Thumbscrew, 2.0

Software vendors unveil a new program designed to maximize revenues -- their revenues, not their customers'.
John EdwardsFebruary 2, 2005

Seems those 17th-century Italians were wrong: you can get blood from a stone.

In a move that is guaranteed to raise the hackles of finance chiefs at cash-strapped companies, software vendors are attempting to wring more money out of existing customers. Part of the wringing stems from revamped pricing strategies — strategies necessitated by such emerging technologies as partitioned servers and multicore chip processors.

A good portion of the extra vendor income, however, is coming from aggressive policing of current licensing agreements. The new get-tough attitude of vendors has, in part, been spawned by the revival of the enterprise software industry. During the tech downturn that commenced in 2001, application makers were so keen to hold on to customers that they often looked the other way when clients violated terms of their agreements.

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No longer. With the return of corporate spending on software, vendors now appear more willing to confront abusers and cheats (aka paying customers). Licensing fees, which include yearly charges for maintenance, support, and upgrades, are on the rise, and now routinely top 20 percent of the purchase price of an application. Tech research firm Gartner sees no letup there, noting that the cost of software licenses could bump up by as much as 50 percent by 2006. With the cost of enterprise apps also on the way up, the recurring income generated by licenses has become too sizable for software makers to ignore. “Vendors are now looking at their licensing agreements,” confirms San Francisco-based David Marston, PricewaterhouseCoopers’s U.S. leader for licensing management services. “Customers are going to have to start living with the terms of their agreements.”

They may not have any choice. While Ford Motor Co. ditched its Oracle procurement system in August, few management teams are willing to rip out entire enterprise applications. For large companies, such programs cost tens of millions of dollars to buy and take months — if not years — to deploy. Indeed, it appears a growing number of executives at IT companies now view their existing customers as chickens ready for the plucking. “Where [else] can vendors get growth in earnings per share?” asks Marston. “It means they don’t have to spend to acquire new customers.”

But industry watchers say some old customers resent being socked for products and services that, until recently, could be taken for granted. “Customers felt like they had finally been liberated from this onerous and somewhat unpredictable cost structure,” says Steven Frank, a partner in the patent and intellectual-property practice group at Boston law firm Testa Hurwitz & Thibeault LLP. “Many now feel that they’re essentially paying to maintain a product they’ve already bought.”

License to Bill

The hard-as-nails attitude of vendors reflects a marked change in the software business itself. Increasingly, companies are purchasing suites of software from single businesses, rather than buying best-of-breed applications from various designers. While the approach simplifies systems administration — and improves data flow — it virtually locks customers into one product line.

At the same time, this rise of single-vendor shops has made it tougher for vendors to poach large accounts from rivals. Hence, technology sellers have come to realize that connections with existing customers must be leveraged — some would say exploited — to pump up recurring revenues. “During the tech drought, software vendors were practically giving maintenance and upgrades away,” notes Frank. “Software vendors are now going back to the more-traditional model: maintenance fees are going up, upgrade fees are going up.”

A recently released survey supports the assertion. Conducted by PricewaterhouseCoopers, it found that 42 percent of executives at U.S. technology companies believe licensing fees will grow by 10 percent in 2005. With vendors counting on the fees to help meet income projections, says one consultant, “the need for companies to focus their controls over revenue leakage will be essential.”

Easy Money
The majority of technology companies surveyed expect a bump-up in licensing revenues this year.
No growth:
Less than 10%
More than 10%
More than 20%

Source: PricewaterhouseCoopers

Toward that, a number of vendors have started “license management” or “license compliance” programs. Typically, such programs include tougher and more-frequent customer audits. In some cases, vendors force business users to run software that automatically counts the type and number of products installed. “It’s up to you to make sure you have a license for everything,” advises E. Robert Yoches, a partner at Finnegan, Henderson, Farabow, Garrett & Dunner LLP, a Washington, D.C., law firm that focuses on intellectual-property matters. “If you don’t have a license for a particular product, you’ll have to work out some sort of settlement agreement.”

The Internet is also helping vendors enforce the stipulations of licensing agreements. Browser-based monitors, built directly into such products as operating systems and databases, can automatically detect a customer running more than the permitted number of copies of a program, or accessing features in a way not authorized by an existing agreement. “While these types of monitors have existed for some time,” notes Yoches, “they’re more sophisticated now.”

Many software vendors are also starting to move support, maintenance, and upgrades to a subscription model. While a company may have a perpetual license for a product, points out Fred Hoch, vice president of software programs for the Washington, D.C.-based Software and Information Industry Association, “you can only get support for it for a three-year subscription period.”

The “L” Word
Some push-back is possible. But standing fast against increasingly vigilant vendors requires increasing vigilance on the part of users. First off, experts say, tech managers, IT workers, and even midlevel employees should become completely familiar with the agreements linked to the products they regularly use. Advisers point out that vendors often make claims that contravene license terms. Says Marston: “I cannot tell you how many companies I see where the legal department signs an agreement that never leaves the legal department.”

When contracts do come up for renewal, corporate customers shouldn’t be afraid to ask for terms that are decidedly in their favor. Midmarket vendors, digging hard for market share, may still be willing to adjust terms to retain a client. Large software publishers, on the other hand, may budge on some points to sidestep any chance of antitrust litigation.

Wherever possible, users should try to build as much certainty as possible into their vendor pacts. If a software maker promises, for example, not to release a major upgrade for the next two years, get the pledge in writing. Says Frank: “At least then you’ll know that for the next two years this is what your cost is going to be, instead of being surprised by new releases and upgrades.”

For added clout, corporate users might let it slip that they’re considering moving to open-source alternatives. Barring that, businesses would be wise not to hook up with vendors that insist on pushing a proprietary platform for programs. “You don’t necessarily have to replace Windows with Linux,” advises Frank, “but [you should have] the capability to migrate to other platforms for particular applications.”

Still, the ongoing consolidation in the software industry is going to make it nearly impossible for finance chiefs to rein in the total costs of enterprise applications. Now that Oracle’s acquisition of PeopleSoft is complete, for instance, large multinational corporations have two — count ’em, two — viable ERP vendors to choose from.

“There’s going to be fewer vendors for larger companies to choose from, so you’re going to have fewer choices,” warns Marston. “Given current trends, you’ll have to negotiate hard to gain any advantage.”

John Edwards is a freelance writer based in Gilbert, Arizona.