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Outsourcing contracts: types and myths

Reading time: 7 min

A lot of companies that are considering outsourcing for the very first time worry about the legalities of the contract. No surprise there – many long-term international agreements can be convoluted enough to keep even lawyers up at night. However, if you learn the basics and choose an experienced, renowned partner, the legal documents can become transparent and understandable for everyone, and most importantly, protect your interests.

Below, you’ll find a short overview of the 4 most popular types of outsourcing contracts and a list of contract-related myths, debunked. The type of contract that will work best for you depends on the specific nature of your project and your own preferences (however, not every software company will have so many options for you to choose from).

4 types of outsourcing contracts

1. Time & Materials Contract (T&M)

According to the T&M contract, as the name suggests, the client is billed for the team’s working hours and the materials used. The client is informed of the hourly rate of each team member, as well as the costs of some materials (like software licences or hosting services), prior to the cooperation. The latter may change as the project progresses, since there may be shifts in requirements or business needs.

There are some big advantages involved with using this type of contract:

  • It’s flexible, scalable and in line with the Agile methodology of software development.
  • The client is in full control of deciding what feature they want to develop, and what to prioritise in the project.
  • There’s no need for any detailed specifications beforehand – project requirements are discussed before every sprint.

However, if the final costs and deadlines are not specified at the beginning, this may contain some risks for the client, so the project has to be very well managed. The T&M contract works best for short-term projects, as well as for projects where it’s difficult to define the scope early on.

2. Fixed Price Contract

This is a kind of contract in which the price is set at the beginning of the cooperation, based on thorough software specifications provided either by the client or by the client and the IT partner, together. If the scope is well defined, the risks of any additional costs or failing to deliver the product falls on the supplier. The fixed price aspect may also be applied in other ways; for example, so that the customer pays a fixed price for each individual iteration.

The advantages of the fixed price contract are undeniable:

  • The deadlines, scope and budget of the project are established at the very beginning.
  • It’s a financially safe option for the client.
  • The bugs are fixed during the acceptance procedure or this may also be covered by the maintenance agreement.

But, of course, this type of contract is not without its vulnerabilities. Since it provides very little flexibility and includes a huge amount of conceptual work that has to be done at the beginning, the development phase cannot start immediately.

3. Flexible Scope Contract

The Flexible Scope Contract applies to the Dynamical Systems Development Method (DSDM), which covers the full project lifecycle. This type of contract falls somewhere in between T&M and fixed price contracts. Although the methodology behind it is totally Agile, it also puts a lot of emphasis on the work that has to be done before development can begin. This involves gathering and discussing in detail all of the client’s strategic goals, needs and requirements, in order to thoroughly understand the nature of the project, which can be very helpful later on during the development phase.

And there are even more advantages to taking this approach:

  • Roles and responsibilities are clearly defined during the early stages of cooperation.
  • Gathering requirements and running detailed analyses go hand in hand with the Agile style of development.
  • The MoSCoW method is used to help prioritize tasks (it consists of 4 prioritization categories: Must have, Should have, Could have, Won’t have) and according to the best practices for this method, requirements should be fulfilled in an 80% ratio (60% must-haves and 20% could-haves).

This type of contract is super flexible and also guarantees a high quality of delivery while maintaining the costs at the agreed upon level. However, this method often requires a shift in the working style, plus some developer and user training.

4. Pain Share/Gain Share Contract

In this model of cooperation, both parties are involved in setting up the target cost and they also discuss their mutual attitudes towards the risks involved in the development process. Then, if the actual development cost goes above the target level – the contractor shares the cost, and when it’s below – they gain a bonus.

There are a few advantages to this kind of contract:

  • It works well when it’s hard to define the scope of work.
  • The client can track project costs precisely, thanks to the accounting system that the provider has set up.
  • Both sides of the cooperation agree to the Baseline Delivery Schedule.

However, since the customer doesn’t know what the total cost of the project will be, they may find it to be a bit risky.

Outsourcing contracts: types and myths

5 contract-related myths, debunked

  1. There will be hidden costs inside the contract.
    While costs may not be perfectly clear right away, depending on the selected cooperation model, the client will be fully aware of this fact and of any potential risks involved. Nothing will be hidden from them.
  2. The risk related to currency fluctuations is too high.
    This is not a problem for short-term contracts. And in long-term partnerships, there should always be a mechanism that divides both the risks and the benefits of currency fluctuations between both parties.
  3. The rights to the code will belong to the supplier.
    No. It should be stated directly in the agreement, that the rights to the created code should be transferred entirely to the client.
  4. If the outsourcing vendor fails or breaches the contract, the client will lose their money, time and effort.
    Not if you select a reliable IT partner. First of all, you will be able to work out the contract details to make sure that your rights are protected if the requirements are not fulfilled. Secondly, you should also check to see if the supplier has some insurance in place to help you feel more secure (like professional indemnity or cyber risk insurance).
  5. The project (or part of it) can be subcontracted to a third-party company, without the client’s knowledge and consent.
    No, as long as there’s a proper clause in the contract, this is not possible.

Wrap-up

If you choose a modern and reliable software company to be your IT partner, then you won’t be limited to just picking between the most common T&M and fixed price contracts. Your partner will be much more flexible in their approach to legal solutions, especially if a long-term cooperation is considered. You also won’t have to worry about the complexity and subtleties of the contract, as the agreed upon conditions are always the result of mutual discussions and negotiations, with the help of legal experts from both parties. This way, you and your partner will be able to cooperate on equal terms throughout the entire process.

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