Time and material vs fixed price: how each contract splits risk in software development
Buyers of software development either pay for the time spent, at agreed rates, or pay an agreed price for an agreed scope. Each model moves risk to a different party and needs different clauses to work. This page compares the two, the hybrids between them and the way each one fails in practice, without quoting rates or prices.
What is the difference between time and material and fixed price?
Quick answer
Time and material vs fixed price is a choice about who carries estimate risk. Under fixed price the vendor carries it, so the scope must be precise; under time and material the buyer carries it and needs budget guardrails. Agnotic Technologies recommends a model for each phase of a build on the scoping call.
| Criterion | Time and material | Fixed price |
|---|---|---|
| Who carries estimate risk | The buyer: more hours than expected means a larger bill | The vendor: overruns come out of its margin, so it prices that risk into the bid |
| What the price covers | Hours worked at agreed rates, plus agreed expenses | A defined scope, delivered and accepted |
| How change is handled | Reprioritize the backlog; change costs time, not a contract amendment | A change request with its effect on price and dates, agreed in writing before work starts |
| Acceptance | Increment by increment, against the agreed definition of done | Formal acceptance against written criteria, usually tied to a milestone payment |
| Ceiling or cap | None unless agreed; a not-to-exceed amount turns it into capped time and material | The price is the ceiling for the agreed scope |
| Buyer's effort | Steady: a product owner sets priorities and reviews work every sprint | Front-loaded: specifications and acceptance criteria before signing |
| Warranty | Defect fixing is billable time unless the contract sets a warranty | A warranty period for defects against the specification is normally part of the price |
| Exit | End with notice and keep the work done so far | Termination clauses set what is paid for completed milestones |
What they are
What is Time and material
Under a time and material contract, the buyer pays for hours worked at agreed rates by role, plus agreed expenses. Scope can change while the work runs, and the buyer carries the risk that the work takes longer than estimated.
What is Fixed price
Under a fixed price contract, the vendor delivers an agreed scope for an agreed price. The vendor carries the risk that the work costs more than estimated, so the scope, the acceptance criteria and the change procedure must be written precisely.
Key differences
Which clauses make a time and material contract safe?
A rate card by role; a monthly or phase budget with a not-to-exceed amount; written notice when spend reaches an agreed share of that budget; reporting of hours against the work done each sprint; ownership of work in progress; and termination with a short notice period. Without the budget and notice clauses, time and material has no brake.
Which clauses make a fixed price contract safe?
A scope document precise enough to test; acceptance criteria per deliverable; a change request procedure with a response time and a pricing method; milestone payments tied to acceptance; a warranty period and what it covers; the assumptions the price depends on; and what happens if the buyer is late with inputs. Vague scope in a fixed price contract turns into a dispute later.
What does federal contracting law say about the two models?
The US Federal Acquisition Regulation is a neutral reference even for private deals. FAR 16.202-1 says a firm-fixed-price contract places maximum risk and full responsibility for all costs on the contractor. FAR 16.601 allows a time-and-materials contract only when the extent or duration of the work cannot be estimated with reasonable confidence, requires a ceiling price the contractor exceeds at its own risk, and notes the model gives no profit incentive for cost control, so the buyer must oversee it.
How does each model fail?
Fixed price fails through padded bids, where the vendor prices in every unknown; through change request disputes over what the scope really said; and through quiet corner cutting when the budget runs low. Time and material fails through open-ended spend with no guardrails, through a buyer who never sets priorities, and through work that looks busy but never ships. Each failure has a clause or a habit that prevents it.
Which hybrids sit between the two?
Fixed-price discovery, then time and material: a short fixed phase produces the scope, architecture and estimate, and build work runs on time. Capped time and material: time-based billing with a not-to-exceed amount, so the buyer keeps flexibility and the vendor shares the overrun risk above the cap. Fixed price per phase: each release is priced once the previous one is accepted. FAR 16.104(e) follows the same logic, asking whether part of a contract can be fixed when the whole cannot.
When to use each
When to use Time and material
- The work is research, an experiment or open-ended improvement of a live product.
- You can give a product owner time every sprint to set priorities and accept work.
- You want to change direction without renegotiating the contract.
- You will control spend with a cap or a monthly budget and a notice point.
When to use Fixed price
- The deliverable has written specifications and acceptance tests before work starts.
- Your budget process needs one approved amount for one approved scope.
- You will have little time to manage priorities during the build.
- The work repeats something the vendor has built before, so estimate risk is low.
How do you choose between time and material and fixed price?
1. Write down what is known. If the scope, acceptance criteria and integrations can be specified and tested today, fixed price is realistic for that part.
2. Split the work. Fix the well understood parts and leave discovery or experimental work on time and material.
3. Decide who manages scope. Time and material needs a product owner on your side every sprint; fixed price needs someone with authority to sign off specifications and acceptance.
4. Set the brake before work starts. Under time and material, agree a cap or a monthly budget and a notice point. Under fixed price, agree how a change request is priced before the first one arrives.
5. Review at every phase. Move a phase to fixed price once its scope is stable, or back to time and material if discovery shows it is not.
How sprints are estimated without a fixed price is covered on our agile software development page, and the engagement models we run are listed on our software development page.