6 Steps to Accurately Estimate Software Development Costs

20 min read
6 Steps to Accurately Estimate Software Development Costs

Are you starting a software development project and looking for ways to accurately estimate the cost? The software development cost estimation process can be daunting, especially when you consider that 45% of software projects are over budget while delivering 56% less value. You may be wondering how to make sure that you don't fall into that same trap.

This article will provide useful insights into software development cost estimation, including the 3 main methods of cost estimation, the key factors that can affect software development costs, and the 6 steps to accurately estimate your own development costs.

By understanding the cost estimation process, you can set your project up for success and minimize the risk of your project going over budget.

Why is accurate software development cost estimation important?

Software development cost estimation is notoriously difficult. Budget overruns are the norm more than the exception when it comes to software development projects. So why even bother trying to estimate the cost of software development at all? While no estimate will ever be 100% accurate, working towards an accurate-as-possible software cost estimation for your software project can help you:

  • Manage stakeholder and client expectations by providing a realistic indication of the cost of the software project.
  • Highlight areas of the budget that are driving costs up. From there you can look for ways to reduce costs such as finding an alternative technology or utilizing a different development team hiring strategy.
  • Identify risks and opportunities early on in the software development process, allowing for better planning and decision-making.
  • Ensure they have enough resources set aside for the software project at hand before kicking off work.
Depending on your priorities, you may want to set aside less or more time and resources to develop a software cost estimation. Sometimes a rough estimate is sufficient. Other times, it’s worthwhile to build a more accurate estimate by pulling together more detailed data points. It’s up to you to decide what’s important for your software cost estimation!

With that in mind, let’s take a look at the main methods to estimate software development cost, so you can find the one that suits your software project the best.

What are the main methods of cost estimation?

There are three main methods of software development cost estimation: parametric cost estimation, analogous cost estimation, and bottom-up cost estimation.

Each of these methods has its advantages and disadvantages and can be used in different situations to generate an accurate software cost estimation. By understanding the different methods of cost estimation, software project managers can make informed decisions about their project budget and timeline before software developers even begin their work.

Parametric cost estimation

Parametric cost estimation is a technique that uses a set of parameters or factors, such as the size of the project, the complexity of the project, the number of software developers, and the estimated duration of the project to generate development cost estimates for the project.

This type of software cost estimation is particularly useful when getting cost estimates quickly and is more important than having an accurate estimate, as its accuracy is heavily dependent on the scope of work and inputs being well defined - which may not be available at an early project stage.

However, if you do have a sophisticated estimation model available and have a very precise project scope defined, you’ll be more likely to get an accurate software development cost estimation.

Pros

  • Can be used to compare different approaches to the same project
  • Can provide more precise software development cost estimates than analogous cost estimation

Cons

  • For complex projects, it may be too simplistic and fail to take the full scope of the project into account
  • Unless you have a very precise scope of work defined, your estimated cost will be inaccurate

Analogous cost estimation

Analogous cost estimation is a technique that relies on historical data from similar projects to provide an estimate of a future project's cost. The historical data is used to find a software project similar to the one at hand and the cost associated with that project is used as a reference point. From there, adjustments are made to the reference point cost to reflect the differences between the current project and the historical project.

Pros

  • If you have access to data from a past project that is similar, this method is generally easier to perform than other approaches to software cost estimation
  • Often faster than other approaches and can be done without the need for detailed project plans

Cons

  • Estimation will be inaccurate unless you have a very similar past project you can use as a reference
  • Based on past data, which may not be representative of the actual project being estimated
  • May require additional work from the project manager or development team to gather data from past projects if it isn’t readily available
  • Accuracy of an analogous development cost estimation may be affected by changes in the market or technology over the course of the project

Bottom-up cost estimation

Bottom-up cost estimation is a technique used to estimate the cost and is based on the analysis of activities and tasks that need to be completed for the project. This type of software development cost analysis can be used for projects that are complex, requiring a high degree of accuracy.

The bottom-up estimation process begins by breaking down the project into smaller tasks and activities. For each task, the resources required and associated costs are estimated. These estimates are then aggregated to calculate the total development cost of the project. It is important to note that the more individual items you have broken your project into, the higher your estimate will be, as you will add some amount of cost “buffers” to each individual item. The more buffers added, the higher the estimate.

Overall, this cost estimation method is flexible, allowing a development team to scale up or down the work required based on how detailed they need their estimate to be. If a high level estimate is sufficient, you could break your project into a few large buckets of tasks. Or, if a more accurate or detailed estimate is required, you could break things down into subtasks.

Pros

  • Provides a more accurate development cost estimation compared to other approaches as it considers all tasks and activities in detail
  • Flexible method that allows the development team to decide how accurate or detailed of an estimate they require
  • Can provide high accuracy, which can help the project manager with early project decision making

Cons

  • Depending on the level of detail you’re looking for, this method can be time consuming and require a significant amount of resources
  • The estimate can vary depending on how pessimistic or optimistic the estimator wants to be, as buffers added for each item can drastically affect the total

6 steps to accurately estimate software development costs

Accurately estimating the software development cost is essential to the success of any project. Without a sound financial plan, it is easy to overspend and cause significant delays to your project. And, as we have seen, there are a few main methods for estimating the cost of software development. Depending on your project, you may find that one method is more suitable than another.

The 6 step process below blends techniques from parametric and bottom-up estimation techniques to provide teams an accurate way to put together a software development cost breakdown for any project.

Create a project brief and high-level modules map

When it comes to estimating the cost of developing software, it is important to begin with a high-level understanding of the project at hand. If you do not already have one, write up a project brief that describes the purpose of the software product, its audience, and its basic functionality.

From there, describe the modules involved in the project as well as their dependencies. A high-level map of the modules and their features will help you to understand the scope of the project and give you a good basic understanding on which you can build a more detailed software development cost estimate.

As you put together a module map, make sure to take into account:

  • Databases
  • Algorithms
  • User roles
  • User interface
  • Infrastructure
  • Feature-specific modules
  • 3rd party integrations

Next, consider the different dependencies between these modules, such as how each module relies on other modules or how the modules need to be tied into other systems.

Read More: Product Brief: Template & Writing Process Steps [with Examples]

Research and select technologies

Once you have created a high-level map of the modules and their dependencies, the next step is to research the technologies that are most suitable for your project.

If you have one or more technologies that you know you’d like to use (or that are simply required), it’s important to work with your software development team to conduct additional validation work at this stage to ensure that they are actually suited for your project.

There may also be other technologies that are more flexible. For example, you may be able to utilize “building blocks” such as open-source or commercial components or services to speed up your software development project and keep costs down. This is a good time to research these and select the most appropriate and cost effective options.

When researching technologies, consider the following:

  • What technologies are required for your project? Have you validated that there aren’t any better alternatives?
  • What open-source or commercial components are a good fit for your project?
  • What are the one-time costs for each of the technologies you are considering?
  • What are the ongoing subscription, maintenance, or software costs for each of the technologies you are considering?
  • What engineering or development costs would be required to customize the technologies you are considering?
  • How quickly will you be able to build your software solution with the technologies you’re considering?
  • How stable are the technologies that you are considering?
  • Will finding engineers to work with each technology be an issue?
  • Will the cost of hiring engineers be affected by each technology you’re considering?
  • What are the benefits of each technology?
  • What are the limitations of each technology?
PRO TIP: As you conduct your technology research, think through how each of your technologies will work together and what the tradeoffs will be for each. There may be certain limitations that you need to take into account, such as the cost of hiring developers with the right skillset or the difficulty of integrating existing software.

Draft software requirements specification (SRS) document

Before you can accurately estimate software costs, you need to create a Software Requirements Specification (SRS). This document should outline at a high level:

  • Product summary and scope
  • Intended audience
  • Assumptions and dependencies
  • Functional requirements (what the system is supposed to do)
  • Non-functional requirements (how the system should perform)
  • Acceptance criteria

By creating an SRS, you can ensure that all members of the project team and all other stakeholders have a clear understanding of the project requirements.

The SRS document is also a valuable tool for prospective vendors, as it will allow them to create more detailed estimates. By providing a complete and detailed SRS, vendors can identify the scope of the project and the potential costs involved.

Read More: 7 Key Elements of Effective Software Requirements Specification

Create low-fidelity UI wireframes

Creating low-fidelity UI wireframes is a great way to improve the accuracy of your cost estimates with only a moderate time investment. By sketching out your desired interface, your software development outsourcing company (or internal team) can get a better idea of what you intend to build, and therefore, help you build a more accurate development budget.

While wireframes can be a helpful tool to improve the accuracy of your cost estimate, there is a risk that the software vendor will treat the wireframes as though they are completely “locked in” and not able to be modified at all. It’s very important to clarify with your development team that your wireframes are a very early version of your product and can be modified.

PRO TIP: Wireframes can also be used as an early identification tool for areas of your software that will be costly or difficult to implement. Take the time to ask your development team for input during this stage and make any necessary changes to simplify your design.

Design high fidelity UI prototype

If you’d like to improve the accuracy of your estimate, we recommend you build on your low-fidelity wireframes and create a high-fidelity UI prototype. You can also think about this as another phase in your estimation process - a means to get a new, more accurate version of your project estimate.

Creating high fidelity UI prototypes can provide a more accurate representation of the user experience, as well as the technical complexity of the project. This can help stakeholders get a better understanding of the scope of the project, and developers can gain insights into the design and development process.

Additionally, having a high fidelity prototype can help to identify technical issues and UI design flaws that may have gone unnoticed during the early stages of design. This in turn can help to reduce project costs and ensure the project is delivered on time.

PRO TIP: Using UI design templates such as Tailwind UI can also be beneficial, as they are visually stunning, easy to customize and built with React and Next.js, making them relatively easy to implement.

Create a work breakdown structure (WBS)

Another way to improve the accuracy of your estimate is to put together a work breakdown structure (WBS). Essentially, a WBS lists all of the tasks required to complete the project along with an estimate of the cost of each task.

The level of detail of your WBS is up to you. Teams can create anything from a high-level WBS (like the one shown below) to a low-level WBS that breaks tasks down into a detailed list of sub-tasks. When in doubt, aim for something in the middle that will provide you a reasonable level of accuracy without risking overestimation that can sometimes occur if you try to make it too detailed.

A work breakdown structure should:

  • Be put together either by or in tandem with your software development company. The people actually doing the work must be involved or it will not be accurate.
  • Help your project manager or development team to build a project timeline.
  • Provide a way for teams to monitor progress and keep an eye on tasks that may be at risk for running over budget.
PRO TIP: A WBS can be an effective communication tool for stakeholders, ensuring that everyone is on the same page when it comes to understanding the project’s scope and cost. This can help reduce misunderstandings, which in turn can help reduce risk and improve the accuracy of the project’s estimates.

Tips to prevent budget overruns

Software development projects can be complex and costly, so it’s no wonder that many companies are looking for ways to not only estimate their project budget accurately but also to prevent budget overruns throughout the project. To help prevent such overruns, we recommend you:

  • Align on project scope early: The fastest way to go over budget is to change the scope of your project. As much as possible, get all stakeholders and management to align on the project’s scope before development begins.
  • Consult with an experienced vendor: A software development company will be able to use their years of experience in the industry to help you hone in on a more accurate project estimate.
  • Plan for the unexpected: Include contingencies in the budget for any unexpected costs or delays.
  • Define project milestones: Break the project into smaller deliverables and milestones and set targets for each of these.
  • Monitor progress and costs: Regularly review the progress of the project and the associated costs, and as project parameters change, update your estimate.
  • Use proven development strategies: Adopt proven development strategies such as agile, scrum, and DevOps to increase efficiency and reduce costs.

Software development cost factors

As you build your own software development project estimate, you’ll find that there are many factors that can drastically affect the overall cost. Of course, the complexity of the project will be a driver of cost, but other factors can be at play as well. Let’s take a look at the key factors that can affect the cost of your software development project:

Research and planning

Regardless of the complexity of your software product, you will need to do some level of research to help you define exactly what it is you want to build and how you want to build it. While every software development project will require some level of research and planning, the scope of work can vary significantly.

PRO TIP: The more in-depth and comprehensive the research and planning phase is, the more expensive it will be.

Technology choices

Technology choices can certainly affect your software development cost. When considering various technologies, developers must take into account the long-term costs associated with maintaining the technology, as well as the cost of training staff to use the technology.

Choosing an open-source technology can be an effective way to reduce upfront costs, but the cost of maintenance must be taken into consideration as well. Similarly, choosing an off-the-shelf technology can reduce development time, but the license costs should be taken into account.

PRO TIP: Ultimately, technology choices should be made based on the long-term costs associated with the software project, as well as the specific needs of the project.

Complexity of the project

It may seem obvious, but the cost of developing a software product is closely related to its complexity. Complex software requires more time and resources to develop, as it involves more intricate coding, more complicated testing, more robust security, and more complex user interface design. This can result in a significantly longer development cycle and higher costs.

PRO TIP: The complexity of your project will be affected by both functional and non-functional requirements. Nail both sets of requirements down and you’ll have a very good sense for the complexity of your project.

UI/UX requirements

UI/UX requirements can have a significant impact on the software development cost. The amount of work and resources that go into the design - both the user interface (UI) and user experience (UX) - can be significant. You should ensure you are properly scoping this out if you want to estimate project cost accurately.

PRO TIP: The scope of UI/UX work can vary significantly, and may include things such as: user research, user persona development, user journey maps and stories creation, building wireframes and clickable prototypes.

Hiring model

Consider who will be supporting the development of your software product. Will you be working with an in-house team, freelance developers you hire and manage, or perhaps a full-service dedicated development team hired through an outsourcing company? The hiring model you choose will affect the software costing estimation.

PRO TIP: Especially for enterprise level projects or complex, custom software development projects, working with a full-service software development company is a good option, as it allows you to tap into a larger pool of developers, which can often result in cost savings.

Development team location

If you’re outsourcing your development project, you should consider the location of the software development company or freelancers you hire. The location of your developers can dramatically impact the rates you pay. Generally, we can divide software developer locations into four categories:

  • Asia/India ($25-40/hr): Tends to be the cheapest option; however, you may find the cultural differences, time zones, and development quality may not meet your needs.
  • Eastern Europe ($35-60/hr): Has become a popular region for development due to its relatively low labor costs and access to a large pool of highly-skilled developers.
  • Western Europe ($60-80/hr): Generally more expensive than Eastern Europe due to higher labor costs; however it may be the right option for some.
  • US ($80-100+/hr): One of the most expensive places in the world for software development; however, teams would have access to a large pool of highly-skilled software developers.

Considering outsourcing software development to Eastern Europe? Check out our article 6 Reasons Tech Companies are Outsourcing to Eastern Europe

Support and maintenance

Support and maintenance can significantly impact the cost of software development. Without proper monitoring, on-call support, and technical improvements, the software developed can quickly become outdated and expensive to maintain.

When comparing quotes from vendors, don’t forget to consider costs that may be necessary post-launch, including performance monitoring, on-call support, and long-term technical improvements.

Average cost of software development

The cost of software development can vary widely. Factors such as the scope of the features, complexity of the UI design, platforms selected, technologies required, and the integrations required can all impact the custom software development cost.

However, in general, we can break down software development projects into three main categories. You can get a ballpark for you own project by viewing the estimate spreadsheets for each:

Simple software

  • Limited, core feature set
  • Simple user interface
  • No third party integrations
  • Limited data processing
  • Likely optimized for a single platform

Time frame: 1-2 months

Cost range: $5k - $15k USD

Medium complexity software

  • More robust feature set
  • More complex or custom UI/UX
  • May require third party integrations
  • May support advanced data processing or analytics
  • May be optimized for multiple platforms

Time frame: 2-6 months

Cost range: $15k - $45k

High complexity software

  • Multiple complex features and components
  • Complex and custom UI/UX
  • Likely requires third party integrations
  • Likely supports advanced data processing and analytics
  • Likely optimized for multiple platforms
  • May support enterprise-level requirements

Time frame: 6+ months

Cost range: $50k+

Software development cost estimation template (Google Doc)

Ready to begin your own estimation work? Get a copy of the software development cost estimation template here!

Conclusion

Software development cost estimation is a difficult process, but it is essential to the success of any project. By following the 6 step cost estimate process, project managers can evaluate the key project factors, develop a comprehensive plan, and ultimately put together a thorough software cost estimate for their next project.