Software Development Cost Breakdown: A 2023 Analysis

Jeffery Thompson
Leading the Charge in Custom Software Solutions as Founder/CEO of BIT Studios
Software Development
15 min read
Published: Apr 7, 2023
Updated: Apr 7, 2023
Software Development Cost Breakdown: components of software development costs in 2023, with pie chart and budgeting tips for success

Outsourcing software development is a smart way to have the necessary software without breaking the bank. There are many costs associated with finishing a software project. For this reason, knowing the software development cost breakdown is crucial to stay within your budget.

In this guide, we’ll explore what goes into the cost of software development. Let’s break down the essentials of successful software development budgeting for better results and greater efficiency!

Why It’s Important to Estimate Software Development Cost

Understanding the software development cost breakdown is essential to ensure you stay on track with your spending. Knowing the different components of the software project budget can help you plan for unexpected expenses. It allows you to adjust your budget and stay within it if you need to change something. Staying on a budget can only be manageable if you understand the full scope of the costs involved.

Here are other benefits of knowing the software development cost breakdown:

Improved Accuracy of Estimates

Knowing what makes up the software development cost gives you greater insight into the likely cost of any project. Hence, you can be more accurate when making estimates.

Improved Risk Management

Knowing how the budget works makes it easier to identify potential risk areas. It allows for better decision-making and planning for contingencies.

More Efficient Use of Resources

Preparing for the cost of software development requires an understanding of available resources. It would help if you understood how to use these resources to maximize efficiency and minimize waste.

Increased Ability To Meet Deadlines

A clear idea of what is required will help teams stay on track and ensure that deadlines are always met or exceeded.

Greater Control Over Costs

With a comprehensive software development cost estimation in place, it is much easier to keep an eye on spending. It helps to ensure that budgets remain within limits at all times.

Better Communication Between Stakeholders

Understanding the software development cost allows for improved communication between different stakeholders. It will enable them to work together more effectively towards a common goal.

Enhanced Ability To Anticipate Flaws or Failure Points

A thorough understanding of the software development cost can help teams anticipate problems. It helps determine where unexpected issues might arise, giving them time to prepare accordingly.

Types of Outsourced Software Development Costs

When it comes to custom software development, there are various costs associated with the process, including:

Direct Costs

Direct costs are the expenses directly linked to software development. These expenses include software licenses, hardware, development tools, salaries, and other fees. The two types of direct costs are labor and material costs.

Labor Costs

Labor costs are the most common software development cost. They cover salaries for the software development team. They usually take the lion’s share of the total software development cost. Labor costs include the following:

  • Salaries and wages
  • Employee benefits
  • Training and development

Material Costs

Material costs are associated with hardware, software licenses, and software development tools. They could be other materials used to build and deploy software. Material costs may include:

  • Hardware and software
  • Office supplies and equipment
  • Travel and lodging

Indirect Costs

Indirect costs are expenses related to software development but not directly linked. These costs include marketing expenses and legal fees. They also have administrative overhead costs like utilities and rent. Indirect costs typically account for a small portion of software development costs but can still increase over time.

Overhead Costs

Overhead costs are expenses not directly tied to development. But they must be included in the software development cost estimate because they are necessities. These costs include the following:

  • Rent and utilities
  • Insurance and taxes
  • Legal and accounting fees

Opportunity Costs

Opportunity costs are the potential lost revenue associated with software development. These are the expenses incurred when a software project is delayed or canceled due to unforeseen circumstances. These costs can include the following:

  • Lost revenue from delays
  • Lost customers from poor quality
  • Lost market share from the competition

Outsourcing Costs

Outsourcing costs are the expenses you pay to your outsourced team. It may include the following:

  • Service provider fees
  • Communication and collaboration costs
  • Management and supervision costs

Factors That Affect Outsourced Software Development Costs

Outsourced software development cost increases or decreases based on some critical factors. Here are some of them:

Location and Time Zone of the Service Provider

When you hire a company for your software project, their location can influence how much their services will cost. Paying people in different countries or other time zones might cost more. You can reduce costs by choosing a service provider in the same time zone or country.

Complexity of Software

The complexity of the software you want to build affects the software development budget. A more complex project costs more than a simpler one.

Type of Service Provider (Onshore, Nearshore, Offshore)

The kind of service provider you choose for your software development project can significantly affect the cost. Onshore providers are typically more expensive than nearshore and offshore providers.

Level of Expertise and Experience of the Service Provider

The more experienced and skilled the service provider, the higher the cost of software development will likely be. It would be best to balance getting a quality product and staying within your budget.

Quality and Reliability of the Service Provider

Choosing a custom software development company with a good reputation is essential. Choose one with plenty of experience in custom software development and who has worked on similar projects as yours. Doing so will help ensure you get the best product at the best price.

Timing and Schedule of the Project

The length and timeline of the entire project can also affect software development costs. Longer projects typically cost more than shorter ones since more work is usually involved in more extended projects.

These are some factors that can affect software development costs. Knowing which ones to consider will help you decide what service provider to choose.

Methods for Calculating Outsourced Software Development Costs

There are three methods to estimate software development costs. Let’s look at each one in detail.

Time and Materials (T&M) Method

The cost of the T&M method is based on the actual time and materials used in the project. The service provider tracks the hours spent working on the software and any additional materials or services used.

Advantages of the T&M Method

  • Cost-effective

The time and materials model offers a viable cost-saving solution because you only need to pay for the work you use. This model helps ensure that you manage your budget effectively.

  • Flexible

It allows businesses to increase or reduce staff according to the software project’s needs. As a result, they have better control over their budget.

  • Agile

This model provides an agile approach. It allows companies to react quickly to changing needs and circumstances during the project.

  • Performance-based

Clients can easily monitor the performance of their vendors. The time and materials model tracks the hours they’ve worked and the completed tasks.

  • Scalable

The time and materials model allows a project to scale up or down based on changing requirements. It results in efficient resource utilization for optimal results.

Limitations of the T&M Method

  • Unpredictability

The time and materials model makes it challenging to predict project costs or timelines accurately. It may lead to potential cost overruns.

  • Difficulty in judging the quality of work

It can be difficult for clients to assess vendors’ work quality. They often have to rely on trust and communication alone.

  • Loss of authority

In this model. the client has limited control over how the outsourced team uses the resources. Without authority, it could lead to unexpected delays or cost overruns.

  • Lack of motivation

This model does not incentivize vendors to exceed expectations because there is no direct financial reward.

  • Increased risk

Companies using the time and materials model are exposed to a higher level of risk. The project may take longer and exceed the estimated costs.

  • Difficult to budget accurately

Software development cost estimation can be tricky since each task has a separate charge. It can lead to inaccurate estimates and budgeting.

  • Communication issues

When dealing with multiple vendors, it can be difficult for the client to ensure the quality of each vendor’s work. Ensuring all vendors work in sync and follow a timeline is also challenging.

In summary, the time and materials model of pricing is a viable option for some companies. But it can lead to increased risk, inaccurate budgeting, and communication issues. Companies should consider these factors before selecting this type of pricing model.

Fixed-price Method

The fixed price method establishes the project’s overall cost, regardless of how long it takes to complete. It ensures that the client and developer understand what they need to achieve and how much it will cost.

When you use fixed pricing, you agree on a price for the project before you start. It is good because it means both parties know how much money they will spend. It can be harmful if the project changes and we need to add more features because that would cost extra money.

Milestones and Deliverables

The fixed-price method is based on the creation of milestones and deliverables. A milestone is a goal that the service provider needs to reach within a specific timeframe. Deliverables are the products or services the developer will provide at each milestone.

Advantages of the Fixed Price Model

  • Cost Predictability

The fixed-price model eliminates surprise expenses. It ensures that the cost remains static throughout the development process.

  • Reduced Risk of Project Failure

Fixed pricing establishes a clear timeline and an agreed-upon fee structure. This model makes deadlines more likely to be met, reducing the risk of project failure.

  • Clarity in Scoping and Requirements

In the fixed price model, both the client and service provider know what the goals are for the software. So, there’s no guesswork involved regarding timelines or costs related to deliverables.

  • Faster Go-live Dates

The development team considers the software project timelines at the start of development. Teams can better plan for resources needed to complete the project faster.

  • Minimal Change Requests

Updates requested after starting development must be re-evaluated and approved before implementation. It ensures minimal change requests occur throughout the project lifecycle.

Limitations of the Fixed Price Model

  • Misaligned Incentives

The fixed price model is not ideal when it comes to risk-sharing. The service provider may cut corners and quality. This risk can happen because they receive a fixed sum regardless of the time and effort required to complete the project.

  • Little Oversight Over Quality Control

You cannot monitor the quality of the project during development. It increases the risk of poor performance and hidden costs post-go-live.

  • Poor Understanding of Complexity

The fixed price model does not factor in any complexities that may arise during development. It may lead to additional costs that can become difficult to manage for both parties.

  • Limited Scalability

If the scope of a project changes during development, it may require renegotiation. It can result in delays and additional costs.

  • Loss of Vendor Flexibility

Some software projects may require more agile approaches that aren’t possible with a fixed rate agreement. They lack the flexibility needed to accommodate rapid changes in technologies or trends.

  • Difficult to Measure Success

There are no metrics that measure success within a fixed-price model. It’s difficult to determine whether or not the project has been successful from an ROI perspective once complete.

Hybrid Method

The hybrid method is a mix of time and materials and fixed-price methods. It sets a base cost for the project. Still, it includes additional fees based on the time and materials used during development. This way, you get an accurate estimate of the total cost. However, you can still have flexibility regarding changes or unexpected issues.

Advantages of the Hybrid Model

  • Flexibility

The hybrid model gives you and the development company more flexibility regarding timeline and scope changes.

  • Improved Stakeholder Engagement

The custom software development company delivers projects in increments in the hybrid model. So, stakeholders have more opportunities to review progress throughout the process. It ensures everyone is on board with decisions and any changes impacting delivery.

  • Reduced Risk of Project Failure

There is a clearer understanding of what to expect and how timelines can adjust as needed. So, there’s less risk that you will miss deadlines or exceed budgets.

  • Enhanced Quality Assurance

Testing and measuring success occur periodically throughout development. It allows you to quickly identify gaps in quality or security so you can address them as soon as possible.

  • Faster Go-live Dates

Due to its flexibility, teams can better plan the resources needed to complete the project faster. As a result, there are shorter time-to-market cycles for new products or features.

Limitations of the Hybrid Model

  • Lower Cost Visibility

Since costs and timelines can fluctuate throughout development, it can take time to predict the total cost. The hybrid model makes it difficult to plan or compare estimates against other projects.

  • Limited Long-term Benefits

The hybrid model relies on short-term goals and needs. While it can help shorten time-to-market cycles, it cannot offer long-term advantages.

  • Unforeseen Complications

Any delays or problems which arise during development can significantly increase costs. There may be extra fees added when unexpected changes occur within an agreement.

Managing Outsourced Software Development Costs

Finding the right balance of quality, speed, and cost in software development is challenging for any organization. Outsourcing your software development projects can be an effective way to meet your goals. But, like any project, you need to manage its costs.

Here are three proven ways to manage costs when you outsource software development:

Cost Control and Budgeting

Cost control and budgeting are essential when managing software development costs. By setting a realistic budget for your project, you can ensure that you’re getting the most value for your money. Here are three steps to control costs successfully.

  • Identifying and Tracking Costs

Tracking every cost associated with a project is essential. Doing so ensures that you are staying within budget.

  • Setting and Monitoring Targets

Monitoring progress against your targets will help ensure that you stay on track.

  • Managing Variances and Risks

You should identify variances and risks early to prevent project cost overruns or delays.

Cost Optimization and Value Management

Cost optimization is a process that helps identify areas where you can make savings. This practice includes looking for improvement areas in the custom software development process. It may cut out unnecessary steps or trim down features not essential to the project’s goals. Here are three steps to optimize your expenses:

  • Prioritizing Features and Requirements

Prioritizing these things allows you to focus on the most critical tasks while cutting out those that are non-essential.

  • Eliminating Waste and Inefficiencies

Looking for areas of waste and inefficiencies can help identify opportunities to reduce costs. It also maintains quality.

  • Maximizing returns and Benefits

Software developers can maximize their returns and benefits from the project by focusing on the most critical tasks.

Cost Reduction and Outsourcing Strategy

Cost reduction and outsourcing can help reduce software development costs. When selecting an outsourced vendor, looking for the best value for money is essential. Choose a partner with a proven track record in delivering successful projects. Here are three tips on how to find the right service provider:

  • Select the Right Service Provider

Finding the right service provider is essential in reducing software development costs. Consider the vendor’s experience, expertise, and track record in delivering successful projects.

  • Negotiating and Managing Contracts

Negotiating a contract that meets the client’s and vendor’s needs is vital to minimizing costs.

  • Leveraging Existing Systems and Platforms

Using SaaS, open source, and cloud computing reduces the costs of software development projects.

Outsourcing software development saves time and money. However, there are still risks involved. To ensure success, you should do your due diligence before committing to an outsourced project.


Managing outsourced custom software development costs is important because it helps you get the most out of your money. You need to set a budget, track all expenses, and look for areas where you can save money. Looking for a project manager with the best value and experience in delivering successful projects would be best. Doing these things increases your chances of success.

It’s crucial to estimate software development costs to create a successful product. This guide should help you better understand the cost of software development. As a result, you can make informed decisions about your project.

If you’re looking for help managing your custom software development services cost, BIT Studios is here to help. We specialize in helping our clients maximize the cost-effectiveness of their projects. Contact us today and see how we can help you minimize costs on your next software development project.

Originally published April 7, 2023, updated April 7, 2023

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