Fixed Price Models 

Lacking the bells and whistles of newer outsourcing models, fixed-price contracts can still be very advantageous to projects with a clearly defined scope and a stable set of requirements. Fixed-price contracts put all of the risks associated with the project not being completed on the outsourcing partner by not paying them until the work is completed, conveniently protecting your budget as well. With this outsourcing model, there won't be any surprise costs that pop up, both your development team and your outsourcing provider will know exactly what to expect. The outsourcing contract in this model will be clear of the drivers of costs.

Fixed-price models are perfect for long-term projects with a high value to the outsourcing partner since they incentivize them to complete the work more efficiently and derive more value from the contract. However, be prepared for your partners to ask for flexibility in payment terms. Some outsourcing providers will ask you to pay a percentage of the contract price based on the achievement of certain milestones, like completing the front-end design.

Open communication and transparency are essential for establishing an outsourcing model that adequately addresses risks. Clearly defining responsibilities, expectations, and the scope of work can help minimize misunderstandings and ensure that both parties are aware of their respective obligations. 

By fostering a collaborative relationship, you can build trust and confidence in the outsourcing arrangement. Since they’ll be assuming all of the risks, they will want to make sure they aren’t left high and dry. If you’re too rigid on terms, you may end up costing your business more in the long run, as some providers will build the cost of risk management into their pricing.

Time and Materials (T&M)

The well-worn old shoe of pricing models, T&M requires your outsourcing partner to bid for the project based on your requirements, depth of scope, and the amount of work that will be completed. This model works well if your teams are great at outlining your project needs. That way, your outsourcing partner will spend less time reworking problems, shortening your project completion time and saving you money. However, this outsourcing model will require a lot of heavy lifting on your part. Whether it be your project manager or internal development team, they need to do their due diligence on what your software development project will typically cost in the market. This project based model is dependent on the complexity needed for your software outsourcing. 

In this particular outsourcing model, the key principle to remember is that the more effort and information you invest, the greater the rewards you'll reap in return. Opting for this outsourcing model requires your project manager to thoroughly explore and comprehend the true scope of your software development project. It is crucial not to overlook any aspect during this crucial step. Leave no stone unturned and meticulously document every single detail and functionality that should be included. By providing an exhaustive list of requirements, you provide your outsourced software developer with a solid foundation to build upon. The more comprehensive and detailed the information provided, the more effectively they can shape the development process and deliver outcomes aligned with your expectations. This level of clarity minimizes the chances of miscommunication or misunderstandings, enabling your outsourced team to work in sync with your vision and goals. So, embrace the power of thoroughness and ensure that no aspect is overlooked when diving into this outsourcing model for software development projects.

Be ready to build effective project management teams to ensure the entire project gets finished on time and within budget. You will need to tightly track project performance and avoid costly project delays. Keep in mind, that building in a cushion can help you if the project goes over time or budget with this outsourcing model.

Incentive-based Pricing Models

Often an add-on to the more traditional models described above, incentive-based models contain bonus payments to the outsourced developer as a reward for meeting or exceeding performance goals as stated in the contract agreement. Incentives can make up for limitations in fixed-price or T&M outsourcing models, and ensure your partner’s motivations stay in line with your own.

Incentive-based models can be highly effective in bridging the gaps that may exist in fixed-price or time and materials (T&M) outsourcing models. While fixed-price and T&M models have their own merits, they may sometimes have limitations when it comes to motivating the outsourcing partner to go above and beyond. The inclusion of incentives in the outsourcing agreement ensures that the motivations of the outsourced developers are aligned with the goals and expectations of your own business. By offering these bonuses, you provide a clear incentive for the developers to consistently deliver high-quality work and strive to meet the established performance targets.

Moreover, these models also promote a sense of accountability and responsibility among the outsourced developers. With clearly defined performance goals, the developers are fully aware of the expectations placed upon them. This transparency not only enhances their commitment to delivering satisfactory results but also provides you with a reliable means of measure to gauge their performance.

Adding complexity to your engagement model means you’ll need to rigorously ensure that your partner drives measurable benefits for your business. Many companies end up paying partners for premium services that don’t actually benefit them.

Shared Risk-Reward Pricing Model

If you’re looking for a model with a bit of extra flair, the Shared Risk-Reward Pricing model may have you coming in on Saturdays. Like the Incentive-based model, this model contains a flat rate and holds additional payments until your partner achieves specific objectives. Let's delve deeper into how this model works and the benefits it can offer.

Similar to other outsourcing models, the Shared Risk-Reward Pricing model involves setting a predetermined flat rate for the services rendered. However, what sets it apart is the additional element of shared funding for the development of new products or projects. In this model, both the client and the service providers contribute towards the financial investment required for the development phase. This builds reliability and accountability into the outsourcing contract. Your outsourcing provider has their own risks and benefits tied to this project so they want the project to succeed as much as you.

By pooling their resources together, the partnerships formed in the Shared Risk-Reward Pricing model create an environment of mutual investment and commitment. The client becomes actively involved in the development process, providing valuable feedback and suggestions while also sharing the financial risk with the service providers. This collaborative approach fosters a sense of shared responsibility and encourages both parties to work towards achieving common objectives.

The Shared Risk-Reward Model encourages your partners to develop ideas that improve your business by sharing the financial risk between both parties and, according to Gartner, assigning responsibilities to the partner mitigates some risks associated with new processes, technology, or models. Be ready for a detailed - and we mean detailed - level of oversight. The result of your partner’s work may be difficult to measure, so you’ll need to be prepared to enjoy the upsides and weather the downsides.