A fixed-price contract moves one risk to the vendor: the risk that the work takes more effort than estimated, on a scope that is written down. It does not protect you from an incomplete specification, from software that meets the contract but that your teams won't use, or from your own late sign-offs. Time and materials moves even less, but you don't pay a premium for trouble that never happens. Which one fits depends on how mature your requirements are, and most enterprise projects do better mixing the two, phase by phase.
The question usually comes up while the RFP is being written. Procurement wants a firm amount to compare across vendors, IT knows part of the scope isn't described yet, and the CFO leans toward a fixed price because it fixes a budget line. Yet the case that hurts a CFO most is a tool delivered on budget that users route around with their old spreadsheets.
Who builds the software (an in-house team, an IT services firm or an offshore vendor) is a separate decision, covered in our comparison of development team models. Here the question is how the contract splits the risk.
Are the twenty requirements that weigh most ready for a fixed price?
Take the twenty requirements that weigh most in the estimate and ask three questions of each. Can you write today the test that will prove it is delivered? Do you know who on your side will decide if it has to change? And could a process being redesigned, or a business rule still to be settled, make it move in the next six months?
Then sort the twenty lines into three colors. A requirement that is testable and unlikely to move goes green. One that is stable but has no written acceptance criterion yet goes orange, and one that depends on a decision not yet made, or on another project, goes red.
Green can go fixed price now. Orange needs two or three workshops before anyone prices it, or the vendor will price your vagueness and add a buffer on top. Red belongs in capped time and materials, or in a scoping phase first, and when red dominates, a single fixed price will only buy you a string of change orders. Ideally, do this sort before you even write the RFP for your custom software project.
What risk do you really transfer with a fixed price?
Under a fixed price, the vendor commits to a described result for a set amount and deadline. If they underestimated the effort, they eat the difference. That is the only risk that changes hands, and it matters, because estimation errors are common in IT.
Everything else stays with you. Anything not written down is not owed, so a forgotten or vague requirement comes back as a change order. Value risk is yours too, since the vendor is paid to deliver what was specified even if the need moved in the meantime. Your dependencies remain your problem as well, whether that's access to your ERP's APIs or the time your business experts spend on sign-offs. Every delay on your side will end up in the vendor's weekly status report.
A tight fixed price also tempts the vendor to cut what acceptance testing doesn't see, like automated tests or documentation, and acceptance criteria that name those items protect you, since a fixed price covers only what is written.
Is the risk premium in a fixed price worth paying?
It is worth paying when your budget cannot absorb an overrun. Every fixed price carries such a premium. The vendor estimates the effort, then adds a buffer for the uncertainty they agree to carry, and that buffer never shows up as a line on the quote. You've probably heard the counterargument: with time and materials you pay only for the time spent, and less if all goes well.
That argument assumes all goes well. Bent Flyvbjerg and Alexander Budzier compared budgets with actual spending on 1,471 IT projects (Harvard Business Review, 2011). The average cost overrun was 27%, and one project in six overran its budget by 200% on average, with a schedule overrun of almost 70%.
On the finance side, could you absorb an overrun of that size on this project without going back to your board? If not, the premium buys real protection, even though you also pay it when nothing goes wrong. If your budget can move from one quarter to the next, you can carry the risk yourself, provided you manage it closely.
Ask for the list of estimating assumptions too. The premium hides there as much as in the price. Each assumption ("source data is clean", "the vendor's API is documented") becomes a change order the day it turns out false. A vendor who won't list them is selling you a fixed price whose limits you'll find out about halfway through.
What does time and materials leave with you, and what does it demand of your team?
Under time and materials, the vendor provides people and bills the time spent at an agreed day rate. They commit to effort, and steering toward the outcome is your job. You set the priorities and can change your mind without a change order. But every week of drift is billed to you, with no ceiling.
Time and materials also asks more of you than people expect. Companies often pick it because the need is fuzzy, yet someone on your side has to prioritize the backlog every week, attend the demos and read the days consumed with a skeptical eye. That product owner needs to be able to set aside several half-days a week. Without one, the vendor ends up setting both the priorities and the bill.
If you can't name that person before kickoff, a fixed price by phase, premium and all, beats time and materials without an available product owner, which gets you the downsides of both models.
Fixed price, time and materials or hybrid: how do you decide for your project?
For each row, tick the column that describes your project as it is today, not as you hope it will be in three months.
| Criterion | Points to fixed price | Points to time and materials |
|---|---|---|
| Specification maturity | Requirements written, each with its acceptance criterion | Clear intent, details to discover |
| Scope volatility over six months | Low, processes and rules settled | High (reorganization, regulation under discussion, a neighboring project) |
| Who sets priorities each week | The contract is enough | An internal owner prioritizes the backlog |
| Hard budget cap | Approved envelope that cannot be reopened | Budget revisable each quarter |
| Acceptance criteria | Ready and testable before kickoff | To be built during the project |
| Internal product owner | Present for scoping, scarce afterward | Available several half-days a week |
| External dependencies (APIs, data) | Known and tested | Uncertain or unverified |
If all your answers land in one column, you're done. If they split, you need a hybrid contract, and the table already shows where to cut: every answer in the time and materials column marks a part of the scope to take out of the fixed price.
Which clauses make a hybrid contract hold up?
A hybrid splits the scope by stability rather than size, so a large stable module goes fixed price while a small dashboard whose rules are still being argued over stays on time and materials. Five clauses hold it together. Below is what each one needs to say in substance; adapt the wording with your legal counsel before it goes into the RFP.
- Fixed price per stabilized phase. Each phase has a written scope, its acceptance criteria, a firm amount and a schedule. The next phase is priced only once its specifications are stable.
- Capped time and materials on the moving part. A cap in days per period, a written alert at an agreed threshold (80%, for example), then at the cap a signed decision that either cuts scope or raises the cap.
- Change request procedure. One written form per request, an impact analysis (time, amount, risks) returned within a deadline set in the contract, a written decision by a named person on the client side, and no work before that signature.
- Unit-of-work catalog. An appendix fixes at signing the unit effort for standard tasks (simple screen, business rule, export, report, standard interface), and any change is then priced by counting units. The same logic works after go-live, as our article on where corrective maintenance ends and evolutive work begins explains.
- Acceptance tied to each phase. Acceptance criteria written before the phase starts, an acceptance period fixed in the contract, defects classed as blocking or minor, and payment for the phase once the acceptance report is signed. Minor defects roll into the next phase without holding up payment.
On a shipment-tracking portal, does the hybrid really cost less?
Take a logistics and transport company that wants to give its business customers a shipment-tracking portal. The figures below are illustrative assumptions, in working days so they don't depend on anyone's rates, and they are not market data.
- Stable part (customer accounts, step-by-step shipment tracking, proof-of-delivery downloads, interface with the transport management system): 200 days estimated, requirements and acceptance criteria written.
- Moving part (delay alerts and an on-time dashboard per customer, with rules that sales and operations have not yet agreed): 60 to 140 days.
- Vendor's risk buffer on a fixed price: 15%.
| Setup | Days billed | If the project slips |
|---|---|---|
| All fixed price | (200 + 140) × 1.15 = 391, fixed | Alert rules frozen too early come back as change orders |
| All time and materials | 260 to 340 if estimates hold | 400 if the stable part slips 30% and the alerts hit 140, no cap |
| Hybrid | 200 × 1.15 = 230 fixed, plus 60 to 100 capped time and materials, for a total of 290 to 330 | Past 100 days on the alerts, a written decision |
The all-fixed option charges the buffer on 340 days, 140 of them for a module nobody can describe yet. All time and materials has the best case at 260 days, but its bad case has no limit. When everything goes right, the hybrid costs more than time and materials. Its 330-day ceiling sits below the all-fixed price, but it assumes you stop the alerts module at 100 days. Like for like, if that module really needs 140 days, the hybrid reaches 230 + 140 = 370 days, on a written decision. Since the buffer now applies only to the part the vendor knows how to estimate, it still comes in under the 391 of the all-fixed option. To get amounts, multiply by the rates in your own bids.
FAQ
- Do I have to specify everything before a fixed-price project starts?
No, as long as you split the project. You detail the first phase, sign it at a fixed price, then write the next phase's specifications while the first one is being built. The scoping phase can itself be bought at a fixed price, with a defined deliverable (requirements, acceptance criteria, an estimate per phase), which leaves you free to take the rest to other vendors.
- Is capped time and materials just a fixed price in disguise?
The difference is what happens at the cap. When it's reached, the vendor doesn't have to finish at its own expense; it stops, and you decide what comes next. The cap protects your budget but doesn't secure the outcome. If you want the vendor to finish no matter what, you're buying a fixed price, and it will be priced that way, premium included.
- Who should sign change requests on the company side?
A person named in the contract who holds the project budget, backed by the product owner on content. Not end users, and not a department head who runs into the vendor's team in the corridor. Without that rule, small verbal requests pile up until they reach the invoice.
- Can we switch from time and materials to fixed price mid-project?
Yes, if the contract allows it from the start. A conversion clause lets you move a part run on time and materials to a fixed price once it stabilizes. The consumption history then gives the vendor a factual basis for pricing, and gives you a fairer amount than an estimate made at kickoff.
Sources
- Bent Flyvbjerg and Alexander Budzier, "Why Your IT Project May Be Riskier Than You Think", Harvard Business Review, September 2011, authors' version: arxiv.org/abs/1304.0265
Last verified: 1 November 2026.
If a time and materials contract is coming up for renewal, run the twenty-requirement sort at least a quarter ahead, to leave time to recut the scope. Before your next RFP goes out, we offer to review your requirements document, or the contract you are about to renew, at no charge and to tell you which parts can go fixed price.
