How much will software development cost your business?

Predicting the cost of developing custom software is one of the most difficult challenges in this industry. Even developers who have been building software for decades have trouble with estimating costs due to the many factors involved. These factors can also vary greatly between projects, even with the same development team. This post provides general guidelines on the cost of custom software development based on the most important factors influencing this issue.

Market Overview

Business software allows organizations to achieve their goals for data privacy and security by providing quick, easy access to unstructured data through analytics. These solutions can also significantly reduce the costs of inventory and raw materials, thus increasing profitability. They can increase operational efficiency by performing administrative tasks and updating departmental data in real-time, improving data transparency.

A study by Grand View Research estimated the global market for business software and services at $474.61 billion in 2022. It also predicts a compound annual growth rate (CAGR) for this market of 10.7 percent between 2023 and 2030. Factors driving this strong increase in demand include the rapid growth of business data and automation of business processes, especially in data-driven industries like healthcare, manufacturing, retail and transportation. The increased use of enterprise software and services to facilitate decisions that reduce costs, increase profits and improve market position.

The following chart illustrates this expected growth:

Fig. 1: U.S. Business Software Market Forecast

Initiatives for expanding business are driving the demand for business software, especially in industries like finance, sales & marketing, human resources and supply chains. The rapid rise of cloud platforms is also doing so, due to their ability to provide business agility while reducing operating costs. These advantages create a particular demand for cloud-based solutions among small and medium-sized businesses (SMEs). In addition, the rapid evolution of technologies like artificial intelligence (AI), machine learning (ML), blockchain and hybrid architecture are expected to benefit the software development market over the forecast period.

The COVID-19 pandemic of 2020 favorably impacted the commercial software and services market. International Data Group, Inc. (IDG) commissioned a report by NTT showing that the widespread adoption of the work-from-home model boosted the demand for value-added services, especially for security. Analysts expect this trend to continue to its benefits for remote workers. For example, Microsoft announced features focusing on these workers for Microsoft Teams and Microsoft Viva. Microsoft also partnered with Zebra Reflexis, Inc. to streamline shift scheduling.

Barriers to the expansion of the commercial software market include the need for rapid customer assistance and rising licensing fees, reflecting the cost of development. Maintenance and support costs are increasing, largely due to the greater need for personalization and integration with existing software. More frequent updates are another reason for increasing software maintenance costs.

Custom Software Development Costs

Since the majority of software development costs are the developers’ labor, the time needed to build the software has a direct impact on its costs. The following table from eLuminous Technologies shows a common breakdown of software complexity by development time:

Fig. 2: Software Complexity by Development Time in Hours

The figure above shows that simple applications typically require 600 to 1,000 working hours to develop, although their development time can be even less than this range. Software of medium size and complexity has development times between 1,000 and 1,800 hours, and enterprise-grade software requires more than 1,800 hours to develop. These times are the total billable hours for development and have no correlation with the actual time needed to complete a project.

The next step in calculating development costs is to determine the hourly rate for each person on the development team. Multiply each person’s hourly rate with the number of hours billable to that person to get the labor cost for that person. Add the labor cost of each team member to get the total labor cost for the project.

Among other variables, the size of the development company significantly affects the billable hourly rate of developers, since larger companies have higher overhead and other costs. Typical rates for a small company in the US with 10 to 100 members range from $80 to $135 per hour. A mid-sized company with 100 to 1,000 employees usually charges $100 to $220 per hour. These companies are more likely to have extensive tech stacks and a greater talent pool, allowing them to maintain a larger number of specialties.

The largest development companies charge hourly rates ranging from $300 to $800 per hour and typically handle high-profile projects for reasonably large clients. These companies usually have an extensive history of successfully delivering projects. The rates of these developers often depend on their level of expertise and tech stack required by the project.

In addition, a development team includes members with a variety of roles, each with their own hourly rate. The following chart shows these roles and the average rate range for a small development firm:

Fig. 3: Software Hourly Rates by Role

The chart above shows that a senior software engineer is the developer role with the highest average rate in the US, with a range of $130 to $190 per hour. Developers with expertise across the entire tech stack will tend to be at the upper end of this range. Geographic location is another important factor in determining rates, with higher rates occurring in large business hubs. For example, Clutch reports that the range for software engineers working for companies registered in California is from $150 to $200 per hour.

Rate Composition

While direct compensation comprises the majority of a developer’s billable rate, it also includes other expenses. The following list shows these components:

• Employee compensation
• Benefits
• Overhead
• Profit

Employee base compensation typically accounts for 65 to 73 percent of the total rate. Fixed benefits make up another 25 to 31 percent, which include legally required benefits like Medicare, social security and unemployment insurance. Health benefits include dental, disability and life insurance, with additional benefits including paid time off (PTO), retirement savings and training costs. Other fixed benefits include additional compensation, such as bonuses and overtime.

Overhead costs of the development company include the costs of its daily operations, such as rent and utilities. Many companies offer their employees additional perks like corporate events and meals. Office supplies are another form of overhead, including furniture and computer equipment. Overhead costs must also cover bench time and research projects. The company’s profit is the remaining portion of the developer’s costs.

Scalability

Custom software is a long-term investment compared to simply paying for a license fee or subscription. The need to accommodate a company’s evolving needs for years makes it crucial for developers to incorporate scalability and flexibility into the initial design, making it easier to add features and increase capabilities later on. Scalable software is able to accommodate changes in demand, whether it’s a sudden spike or drop-off. Flexible software can handle feature additions, updates and changes in integration, allowing organizations to respond quickly to changes to the market or technology.

Future-proofing a software solution requires strategic planning on the developer’s part, especially during early development. In particular, the developer must consider the technology stack, architectural design and programming language, ensuring the solution can adapt to evolving requirements in a sustainable manner.

Challenges and Risks

Custom software generally poses less risk than off-the-shelf (OTS) software, as developers can address client-specific issues like integration with existing systems. However, falling behind schedule and going over budget remain prominent risks, making it crucial to maintain open, honest communication with the developer. These measures include regular updates with transparent feedback loops, in addition to proactive engagement from stakeholders. Such a collaborative environment is far less vulnerable to the inevitable challenges of developing software. It’s also helpful to work with highly experienced developers, who are often effective communicators.

Cost Factors for Custom Software

The following seven factors greatly affect the cost of developing software:

1. Design
2. Location
3. Migration
4. Size
5. Complexity
6. Integration
7. Creativity

1. Design

It’s important to assign a reasonable budget based on the time needed to develop the design and the cost of the developers. Software is typically designed to fit within a given budget, so features that fail to align with available funds should be excluded from the design. A good development team should be able to take their client’s ideas and create a design around them, while also considering the target budget. They will often add or remove features to fit the budget after completing the initial design and cost estimate. The client may also modify the budget before authorizing the project, resulting in the addition or removal of additional features. This process often involves prioritizing features to be added after the initial design.

2. Developer Location

The wages of the developers comprise the great majority of software development costs, which are highly dependent upon the developers’ experience and geographic location. Wages differ greatly based on the country and even the city where the developers live. The highest wages for software developers are in the United States, where hourly rates can range from $80 to $250 per hour, depending on experience.

The following table shows the average annual salaries for developers in the top ten countries:

Fig. 4: Average Software Engineering Salaries by Country

The figures above show that it can be tempting to look outside the US for software developers, especially if you’re on a tight budget. For example, hourly wages range from $30 to $80 per hour in Eastern Europe. Wages are even lower in Asia, ranging from $20 to $60 per hour in countries like China, India and Vietnam. These countries have rapidly growing IT sectors, so they have many developers available for work. However, additional obstacles accompany the potential savings, including differences in language, culture and time zone that can cause miscommunications.

3. Migration

A software development project often involves moving data from the existing system to the new application. This data can’t be feasibly entered by hand in most cases, requiring developers to write customized scripts to migrate the data. In addition to moving the data, this process also includes cleaning, removing duplicate records and reformatting the data for the new application.

Stakeholders need to answer questions about how the new system will store data, which usually results in differences between the two systems. Once they’ve made these decisions, the migration process should be relatively straightforward. Developers will usually test the migration process multiple times to ensure it’s translating the data correctly, and the new system is using the data as expected.

Estimating the cost of the project therefore needs to reflect the time needed to agree on the translation rules, write the scripts, test them and make any necessary adjustments.

4. Size

The size of a project obviously affects the amount of work needed to complete it, but the best method of measuring that size is less clear. Historically, developers have measured an application’s size in terms of source code lines for the purpose of estimating cost. Today, however, the number of screens is often a more useful metric for measuring size. The following list shows some common definitions of program size:

• Small applications: 10–25 screens
• Mid-size applications: 25–40 screens
• Large applications: more than 40 screens

Within this context, a screen is a single display on the application’s interface. The screen count includes each unique screen that the user can generate by activating a widget, such as a button, menu or link. The information that screens show need not be unique for them to count as separate screens.

Assume, for example, that one screen allows the user to only view client information, while another screen also allows the user to edit that information. They would count as separate screens because they perform different functions and therefore require different code. The fact that the two screens display the same information is irrelevant for the purpose of counting screens.

5. Complexity

Software with complicated logic will require more time to code and test than simpler software, even when it has the same number of screens. Complicated software may perform heavy analysis, such as scoring or crunching numbers, especially when these algorithms have many permutations and conditions. Software with these intricacies may require advanced features to manage these algorithms, often including extensive customization. The development and maintenance of this software can increase exponentially as the software grows over time.

Complexity directly affects the amount of code the software requires. Smaller applications consist of only a few thousand lines of code. Software of medium complexity may need tens of thousands of lines of code, while enterprise-scale may consist of up to 100,000 lines of code.

6. Integration

Integrating new software with existing systems introduces an additional layer of complexity, especially when those systems are external to the organization with the new application. In these cases, the organization usually doesn’t have the authority to request changes to the existing systems, requiring the new system to accommodate them. The difficulty of the integration process can vary greatly, from almost effortless to extremely challenging.

Payment providers like Authorize.Net and PayPal are usually very easy to integrate into new software, as are credit check services like Equifax, Experian and TransUnion. However, lesser-known systems are usually more difficult to integrate, thus increasing the project cost.

7. Creativity

Creativity is often part of the design process, especially when it comes to selecting color palettes, fonts and images. Many screens also have custom animation and illustrations to make them stand out from similar applications. Just like with buying a house, options can range from nice-to-have to extravagant. These features aren’t closely related to performance, but they can improve user experience. The value of creative options in software must therefore be weighed against their cost when deciding whether to include them in the design.

Offshore vs. Onshore

The issue of using offshore or onshore developers profoundly affects the cost of custom software. It’s common to think that offshore development will have a lower cost in all cases, but the truth is more complicated. For the purposes of cost estimation, offshore developers are located outside the client’s home country, while onshore developers are located in the same country. For the US, the rates for experienced onshore developers can start at $130 an hour, while the rates for offshore developers often start at $30 an hour. Offshore development may sound like a good deal based on this difference, but it’s important to understand that you may also encounter additional fees and challenges.

Offshore Considerations

Offshore developers may live on the opposite side of the world from a client in the US, which can increase development costs through various means. Causes of cost increases include the following:

• Communication barriers
• Programming language preferences
• Lack of business knowledge
• Differences in expectations
• Employee turnover
• Time zone differences

Communication barriers. English may not be an offshore developer’s first language, which could cause the project to take more time. Software development requires clear lines of communication between clients and developers. This is especially true during the discovery phase, where developers outline the project’s requirements. A miscommunication during this step can result in delays due to missed features, requiring rework.  A delay that prevents the software from launching on schedule can be particularly expensive because the software isn’t providing value when expected.

Programming language preferences. Countries often have different preferences for programming languages, which can cause future problems when the developer chooses a language that isn’t common in the client’s country. In these cases, supporting the software may not be practical for an internal maintenance team, requiring an offshore team to support it.

Lack of business knowledge. Cultural differences can make it challenging for offshore developers to understand a client’s business. A client may need to solve problems that require thorough knowledge of a specific business that may not be common in the developer’s country.

Differences in expectations. Cultural differences can also include differences in expectations of quality. This could result in the need for additional communication to agree on quality standards.

Employee turnover. Offshore developers are often under intense pressure to complete projects within specified time frames, which can lead to a high burnout rate. As a result, offshore development is more likely to result in new people coming in during the middle of a project, requiring additional time for them to get up to speed.

Time zone differences. Offshore developers will rarely work according to the client’s normal business day. This difference typically requires some of the client’s own team members to be available outside their normal working hours to communicate with the offshore team as needed, increasing development costs.

Onshore Considerations

US developers remain the preferred option for US-based companies, despite the higher initial costs. The level of expertise is generally greater, and the similar time zones make it easier for team members to collaborate on projects. However, fully leveraging these advantages requires a client to work with the right vendor and properly plan the project before beginning the design phase. Onshore development is especially beneficial for projects requiring a great deal of hands-on guidance and fixed milestones.

In addition, the lack of language and cultural barriers allows team members to be onboarded and integrated into an existing team faster. Finally, workers can transition from a remote to an in-office work model more easily if they’re already based in the US. These advantages of onshore development are explained in greater detail as follows:

Tailored project management

A survey by PWC shows that Agile projects are 28 percent more likely to succeed than traditional waterfall projects. An Agile approach to software development is easier to manage with an onshore vendor due to the greater need for close communication and the ability to quickly change the course of the project

As compared to the waterfall model, Agile development emphasizes the following:

• People over processes and tools
• Working prototypes over excessive documentation
• Customer collaboration over rigid contracts
• Responding to change over following the plan

These major differences in emphasis derive from the Agile Manifesto, written in 2001. This document sets the tone for a successful software development project, primarily at the organizational level. These values affect an organization’s culture, which is the most significant distinction between Agile and waterfall methodologies. Without the necessary emphasis on these values, Agile projects will tend to suffer from the same delays in the decision-making process as traditional development.

Additional distinctions between these models include a dedicated product owner for Agile projects. This person is responsible for making all decisions on the inclusion of features, which should be based on the value they deliver in meeting established Key Project Indicators (KPIs). Furthermore, each Agile team should include a member with the authority and capability of affecting change.

 These teams must be completely dedicated to the development project, resulting in a high degree of focus and reduced multitasking. In addition, team members should be in the same geographic locations to maximize the efficiency of communication, including knowledge transfer and team building. Regardless of its purpose, teams perform better when the membership has a low turnover rate, as trust takes time to develop. Agile also has many other distinctions from waterfall development, including continuous improvement, iterative and incremental development, and short feedback loops. All of these practices are specifically designed to increase the project’s value by satisfying stakeholders.

The following charts illustrate the differences in waterfall and Agile projects throughout the development cycle with respect to visibility:

Fig. 5: Visibility for Waterfall Development

Fig. 6: Visibility for Agile Development

Agile reduces the project’s complexity by breaking the long single cycle of development into smaller cycles called iterations, which typically last for one to four weeks. Iterations result in the development and testing of user-ready segments of the final product. The primary difference in outcome between the two models is that Agile produces working software after each iteration, whereas waterfall development doesn’t do so until the end of the entire development cycle. Agile is thus able to improve the software throughout development by incorporating continuous feedback at multiple points in the development lifecycle.

Both delivery methods result in the completion of the same underlying tasks, and have the same dependencies and environmental sensitivities. However, an Agile team is able to mitigate risks earlier in development due to continuous improvement and greater visibility.

Note in fig. 5 that waterfall development only has high visibility at the beginning and end of the project. This feature shows why progress reports in this model often remain green until the end of the project, when stakeholders realize that the project hasn’t progressed as predicted. Agile mitigates this risk by maintaining high visibility during each iteration. Two additional strengths of Agile development shown in fig. 6 include its increased flexibility to realign the project and accelerated release of iterations.

An organization attempting to use Agile for the first time may introduce anarchy into the development process rather than structure. Agile is a non-prescriptive methodology, meaning that it can only be as good as its interpretation and enforcement. Many factors affect an organization’s ability to adopt Agile, including its culture, managerial systems, technical skills and tools. Leaders can expect to make changes in all of these areas when they first embrace Agile.

An Agile approach to software development also embeds characteristics like collaborative, self-organizing teams empowered to make key decisions affecting the project. It also promotes the use of automation to streamline workflows and continuous checks of code quality, which provides better visibility into the project.

Failing to embed these characteristics into the development process can create a range of problems when transitioning to Agile, such as inadequate change management, project organization and process governance. Ineffective control-tracking and risk mitigation mechanisms are another problem organizations may face when adopting Agile, as is the inappropriate use of Agile tools and techniques. Insufficient buy-in from stakeholders is also a common challenge during this process.

A successful Agile implementation promotes a more effective development environment in many ways. For example, it strongly emphasizes the prioritization of customer satisfaction by continuously delivering working software. Agile also supports continuous excellence in the design phase, resulting in a lower amount of rework. The increased frequency of reviews reduces the risk of delayed delivery, especially since Agile promotes the use of cross-functional teams with multiple areas of expertise and high visibility by stakeholders.

The collaborative nature of Agile development also helps teams analyze problems more effectively and adapt their behavior to changing environmental conditions more efficiently. In addition, Agile is particularly adept at dealing with new user requirements, due to its rapid, flexible response to change. Furthermore, Agile’s encouragement of clear expectations for each iteration allows team members to understand when the iteration is ready for delivery.

Process governance and delivery management are additional areas where project managers can expect improvement when using an Agile approach. Development teams should strive to strike the right balance between delivery speed and project risk, as greater development speed generally increases the risk of delivery failure. Agile employs a highly-focused approach to governance and management that provides a high degree of risk mitigation through various types of planning, such as release and iteration planning. Release planning consists of determining the next set of features across multiple iterations, while iteration planning is the process of developing the goals for each iteration based on user requirements.

Daily stand-ups are another staple of Agile development, which are 15-minute meetings held each day to brief team members on what each team member accomplished the day before, as well as what they plan to do the next day. Task dependencies and barriers to progress are also standard topics of discussion in daily stand-ups.

Face-to-face Communication

An onshore developer is more likely to be available during normal business hours, providing greater peace of mind. The ability to speak to a developer who can understand your needs can greatly impact a project by reducing its completion time and cost.

Faster Time-to-market

Better communication also means onshore developers are less likely to encounter problems during the project that could delay its release. These increased challenges often mean that an offshore company will need a year to finish a project that an onshore company could complete in no more than six months. This difference in development time has a direct effect on the total cost of the project.

Work Quality

The lack of barriers between developers and clients allows them to work more closely with each other, especially during the design phase of the project. This advantage helps ensure they complete the project successfully, resulting in software of higher quality.

Creative Collaboration

Many opportunities exist for vendors to work closely with clients on a software project. Collaboration can be particularly productive during the creative parts of this process, when team members can clearly understand each other’s ideas and provide useful feedback to set those ideas in motion.

Tax Laws

Offshore vendors are subject to tax laws that the client may not be familiar with. The process of learning a new set of tax laws can significantly increase the time needed to complete the project. An onshore vendor and client follow the same federal tax laws, even if they’re based in different states.

Support Plans

Onshore vendors typically offer plans to support their software after the completion of development. Offshore vendors may also offer such plans, but communication and time zone constraints may prevent them from implementing them in a way that’s helpful to the client.

Choosing a Vendor

You should base your decision to choose an onshore or offshore vendor on factors such as the project’s scope, its business goals and the degree of support you expect to need after deploying the software. It’s also important to consider how closely you’ll be able to manage an offshore team and account for the additional time that an offshore team is likely to require when developing the budget. Bear in mind that a custom software developer is likely to remain a partner throughout the software’s lifetime.

Summary

An organization that needs new software should first determine whether an existing solution or a custom solution will provide the best value. If it chooses to develop its own software, the next major decision is often choosing between onshore and offshore developers. This process requires careful consideration of many factors, including development time and costs. Other critical factors for selecting a software developer include differences in communication style, culture and time zones.