Alternatives to Service and Maintenance Arrangements
Enterprise software customers are becoming more aware of alternative ongoing service and maintenance agreements. TomorrowNow is one company that has brought these alternatives to the public. It is an experienced Bryan, Texas-based (US), third-party maintenance and support provider for former PeopleSoft and J.D. Edwards products (which were recently acquired by Oracle.) The company has been PeopleSoft-focused since its creation a few years ago by former PeopleSoft managers, and has received considerable attention in the last several months by offering lower-cost support contracts to PeopleSoft customers—a cost that is about half the price PeopleSoft would have charged—and it offers a 24x7, thirty minute guaranteed response value proposition.
Part two of the Is There a Panacea for Enterprise Software Pricing, Yet? series.
Today, owing to its early 2005 acquisition of TomorrowNow, SAP's is able to include maintenance and software support for PeopleSoft and J.D. Edwards solutions. The program was initially directed at companies that were already joint SAP and PeopleSoft/J.D. Edwards customers, but was recently extended to all PeopleSoft and J.D. Edwards customers. The offer should provide these customers with the comfort and flexibility to plan their maintenance and software migration strategies at their own pace. See While Oracle and PeopleSoft Are to Fuse, Competitors Ruse--Leaving Customers (Somewhat) Bemused for more information.
TomorrowNow contends that, because its service and maintenance costs are half of that of Oracle's current pricing policy, existing customers should be able to save enough money over the next few years to cover new software purchases when the time comes. By this time SAP's and Oracle's next-generation service-oriented products will be real, rather than vaporware. In the meantime, the company also grants enhancements for all required regulatory compliances, and contends that these products have even more functionality than these customers might need for a long time to come. If nothing else, that functionality is more susceptible to application erosion for not being used than becoming obsolete.
One should still expect firms to develop similar value propositions for existing Siebel Systems customers in the wake of its recent acquisition by Oracle, though Oracle's recently unveiled Lifetime Support Policy for its entire offering gives far greater choices to its customers and prospects. Given this, user companies will still eventually have to conduct a cost-benefit analysis in each case before deciding which way to go.
Consequently, some traditional perpetual license models might be wearing out their welcome on both the vendor and customer side. For one, they tend to be cyclical, since vendors first sell their present product versions into the market, and then sell subsequent upgrades. Logically, sales revenue should peak after each major upgrade, and then drop until the next one (on average, every 1218 months), creating a cyclical, erratic revenue stream, which, in turn, creates cyclical, volatile stock prices (for public vendors) and other business-performance related ramifications. On the other hand, many user companies are unhappy with the rigidity of the model, especially in terms of the tiresome and endless upgrade process, maintenance fees that continue to creep up, and non-standard pricing keeps them wondering exactly what kind of deal they have gotten—particularly if they are paying for functionality they will never use, or at least not any time soon.
This is Part Two of a three-part note. Part One presented a problem analysis. Part Three will present a possible customer bill of rights, analyze one company's approach, and make user recommendations.
The Microsoft Solution
To alleviate the upgrades conundrum, some prominent companies like Microsoft have been attempting a switch to a particular licensing model in which customers pay a yearly licensing fee to use the vendor's products and are guaranteed upgrades during the licensing period. To that end, in early 2005 Microsoft launched, Open Value, a software-license payment program designed for small and medium businesses (SMB) with as few as five desktops.
In part, it offers the same advantages of the earlier Software Assurance program, which includes access to the most current Microsoft software during the three-year term of the agreement and the ability to spread licensing payments annually. Software Assurance for Open Value now includes much more than just new version rights. It provides resources such as training, support, and deployment; and management tools that should allow SMBs to spend more time focused on their business and less time deploying and maintaining technology. Instead, the license management tools will help ease the administrative task of tracking licenses. These benefits might be essential for small businesses that lack dedicated on-site information technology (IT) staff.
Yet, while this model can stabilize Microsoft's revenue stream, it does little to break the dreaded upgrade cycle, since the protracted postponement of an upgrade can put its outside of a license period. One of the major complaints from customers about the software assurance program (which comes at a hefty 27 percent of the cost price of software per annum) has been Microsoft's delay in releasing Windows Vista (formerly code-named Longhorn). This delay has left customers without the upgrades they have effectively paid for.
The major benefit of this model to the customer is the free upgrades, but, since implementing upgrades incur other related costs, any upgrade must have enough added value to justify its implementation. The new features introduced in an upgrade may be of little or no value to some customers, causing them skip the free upgrade. Once again, the licensing model loses its value. For more related information, see The Old ERP Dilemma— Should We Install the New Release?.
Challenges of Licensing Contracts
Therefore, while almost every major application provider has attempted to create the perfect bundle of features to attack the mid-market and tap into the billions in potential revenue (see Looking for Software— The Expectations of Small to Mid-Sized Enterprise), the problem typically lies less with the product's features and functions, but more often with the vendors' licensing contracts, because the administration of traditional software licenses leaves customers feeling frustrated and disadvantaged.
And then, what about the possible mergers and acquisitions (M&A) that often occur in dynamic global markets. Most software licenses are non-transferable and the software vendor may grant permission to transfer the license for an additional fee, but the fee may not be determined until the customer makes a formal request. The software vendor's permission to transfer the license, with the associated unknown fee, obstructs selling their business. Nonetheless, software customers strongly feel that they deserve a license arrangement that allows them to negotiate knowing the costs for the transfer of the software. To illustrate this point, imagine applying this concept of ownership transfer fees to, for example, a car or sound system by a manufacturers. It would not bode well to the purchaser.
Last but not least, software vendors have also creatively invented a variety of pricing models that restrict who can use the software and for what purpose. Licenses are written incorporating rights for named users, concurrent users, power users, servers, and other "units", all in an attempt to balance the cost of the software with some measure of the value it provides. Software vendors have spent millions to insure compliance with these terms, including software that counts users and prevents extra users from using the system, and on-site inspections and license audits to determine additional charges.
Conversely, software customers, especially those that are cash strapped in the mid-market, do not have the time or inclination to count users, power users, concurrent users, or to spend additional money on software license compliance. These software customers want software they can use to help them be more competitive, not software that is going to cost them money every time they try to do something new, or worse, that will slow them down instead of making them more agile.
They do not want to pay a license fee for their customers or suppliers that uses the software to access information through a Web portal, nor a license fee for every employee that uses self-service through a corporate intranet. They do not want the president of the company to get the message "Too many users. Try again later." when attempting to view the company financials Monday morning, and who then has to ask some vice president to log off to make space. User enterprises ideally and naturally want the people that need the software to be able to get access to it whenever they have to—without any strings attached.
Negotiating Software Costs
Software customers recognize that traditional software licenses give the software vendor astonishing control over the relationship. The enterprise software industry has enjoyed decades of selling "killer apps" that customers eagerly bought on the vendor's terms, without asking too many questions. But with first generation enterprise resource planning (ERP) products implemented poorly throughout most of the market, prospective manufacturers and distributors enterprises now stand to reap significant productivity gains with more successful implementations of modern ERP and other enterprise applications. These users have meanwhile "wised up" to demand more "bang for their bucks".
As with many other situations in life, size also matters in the world of negotiating software costs. Fortune 1,000 (or so) companies can afford to hire consultants or specialist procurement teams to scope the market and ensure that the deals being struck represent good value for money. Large customers have recently been able to ask some vendors for discounts of 90 percent on the initial license fees. In this battle for control over the relationship, success is dependent on their negotiating skills.
Knowledge is power, and software vendors certainly know more about the details of software licensing than most small and mid-market customers. Even larger customers face significant hurdles in negotiating licensing terms, such as the rate for annual maintenance. In fact, vendors are inclined to forsake their license fees for the more long-term recurring maintenance revenue. Some analyst and consulting companies have even created departments that help clients navigate through these pricing labyrinths. Needless to say that these departments consist largely of contract attorneys rather than of seasoned enterprise applications analysts and functional domain experts. Smaller mid-market companies, however, typically lack the time or resources to be "good negotiators" and to bargain with software giants over the complex terms of traditional licenses.
There are many other factors beside the mere size and clout of the prospective customer that will persuade vendors to increase their discounts. These include an opportunity to beat a fierce competitor in a major deal or even better, to replace a competitor and execute a competitive "knock-out"; opportunities for follow-on cross- or up-sales; the prestige that the customer might bring if it agrees to become a flagship reference site; the size and longevity of a related services contract; or if the vendor's sales staff desperately need to close the sale at the end of the quarter. But it is not just the desire for a bargain or to best vendors that has forced information technology (IT) buyers to seek discounts. In recent years the IT function has had to be financially accountable in a way it never has before.
Namely, manufacturing has been severely impacted by the competition coming from China and other low cost markets causing drastic alteration of business process and cost infrastructure. This is forcing users to question whether they are getting value for their business when buying enterprise software. Knowing that the incremental cost of software production is simply the price of a compact disk (CD), buyers now know how to twist a vendor's arm. The enterprise applications market is experiencing a paradigm shift caused by a second and third generation of savvier business users. The industry is no longer new and most business customers have undergone significant shifts in business requirements, as well a significant recession that has affected their bottom line.
Further, the enterprise applications market has had little to no organic growth over the last few years, and has relied on peer acquisitions as the primary mechanism for new customer growth. To overcome the loss of new license revenue, most independent software vendors (ISV) have chosen to charge excessive fees for maintenance, upgrades, additional users, as well as equipment changes and transfers (see What Does Vendor Consolidation Mean to the End User?). Hosted software as a service (SaaS) approaches, as lead by Salesforce.com and other similar vendors, appear to be another option. They offer user companies a pay per user/per month or per site/per month or annual fee and the user does not have to worry about upgrades. Maintenance also seems fair. However, not everyone has a good economic rationale to opt for SaaS in the long run. See Trends in Delivery and Pricing Models for Enterprise Applications: Pricing Options. Additionally, this approach does not necessarily solve the costly licensing problems faced by user enterprises, because these solutions can still be very expensive for the basic functionality they provide, but at least, for the money they are spending, user enterprises receiving pricing clarity.
This concludes Part Two of a three-part note. Part One presented a problem analysis. Part Three will present a possible customer bill of rights, analyze one company's approach, and make user recommendations.