07 July 2022

The Types of Outsourcing Contracts You Need to Know Before Hiring IT Company


IT outsourcing services are on the rise in these dynamic markets. Many companies look to outsource their app development or other IT business processes as they seek the desired flexibility and lower costs compared with opting for creating internal teams from scratch. What is more, is that an increasing number of countries, such as the US, China and some European countries suffer from the lack of IT professionals and need to look abroad for external services. 

Your company could greatly benefit from working with a reliable IT service outsourcing firm. Although outsourcing has many benefits for your business, it can also be quite difficult to manage and comply with the required legal agreements. That's why you should be aware that successful software development outsourcing requires a business contract that is customized to your company's needs. 

If you want to learn more about the main types of IT outsourcing contracts and what you need to know about them before choosing a provider, let us get started right away. 

What is an IT Outsourcing Contract and why should you care?    

Did you know that roughly 60% of businesses outsource the creation of mobile applications? Major industries include manufacturing, retail, financial services, and to a lesser extent, government and healthcare. If you too are planning to move some of your IT operations offshore, you need to know the contracts inside out. Let us start with a solid foundation.  

Outsourcing contracts are formal documents that detail the expectations between your company and the outsourcing company. They contain information about important terms of your cooperation such as quality standards, scope of services, prices, deadlines, compensation and possible legal implications of NDAs or intellectual property issues.  

What makes this agreement so important? The success of software development outsourcing depends on it. The IT contract must present the defined terms, specify the project scope - the more complex the project, the more numerous the agreements are of importance. 

Types of Outsourcing Contracts You Should Know 

Software development outsourcing agreements vary depending on the various conditions such as pricing, engagement types, or business objectives. We will walk you through the four most typical varieties below. 

Fixed-Price Contracts 

In this scenario, both the client and the vendor settle on a fixed fee for the services. The pricing structure can be typically determined by the vendor after analyzing the specified project parameters, necessary labor hours, as well as deliverables.  

When should you opt for it?  When the scope is clearly defined, you as the client bear the least cost risk. The service provider is responsible for any additional expenses if they exceed the specified amount. Since the costs are agreed upon before the project starts, the service provider earns a substantial margin even if the final costs are significantly lower than agreed. 

Why is it worth it? - This configuration is excellent for projects where the expected software functionalities have already been thoroughly determined or if you, as a future owner, do not plan to update your current expectations or change the already existing design. 

When is best to choose another type of contract? - You should select a different contract if you are open to changes in the scope of the project - these are time-consuming and will most likely result in a change in fixed costs. The same is true if the scope was set only by the same contractor who is to build the software (you have no control over possible inaccuracies or exaggerations of the estimated scope and costs), or if there is no pre-existing project scope at all. 

Target Cost Contract 

It is similar to the previous example in that you also set a fee - but this time it sits in the upper limit of the agreed costs. This type of agreement attempts to share the benefits and potential risks of the contracted development project between the two companies. Both parties to the contract agree on ‘target costs.’  

When should you opt for it? This is perfect for IT or software development projects where the scope is unclear, and no definitive price can be set. Since they are not fully responsible for any additional costs, this contract encourages vendors to take on challenging projects. 

Why is it worth it? - If you want to be sure that the project will be completed despite various problems, changes in scope, or uncertainties as the project progresses, this type of contract is for you. Once a project is underway, changes and risks inevitably arise for both the client and the vendor. An excellent solution for this is a target cost contract. 

When is best to choose another type of contract? - If you have detailed software documentation, there is no need to only target costs before choosing a fixed price. Another case is when you have an experienced and really empowered product owner - in this scenario you should see to a Time & Materials agreement, where daily project monitoring and change management are easier to navigate. 

Time & Materials Contract 

The time and material outsourcing model is one of the most well-known and established types of outsourcing. In this type of agreement, the supplier is paid for the labor and materials used by the outsourcing service provider. 

When should you opt for it? When it is not possible to define the full scope of the project and flexibility is one of the most important components of your business strategy, you should opt for a time and materials outsourcing contract. This type of contract is ideal for clients who have a clear, time-bound goal, such as developing a certain piece of software. With this model, customers typically bear the risk of cost increases while gaining flexibility. 

Why is it worth it? - The main advantage of this contract is that the service is billed according to the actual days and hours worked. Even if the project is already underway, it can still be modified to meet changing market demands. This model is closely related to the popular Agile software development approach - you define the requirements only for the upcoming sprint, while the number of sprints, their scope and complexity can be adjusted to the current business needs.  

When is best to choose another type of contract? When you have specific software documentation. This means that the project will most likely be done using the waterfall approach rather than the agile approach. You should also avoid this if you do not have a competent product owner, a specific budget is available, or you cannot imagine that only part of what you expect will be built.  

Extra module to consider - Dedicated Team for Your Project  

In this case, you hire a team for your development work under this outsourcing contract, and the contract clearly defines the goals in advance. In this case, a dedicated, focused team will work only on your web development projects. 

When should you opt for it? - Since the project is complex and requires frequent revisions and alterations, this option is most suitable if you intend to work with the development team for a longer period of time.  

Why is it worth it? - This strategy is ideal for companies that are looking for someone to focus exclusively on their development project. You can use such a team as an extension of your own team to attract reliable and reputable individuals to work with you on a regular basis. 

When is best to choose another type of contract? - When you have a software design or documentation that focuses on many phases of the project rather than who will perform the tasks at each phase. As the project progresses, the composition of the team can be more flexible. You may want to choose a different form of collaboration if the project does not have a tight deadline or does not require a large amount of effort in a particular area of IT services (therefore, full-time participation by a particular member of the development team is not required). 

Types of Outsourcing Contracts – Made Easy for You  

Your company's operations can benefit greatly from outsourcing your software development requirements if all is done properly. Make sure that the contract you are about to sign is fair for both you and the vendor you are working with by carefully reviewing all the terms. 

It's best to choose a contract type that's right for your business. Our knowledgeable experts can help you if you need assistance choosing the best option available. 

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Piotr Jać
Head of Legal Department

Lawyer, specializes in comprehensive services for companies from the IT and technology industries.