project can quietly become 6 months. That’s why T&M contracts need regular demos, visible progress and a budget cap.

Neither model removes risk. They just decide who notices it first and who pays for it.

Change requests: where contracts succeed or fail

Change is normal in software. Users react to the first demo, competitors launch features, and integrations turn out messier than expected. How each model handles change matters more than the headline price.

Under fixed price:

• You submit a change request describing the new or different work.
• The vendor estimates its impact on cost and schedule.
• Both sides sign off before work starts.
• Expect friction over what counts as a “change” versus a “clarification”. Clear requirements reduce these disputes.

Under time and materials:

• You re-order the backlog. New work replaces or follows existing work.
• The budget impact shows up in hours burned, not in a separate negotiation.
• The risk is drift: lots of small changes nobody adds up. Track spend against the plan every sprint.

Whichever model you choose, put the change process in writing: who can request changes, who approves them, and how cost and time impact are agreed.

Which projects suit each contract type

Fixed price usually fits:

• A small website, landing page or app with clear designs
• A well-defined integration between 2 systems with documented APIs
• Migrating data or code with a known structure
• A discovery or prototype phase with a defined deliverable, such as a requirements document and clickable prototype
• Rebuilding an existing feature with the same behavior

Time and materials usually fits:

• A new product or MVP where you’ll learn from users
• Agile work using sprints, where priorities change every few weeks (see agile vs waterfall)
• Ongoing maintenance and improvement after launch
• Modernizing a legacy system with unknown problems inside
• Research, AI pilots or proof-of-concept work

A useful test: if you can’t write down detailed acceptance criteria for every feature today, fixed price will either be expensive or a source of constant change requests.

Hybrid models that balance both

Many buyers don’t pick a pure model. Common hybrids include:

The government has used similar thinking. A 2019 solicitation guide from 18F, a digital services team at the US General Services Administration whose blog is now archived, argued that time-and-materials contracts with a spending ceiling give agile teams more flexibility, and noted that T&M makes it easier to stop or replace a team that isn’t delivering, as long as the buyer checks software quality continuously.

Where to start: choosing your contract in 6 steps

1. Rate your scope certainty. Could you hand a developer a full specification today? If yes, fixed price is realistic. If no, lean toward T&M or a discovery phase first. Our guide to writing a software requirements document helps.
2. Decide how much you’ll be involved. T&M works only if someone on your side reviews progress and sets priorities every week or 2.
3. Get estimates both ways. Ask the vendor to price fixed and T&M options and explain the difference. Our article on estimating software projects shows what good estimates include.
4. Add protections to either model. For fixed price: clear acceptance criteria, a change process and milestone payments. For T&M: a cap, timesheets or reports, regular demos and the right to pause.
5. Clarify ownership. Confirm who owns the code, designs and accounts at the end, and get access to repositories from day one.
6. Have a lawyer review the contract. Payment terms, warranties, IP and termination clauses matter more than the pricing model.

For broader context on costs and sourcing, see how much custom software development costs and IT outsourcing vs in-house.

This is not legal advice. Contract terms and enforceability vary by state, so have an attorney review any software development agreement before you sign.

Conclusion

Fixed price suits small, clear, stable projects where you value cost certainty and can define success upfront. Time and materials suits new products and evolving work where learning and changing direction are part of the plan. When you’re unsure, start with a fixed-price discovery phase, then build on capped time and materials with regular demos. The best contract is the one that matches how certain your scope really is, not the one that feels safest on day one.

Sources

• Federal Acquisition Regulation 16.202-1: Firm-fixed-price contracts, description — risk placement on the contractor
• Federal Acquisition Regulation 16.202-2: Firm-fixed-price contracts, application — when fixed price is suitable
• Federal Acquisition Regulation 16.601: Time-and-materials contracts — when T&M is used, ceiling prices and oversight
• 18F blog archive: An agile software development solicitation guide — T&M with a ceiling for agile software work