Companies are committed to IT outsourcing for several reasons. Sure, one of the primary motivations is still to reduce costs. After all, setting up an in-house development team is a considerable investment, both cost- and time-wise. Organizations, however, are also focused on other benefits of IT outsourcing. As Forbes puts it: “It doesn’t just have to be a budget concern or a lack of resources; sometimes deciding to work with an outsourced IT operations team is strategic.”
Accelerated time-to-market would definitely be one of such strategic reasons in today’s competitive landscape. On top of that, outsourcing partners can apply their unique expertise to your project, amplifying its success. Finally, IT outsourcing vendors may provide you not only with their software development services but also with valuable support in the digital transformation of your own company.
Seeing the value of IT outsourcing is one thing, but choosing the right cooperation model requires you to understand their possibilities and limitations. In this guide to IT outsourcing pricing models, you’ll read more about the pros and cons of each approach. As a result, you’ll be able to make a more informed decision when it comes to outsourcing your company’s next project.
Here’s what we’ll cover in this blog post:
- What is IT outsourcing?
- What are some typical models for IT outsourcing?
- Select an outsourcing model that fits your needs at the moment
Before we jump into the most common IT outsourcing models, let’s explain the process of outsourcing itself and identify the main types of IT outsourcing.
What is IT outsourcing?
IT outsourcing can be defined as using external vendors to provide IT-based services (e.g., custom software development).
Say you want to create a mobile app for your brand to improve customer experience for people on the go. Or that you want to build a digital ecosystem to streamline your company’s internal operations. When you don’t have in-house teams that are capable of delivering these results, you might want to look into outsourcing.
Onshoring vs. Nearshoring vs. Offshoring: what’s the difference?
There are three main types of IT outsourcing, each coming with its pros and cons. The difference between the approaches listed below is reflected in the physical location of your service provider.
- Onshoring means that you outsource IT services to a development team that’s operating in your own country. The downside of this approach is that development services offered in your country may be rather pricey. This is why many companies look into outsourcing IT services abroad.
- Nearshoring happens when you outsource development services to a neighboring country (e.g., German companies selecting technology partners in Poland). Nearshoring is often viewed as a good compromise between cost-effectiveness, quality, and the physical proximity of your outsourcing partner.
- Offshoring is the process of outsourcing IT services to a company based overseas. This is usually the most budget-friendly option, although you have to account for the time difference and thus some potential communication issues.
The way you go about outsourcing your company’s IT projects depends on several factors: you have to consider the costs, decide whether the geographical proximity (or lack thereof) is crucial for you, and finally, find an outsourcing partner that meets your criteria. Not sure how to select an ideal IT outsourcing partner for you? Here’s our guide to finding the right software vendor.
While budget concerns are no longer the only motivation for IT outsourcing, they’re still important. The differences between countries in terms of software development costs can be huge even if we talk about neighboring states. According to PayScale, German programmers earn, on average, more than twice as much as their Polish counterparts. The difference between the average salaries of Polish and American software developers is even bigger. Given the high level of programming expertise displayed by Polish IT specialists, it’s not really surprising that so many companies outsource software development to Poland.
Now let’s take a closer look at the most popular outsourcing pricing models.
What are some typical models for IT outsourcing?
We’ll consider three different models for software development outsourcing: calculating the price based on time & materials, hiring a dedicated team, and agreeing on a fixed price (project fee).
Time & Materials
Time & Materials (known as T&M) means that you pay for the number of labor hours and the cost of materials.
This outsourcing model prioritizes the quality of your end product. See, as the product is being developed and feedback starts pouring in from the users, it usually turns out that the final version looks slightly-to-totally different from your initial sketches. It’s not a bad thing, quite the contrary: at the end of the day, consumers should be 100% satisfied with the product. This is why teams that work in line with Agile principles prefer not to create a fixed plan for a project upfront.
Pros of the T&M model:
- High flexibility, allowing you to create a truly user-approved product.
- The progress of the project is transparent.
- You can act as a Product Owner for your project and take an active part in shaping the end product.
- You’re able to plug in different roles to the project, depending on your partner’s staff expertise. You only pay for the work they actually do.
- Iterative approach to software development is possible here.
Cons of the T&M model:
- It’s difficult to estimate the total price for the project.
- Longer projects.
- Projects with unclear requirements or requirements that are likely to change.
- Collaborating with a trusted outsourcing company with excellent communication skills.
- Customer-facing projects.
- Running a discovery phase for your upcoming project or defining a product roadmap.
One additional type of the T&M pricing model is T&M with a cap. It means that there’s a monthly/weekly cap of hours that shouldn’t be exceeded. The cap gives you some sense of your project’s scale, plus it can be a good model for your first project together with a given software house.
This IT outsourcing model (also known as fee per team) means that the vendor provides you with a dedicated team of employees to work on your project.
This model could be an answer to the uncertainty that comes with T&M-based collaborations. Having a dedicated development team at your disposal is as close to having an in-house expert team as possible. It’s in the best interest of the outsourcing company to handpick a group of individuals that work well together and can successfully deliver your project. The team may include not only software development specialists but also testers, analysts, or project managers. The project budget is calculated based on the roles and expertise of people that are a part of your team.
Pros of the dedicated team model:
- You’re working with people who understand your project well (together with business goals and customer needs), as this is their primary focus.
- The outsourced team may feel like an in-house team.
- High transparency of all project-related activities.
- You can rely on the team to provide value for your project.
Cons of the dedicated team model:
- It’s not sustainable for very short projects.
- Your dedicated team needs to have something to do, so a backlog of tasks should be in place.
- You might need to wait for your outsourcing vendor to allocate (and potentially even hire) the right people. It is not an issue for teams with a broader roster of talents.
- Longer projects.
- Projects with initial requirements and assumptions (they’re needed in order to allocate appropriate people to your team).
- Agile development process.
Out of all IT outsourcing models, this one is probably the best for close cooperation between the client (you) and the outsourcing company. With time, your dedicated team may notice improvement areas not only in the project itself but also in the broader context of your company. This is why this outsourcing model may turn out to be extremely beneficial for larger organizations that are undergoing the process of digital transformation.
A fixed price is an IT outsourcing model within which you agree to pay a fixed amount of money for a specific project.
At first glance, this may sound like the most favorable option to follow: after all, you’re guaranteed to meet your budget. Here comes the catch, though. A fixed price option will only work for projects with fixed and precise requirements. That means it won’t be a good fit for developing a product according to agile principles, where flexibility is prioritized. Here you agree upfront as to what should be developed.
Pros of the fixed price model:
- It’s a very predictable IT outsourcing model when it comes to finances. You know what the price tag will be, and you can plan your budgets.
- Low risk for the client.
- Low level of control needed from your side.
Cons of the fixed price model:
- Very little flexibility during the development process.
- The project needs to be carefully and precisely planned.
- The tech used in the project should be chosen and tested before the budget is estimated. It’s not a good fit for products based on experimental/innovative solutions.
- The price per hour of work will be relatively high: vendors need to add a risk margin in the fixed price projects.
- Well-defined projects.
- Short projects.
- Working with outsourcing partners with experience implementing similar projects.
Select an outsourcing model that fits your needs at the moment
You don’t have to rely on a single outsourcing model, even if you’re working with one service provider. Most IT companies offer some flexibility when it comes to choosing the collaboration model. You may also end up with a hybrid pricing model (e.g., T&M but with a monthly cap of hours).
Your choice of which outsourcing model to go with will likely be influenced by the budget of your project. Apart from that, try to base your decision on the following factors:
- the scope of your project (known vs. unknown),
- the estimated duration of the project,
- your preferred project management methodology,
- whether the team might need to be scaled during the development process,
- the level of technical innovation in the project.
When drawing up a contract with an outsourcing company, take all of these aspects into account. Ideally, you should get some support from your potential tech partner when making that decision.
If you want to discuss different approaches to IT outsourcing and get some advice as to which model is the best for your current needs just drop us an e-mail at email@example.com to schedule a 1on1 with one of our experts. Having delivered projects within all three of these pricing models, we have a lot of expertise when it comes to their strengths and weaknesses.