Vendors dream up ways to extract more revenue

A rapidly maturing market for client/server software is driving fundamental changes in the way vendors price, support and upgrade their products.

For software vendors, the goal is to ensure a predictable, long-term revenue stream from existing customers via subscriptions, services and add-on fees to make up for sluggish revenue growth from new licenses.

So users need to be extra vigilant when they negotiate client/server software contracts in the next few years.

Pricing changes, combined with a growing user dependency on distributed software, could lock companies into the same kind of costly situations that mainframe users have complained about for years, users and analysts said.

"Vendors are focusing on future revenue streams," said David Floyer, an analyst at IT Centrix Inc., a consultancy in Framingham, Mass. "Where in the past they would have been happy just to get new licenses, they are now focusing on how they can grow revenue from the licenses they already have installed."

Of course, the trend conflicts with users' needs to keep costs down, said David Krauthamer, MIS manager at Advanced Fibre Communications Inc. in Petaluma, Calif.

"It is a concern basically because what vendors are trying to do is lock themselves into user accounts" with long-term contractual tie-ins, he said.

Specifically, there's a growing trend away from the perpetual, per-user and per-server licensing structures that have been standard in the client/ server world for years, said Krauthamer.

Instead, vendors are pushing a variety of new pricing models that present both opportunities and land mines for users.

Perhaps the most prominent example is Microsoft Corp.'s recently unveiled subscription-based purchase option. Called Software Assurance, the option will allow certain classes of Microsoft customers to rent their software for fixed periods of time, starting Oct. 1.

The subscription model could be cost-effective for users who upgrade every time a vendor comes out with something new, but not necessarily for companies that tend to skip product generations.

Microsoft says costs for most users who choose the new option would stay the same or decline over time, but analysts have a different view. One researcher has predicted that costs could soar 68 percent to 107 percent for users who upgrade every four years.

Subscription Skepticism

Some users are cynical about the pricing changes. "Companies don't change pricing models because they are looking to get customers huge savings," said Pat Enright, director of information systems at Clark Retail Enterprises Inc. in Oak Brook, Ill.

The pricing changes are Microsoft's first step toward eventually licensing most of its software as a service. And analysts said other vendors are sure to follow Microsoft's lead.

Others have released online versions of their products hosted by application service providers (ASP), which users can rent or subscribe to on a term basis. For instance, Lotus Development Corp. allows ASPs to deliver a collection of self-service applications and to automatically charge for those licenses based on the number of activated users per month. With most ASP models, companies pay for the software license upfront and strike multiyear maintenance deals so they don't have to deal with upgrades or technical problems.

Oracle Corp. recently added a new wrinkle to the ASP model when it announced that users will be able to run certain versions of its E-Business suite on their own servers while Oracle handles the administration and support work.

Perpetual licenses worked because vendors were able to get customers to keep upgrading their software with the promise of a few new features or upgrade incentives, said Ditka Reiner, president of Reiner Associates Inc., a contract management consultancy in San Francisco.

But market leaders such as Microsoft, Oracle and SAP AG are increasingly selling to a mature base of customers who have been using their products for several years. Such customers aren't likely to move as quickly as they once did to every new release that becomes available, Reiner said.

Instead of trying to sell their software outright, vendors will try to get their revenues from long-term contractual tie-ins, such as maintenance, upgrade and support agreements. Capabilities that were sold as standard parts of packages will come as separately priced options. Upgrade services will be tied to technical support; users won't be able to get one without the other.

The trend is already raising concerns at Millipore Corp., where support costs for distributed software have risen from 12 percent of a product's purchase price a few years ago to more than 20 percent, said Paul Kaminski, director of contracts at the maker of purification products in Bedford, Mass. He said Millipore is paying for upgrade options and bug fixes that it rarely or never uses.

"From a customer standpoint, we are simply not seeing an equivalent value for the increase in support costs," Kaminski said, adding that if costs keep escalating the way they are, the company may start looking at other options, such as Linux.

Migrating to Linux wouldn't be a trivial task, Kaminski acknowledged. "But you'd do it if you reach breaking point," he said.

In many respects, the situation in the client/server market today is no different from what mainframe users faced back in the late 1980s and the early 1990s, Floyer said.

For IT managers, capacity planning and asset management are the keys to coping with the new pricing models, said Marie T. Reeve, vice president of Cicala & Associates LLC, an IT procurement consultancy in Hoboken, N.J. "You need to know what you have and what you need to secure the appropriate licenses."

To avoid getting caught in a bad deal, consultants and savvy IT managers offer the following recommendations:

-- Get it in writing. Be sure the contract identifies the license, support and maintenance implications of adding users or upgrading functions.

-- Establish a good software asset and license management program. Know what software you own and how many people are really using it. Know when software contracts are due to expire or come up for renewal. This information is crucial when negotiating software contracts.

-- Look ahead two or three years. Negotiate contractual clauses that address what would happen if you suddenly downsized or decided to reduce the use of a particular product.

The cost of not doing that can be very high, warned Forrest Eudaily, an associate director at Whitehall-Robins Healthcare, a US$1.7 billion maker of over-the-counter drugs in Madison, N.J.

Because of the way Whitehall-Robins negotiated a mainframe software contract several years ago, it's still paying the same maintenance fees on the software, even though actual usage has dropped to a fraction of what it was a few years ago.

"When you talk with your vendor, you need to have a few 'what-if' scenarios that are contractually spelled out if you don't want to get locked into a huge annual license expense," said Eudaily.

-- Know your upgrade profile. If your company upgrades frequently, it might make sense to get on a software subscription service or upgrade plan. But if your typical upgrade cycle runs more than four years, it might be better to purchase outright, Reeve said.

That's because the cost of paying for an upgrade option fee annually for five years will be almost the same as buying a product outright once every five years, she said.

-- Prepare for vendor mergers. Make sure the contract terms don't change if the software vendor is acquired or merges with another company.

Holyoke Mutual Insurance Co. is learning that the hard way. A few years ago, the Salem, Mass.-based firm purchased a multiyear maintenance contract on an enterprisewide storage product from a vendor that was later acquired. After the acquisition, Holyoke lost a crucial capability it had negotiated and paid for in the original contract relating to the number of servers on which it could do backups, said Josh Turiel, Holyoke's network services manager. Now the company's looking for another vendor.

"Needless to say, we got screwed by that," Turiel said ruefully. "I am going to do my darndest to make sure that [in future contracts], no one takes away what I have negotiated for."

-- Centralize purchasing as much as possible. For instance, instead of having multiple business units separately deploying their own customer relationship management software using per-processor licenses, it may be cheaper to run them all on centralized servers using a single enterprisewide license.

-- Have a realistic tally of how many end users will actually use the application. An enterprise license based on the total number of company employees may be far more expensive than one based on the number of actual end users.

None of the licensing models are inherently bad. The danger lies in getting into long-term deals with the wrong model, noted Advanced Fibre's Krauthamer.

That's why Krauthamer says he loves the short-term agreement he negotiated with his database vendor. It has allowed him to test the software inexpensively for six to nine months and pay for it only after it demonstrates value.

"The approach really minimizes the risk," he said. And it "helps out greatly in avoiding the train wrecks" he added.

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