Fixed price vs time and materials: which software contract should you sign?

What’s the difference between fixed price and time and materials?

Under a fixed price contract (also called fixed fee or fixed bid) you agree the total cost for a defined scope up front; under time and materials (T&M) you pay for the hours actually worked at agreed rates. Everything else follows from one question: who pays when the estimate turns out to be wrong?

Every software estimate is a guess about the future. Under fixed price the vendor owns that guess. If the work takes longer, the vendor absorbs it; if it’s quicker, the vendor keeps the margin. Under T&M you own it. You pay for overruns and you keep any savings.

	Fixed price	Time and materials
What’s agreed up front	Scope, price and usually timeline	Rates, team and a way of working
Who carries estimate risk	Vendor	You
Cost per unit of work	Higher: includes contingency	Lower: no risk premium
Flexibility to change scope	Low: changes go through variations	High: reprioritise any week
Budget certainty	High, if scope holds	Low, unless capped
Management effort for you	Front-loaded: specify carefully, then accept deliverables	Ongoing: review progress and spend weekly
Main failure mode	Padding, disputes over what’s “in scope”, corner-cutting	Drifting scope, slow burn of budget
Best for	Well-understood, well-specified work	Exploratory work, evolving products, ongoing development

Why does fixed price cost more per hour?

Because a competent vendor adds contingency for the risk it’s taking on, and you pay for that certainty. A vendor quoting fixed price on a 700-hour estimate might price 800 to 900 hours, depending on how well understood the work is. That margin is the premium on an insurance policy against overruns.

The size of the premium tracks how clear the scope is. On a crisp scope with known integrations, contingency can be small. On a vague brief, a careful vendor pads heavily, and a careless or aggressive one quotes low and plans to recover the difference through variations. Martin Fowler calls this the fixed scope mirage: a fixed scope contract is only fixed if the vendor really understands the requirements, and that is rare before anyone has looked closely.

This is why fixed price quotes for the same brief can vary so widely. Our custom software cost guide covers how to compare quotes like with like.

A worked example: the same project under three models

Here is an illustrative comparison for a customer portal estimated at 600 to 900 hours, at a blended $165 an hour (AUD, ex GST). The numbers are examples to show the mechanics, not a quote.

Model	How it’s priced	If the work takes 650 hours	If it takes 900 hours	If you add a feature mid-build (+80 hours)
Fixed price on the initial brief	Vendor prices 950 hours for risk: $156,750	You pay $156,750	You pay $156,750	Variation, say $13,200; total $169,950
Pure T&M	Hours × $165	You pay $107,250	You pay $148,500	+$13,200 on top of actual hours
Paid discovery, then fixed price	Discovery $12,000; clearer scope lets vendor price 780 hours: $128,700	You pay $140,700	You pay $140,700	Variation $13,200; total $153,900

Three things stand out. Pure T&M is cheapest if the work goes well, and exposed if it doesn’t. Fixed price on a vague brief is the most expensive in the good case, because you paid for risk that didn’t happen. Discovery shrinks the contingency by shrinking the unknowns, so the fixed price that follows is closer to the true cost.

What hybrid models exist?

Most real contracts sit between the two extremes, and the hybrids are often the best choice. The common ones:

1. Paid discovery, then fixed price. A short discovery phase (usually two to six weeks) produces workflows, integration details, acceptance criteria and an architecture. The build is then quoted as a fixed price, often per phase. See what a discovery phase involves.
2. Fixed price per phase or milestone. Large projects are split into phases, each priced once the previous one has reduced the unknowns. You can stop after any phase.
3. Capped T&M. Hourly billing with a ceiling. Check whether the cap is a hard limit the vendor absorbs, or a trigger to stop and ask for more budget.
4. Fixed budget, flexible scope. Price and time are fixed; the team delivers the highest-priority features that fit. This is how Fowler describes fixed price working with agile teams, and it suits products where learning changes priorities.
5. Retainer. A fixed monthly amount for a set capacity, common for maintenance and continuous improvement after launch.

When is time and materials the better choice?

Choose T&M when you can’t define the scope well enough to fix a price without paying a large risk premium, and you’re able to manage the work closely. It is the right model more often than buyers expect.

T&M fits when:

• You’re building a new product and expect what you learn from users to change the plan.
• The work is research-heavy: an AI prototype, a data quality investigation, performance tuning.
• The work is continuous, such as ongoing product development or maintenance.
• You have a product owner with time to review progress and reprioritise each week.
• You trust the vendor, or have worked with them before.

Protect yourself with weekly timesheets tied to tasks, a monthly budget cap that needs your approval to exceed, a right to stop at short notice with code handed over, and regular demos of working software.

When is fixed price the better choice?

Choose fixed price when the scope is clear, the outcome is well understood, and budget certainty matters more to you than flexibility. Boards, grant budgets and government funding rounds often need a firm number, and fixed price gives it.

Fixed price fits when:

• A discovery phase has already produced a precise scope and acceptance criteria.
• The work is similar to things the vendor has built many times.
• You don’t have time to manage the work week by week.
• Your approval process needs a single approved figure.

It fits badly when the brief is a paragraph, when integrations haven’t been investigated, or when you already know priorities will shift. In those cases, fixing the price means paying for contingency or arguing about variations.

What should the contract say, whichever model you pick?

Both models need the same basic protections: clear deliverables, a written change process, acceptance testing, and your right to walk away with the code. A checklist:

1. Scope and acceptance criteria. For fixed price, specific enough that a third party could tell whether a feature is done.
2. Change control. Every variation is written, estimated and approved by you before work starts.
3. Reporting. Weekly progress and, for T&M, hours by task.
4. Payment tied to milestones for fixed price, and to approved timesheets for T&M. Avoid large up-front payments beyond a reasonable deposit.
5. Acceptance testing period and a warranty period for defects.
6. IP assignment and source code access from day one, so you’re never locked in.
7. Termination for convenience, with payment for work done and handover of everything built.
8. GST. Business quotes are usually ex GST; confirm, and add 10%.

Australian law adds a floor. Under the Australian Consumer Law, services costing less than $100,000, including those bought by a business, come with guarantees that they’re supplied with due care and skill, fit for any stated purpose, and within a reasonable time if no timeframe was agreed. Standard form contracts with small businesses are also covered by unfair contract term protections: a term letting only one party vary the price, for example, can be found unfair and void. Our contract checklist goes through these clauses in detail.

Fixed price or time and materials: which should you choose?

Your situation	Suggested model
Clear scope from a completed discovery, need a firm number	Fixed price
Only a brief, but you need a number for approval	Paid discovery, then fixed price
New product, priorities will change with user feedback	T&M or fixed budget, flexible scope
Large program over many months	Fixed price per phase
Research, prototype or AI proof of concept	Capped T&M
Ongoing improvements after launch	Retainer or T&M

How All Webbed Labs prices work

We run a paid discovery first, then quote a fixed price for the agreed scope, usually per phase. That’s one option among several above, and we use it because it gives you a firm number without paying for contingency on unknowns. Where work is genuinely exploratory, such as an AI proof of concept, we’ll suggest capped T&M instead and say why. Under our MSA, scope changes are written variations that both parties approve before the work starts (the only exception is urgent temporary action to protect systems or data), and our practice is to keep the code in your repository from day one. Read more about how we work or our custom software service.