Time & materials vs fixed fee: how they work and when to use each
The contract model decides who pays when the estimate is wrong. Under time and materials (T&M) the client pays for the effort actually spent. Under a fixed fee the supplier promises a price and absorbs any overrun. Below, one real-world style project is priced both ways so you can see the difference in dollars, not theory.
What is time and materials?
The client pays an agreed hourly or daily rate for each person, plus materials and expenses at cost (sometimes with a handling mark-up). Invoices are usually monthly, backed by approved timesheets. Scope can change without renegotiating the contract — the client simply buys more or fewer days. Many T&M contracts add a not-to-exceed cap so the client keeps some budget control.
What is a fixed fee?
The supplier agrees to deliver a defined scope for one price, typically paid against milestones (for example 20% on signing, 40% on build acceptance, 40% on go-live). If the work takes longer than estimated, the supplier eats the cost. Anything outside the written scope needs a change order with its own price.
Real-time example: a patient booking portal
A regional clinic group wants an online appointment booking portal connected to its scheduling system, delivered in about 13 weeks. A delivery consultancy prices it both ways. Rates: project manager $1,100/day, business analyst $900/day, developer $1,000/day (12 extra days on a new integration cost $1,400/day because a specialist is needed), QA $800/day.
Option A — time and materials
| Phase | Effort | Billed |
|---|---|---|
| Discovery (weeks 1–3) | PM 12 days, BA 15 days | $26,700 |
| Build (weeks 4–10) | PM 25 days, 2 developers 70 days | $97,500 |
| Extra integration requested (week 7) | Developers 12 days | $16,800 |
| Testing & go-live (weeks 11–13) | PM 10 days, QA 15 days, devs 10 days | $33,000 |
Total billed: $174,000. In week 7 the clinic asked for a pharmacy integration. Under T&M that was simply 12 more developer days — no renegotiation, but the client's bill rose by $16,800. The consultancy's margin stayed at its normal rate on every day worked.
Option B — fixed fee
| Build-up | Amount |
|---|---|
| Estimated effort at rate card (157 days) | $157,200 |
| Risk contingency (15%) | $23,600 |
| Risk premium / extra margin | $36,200 |
| Fixed price quoted | $217,000 |
The consultancy quoted $217,000, excluding the pharmacy integration. When the clinic asked for it in week 7, the PM raised a change order for $22,000. Now two outcomes are possible:
- Estimate holds
Effort at rate card is $174,000 (including the change). Revenue $239,000 (fee + change order). Extra margin ≈ $65,000. The unused contingency becomes profit.
- Testing overruns by 40 days
Effort rises to about $210,000. Revenue is still $239,000. Extra margin falls to ≈ $29,000. The client pays nothing extra — the supplier absorbed it.
What the example shows: the client paid $29,000–$65,000 more under fixed fee for budget certainty. That premium is the price of transferring risk. If the scope was genuinely clear, it's worth it; if the scope was vague, T&M was the cheaper, more honest model.
Figures are illustrative, built from typical US consulting rates, to show the mechanics.
Side-by-side difference
| Time & materials | Fixed fee | |
|---|---|---|
| How you're paid | Hours or days worked × agreed rate, plus expenses | One agreed price for a defined deliverable |
| Who carries effort risk | Client — overruns cost them more | Supplier — overruns come out of your margin |
| Scope clarity needed | Low to medium; scope can evolve | High; scope, assumptions and acceptance must be written |
| Change handling | Absorbed naturally — just more hours | Formal change orders with price and schedule impact |
| Client budget certainty | Low unless capped (not-to-exceed) | High for the agreed scope |
| Supplier margin potential | Stable, capped by the rate | Higher if you estimate well, negative if you don't |
| Reporting the client expects | Timesheets, burn rate, forecast to complete | Milestone progress and acceptance sign-offs |
| Typical use | Discovery, agile delivery, interim PM, unclear scope | Audits, migrations with known scope, templated builds |
What changes for the project manager
Running a T&M project
- Report burn rate weekly against the cap or budget.
- Forecast estimate-to-complete so the client is never surprised.
- Get timesheets approved on time — late approval delays cash.
- Warn at 75% of any not-to-exceed cap.
- Show value delivered, not just hours logged.
Running a fixed-fee project
- Baseline scope, assumptions and exclusions in the SOW.
- Define acceptance criteria per milestone.
- Log every request; price changes before doing them.
- Track internal cost with earned value to spot overrun early.
- Protect contingency — don't spend it on gold-plating.
How to choose
- Choose T&M when requirements will be discovered along the way, the work is agile, or you're providing interim capacity.
- Choose fixed fee when the deliverable is well defined, you've done it before and your estimate is backed by history.
- Choose a hybrid — T&M discovery, then fixed-fee delivery — when the client wants certainty but the scope isn't ready yet.
Frequently asked questions
- Is time and materials or fixed fee better for the client?
- Fixed fee gives budget certainty when the scope is well understood. Time and materials is usually cheaper overall when scope is uncertain, because the client isn't paying the supplier's risk premium for unknowns.
- What is a T&M contract with a cap?
- A 'not-to-exceed' T&M contract bills actual hours but sets a ceiling. The supplier must notify the client before the cap is reached. It combines T&M flexibility with some budget control.
- How do you protect margin on a fixed-fee project?
- Write explicit assumptions and exclusions, define acceptance criteria per deliverable, tie payments to milestones, add contingency to the estimate, and run a strict change-order process from day one.
- Can a project mix both models?
- Yes. A common hybrid is a T&M discovery phase that produces a clear scope, followed by a fixed-fee build priced from that scope. It lowers risk for both sides.