Research Note—On Vendor Preferences for Contract Types in Offshore Software Projects: The Case of Fixed Price vs. Time and Materials Contracts

Abstract

Prior research has indicated that, on average, offshore vendors have higher profits associated with time and materials (T&M) contracts than fixed price (FP) contracts. This research raises two questions. First, Is the relative importance of various profit drivers different across two contractual regimes? Second, Does it follow that vendors unconditionally prefer T&M contracts for all projects? We address these questions by using data on 93 offshore projects completed by a leading Indian vendor. We use an endogenous switching regression framework and the program evaluation methodology to show that profit equations are distinctly different for the two contractual regimes. Using these two profit equations, we also identify contingencies under which the vendor prefers an FP contract to a T&M contract. We hypothesize that the vendor's ability leverage information asymmetry about capabilities and experiences translates into the vendor preferring FP contract to secure larger information rents. Our results support this hypothesis and suggest that the vendor would prefer the FP contract for larger and longer projects with larger teams. However, vendors would prefer a T&M contract when the risk of employee attrition from the project team is high. In addition, we discuss managerial implications of these results in the paper.