Written by 
Danil Vilkhovskiy

Cost factors of outsourced software development projects: part II

Published on 
July 31, 2020

Definitely, when walking through long rows of companies that provide software development outsourcing services, you have already noticed that one vendor charges $20 per hour while another $50 or even $150. Why their rates differ? Does this mean that those with $150 ensure better quality than those of just $20? Or, does this mean that some of them just have bigger appetites?

Now, we have come to the labor rates, factors that affect them, and their costing to dig deeper to cost factors of outsourced software development projects. Well, going forward, we can say that rates a vendor charges for his services don’t go directly and in full to developers’ pockets. In other words, these are external rates that include many components. So, here we distinguish project cost factors related directly to the project execution as well as factors associated with running a company and its pricing strategy.

Factors associated with project execution

These factors are associated with the project team and include developers’ salary and project management fees.

The developer’s salary is the accrued salary, the money he earns for his efforts, skills, and experience. After all, an outsourced developer, who works on your project, is an employee for your vendor.

Typically, in software development, salary either goes in the form of or can be decompounded to the hourly rate. There are two main sub-factors that affect or determine the developer’s hourly rates:

  • Location
  • Experience

First, salaries differ from country to country and from city to city within the country. For example, a developer may earn just $5 in a small Indian town but $100 in the capital of the US. Second, juniors are paid less than middles and seniors. So, if your vendor engaged on your project mostly junior developers, you will enjoy with lower bid though may suffer with lower code quality or longer delivery.

Project management fees are money a vendor pays to a project manager, a person who supervises a project. A project manager may run two or more projects simultaneously. So, only part of his salary is included in your exact project. And again, location affects the rate in the same manner.

Factors associated with running a company

These factors stand for company expenses associated with organizational and managerial aspects of running a business in whole. So, the final costing includes the following items that can be named as overheads:

  • Salaries of accountants, managers, etc.
  • Social Security expenditures (pension schemes and contributions)
  • Medical and life insurance
  • Office equipment, hardware, and software depreciation (computers and other devices, and technology licenses, tables and chairs)
  • Office rent and utility bills (rent value, electricity and water bills, etc)
  • Personnel training and recreation (mastering technologies, sport and team-building activities, etc)
  • Marketing and other expenditures (advertisement, search engine optimization, etc)

In general, the bigger a company is, the bigger its overheads associated with infrastructure, staff hierarchy, marketing, and corporate culture policy are. And, once and again, location can be regarded as sub-factor here with the same relation and outcomes as well as taking into account differences in the government policy regarding Social Security.

Pricing strategy

Even if you manage to find two companies that share the same approach to costing and use the same numbers, their bids may still differ. Moreover, even within the same company bids may vary from time to time. This is because the last factor is in the game. Yes, we speak about the pricing strategy with its main sub-factors:

  • Standard company margin
  • Current workload

Company margin depends on the vendor’s appetites, market recognition of the brand, and their experience on the market. For example, newcomers often use a penetration pricing strategy. To clarify, they are ready to take over their first software development projects with a miserable margin or even with no margin at all. In contrast, there are branded companies that have already established themselves on the software development market. Such companies have both name and goodwill, so they can charge a good margin for their software development outsourcing services.

Clever minds say little money is better than no money at all. So, if an IT company experiences a long-term gap in project orders in the given moment, it can apply a lower margin to win the contract and cover this gap. By the way, the current workload may affect not only the size of a vendor’s margin but partly overheads he includes in the project prime cost as well.

So, when outsourcing your software development to an IT company, a project manager and software development team’s salaries are what lie on the surface as factors that determine vendor’s rates. However, there are plenty of other expenses an IT company has to incur (and, thus, include in its quote) as well as other financial aspects to consider. They may be invisible to you, but still, they are here either by law, circumstances, or company’s own choice.

Of course, you can’t manage these factors as they are not on your side. However, you should understand them clearly. Understand and be aware of why the particular vendor bid may be low or high and what risks, pitfalls, or benefits it may provide for the project and your budget.