Avoiding the Pitfalls of the "Unlimited" License - Four questions you should ask: The Second Question

by Pillsbury Global Sourcing Practice
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Deploying a software package across the company (or most of the company) is becoming a reality for most companies. Standard processes and systems drive cost, quality and performance improvements. Unlimited deployment rights may also reduce transaction costs and project completion timeframes. The right enterprise and unlimited license agreement can make all the sense in the world.

In the first installment of this blog, we set up a scenario where you are a CIO faced with a decision on whether or not to enter into an "enterprise" or an "unlimited" license arrangement with a major software publisher. In discussing the first of our four questions ("What does "enterprise" or "unlimited" really mean?"), we explained that there are many potentially perilous pitfalls in these license arrangements, and conveyed how you might to look to avoid or mitigate them.

Again working from our four-question framework, let's now focus on the second question: "Do we really want to be doing business with this publisher?"

The customer-publisher relationship born under an enterprise or unlimited agreement often lasts a very long time. With apologies for using perhaps a tired analogy, these relationships may last longer than many marriages (and probably are even more difficult (certainly more expensive) to dissolve). Like marriages, people enter into these arrangements for a variety of good reasons.

IT professionals understandably embrace the benefits, perceived flexibility and freedom these arrangements appear to create. (Remember back to the first installment of this blog where we pointed out how these arrangements may not be as flexible as they appear on the surface). With the appearance of little or no marginal license fees for the next deployment (and since these arrangements often are the byproduct of a broader, perhaps mission critical, strategy that must be implemented quickly), the IT professional may encounter less scrutiny on his or her deployment choices or may be encouraged to deploy products covered by an existing arrangement.

For the CIO, where the business case is met, enterprise and unlimited deployment agreements also tend to be attractive because these agreements are seen as a vehicle to secure a closer relationship with a mission critical supplier.

While the arrangement may well advance the strategic goal of teaming up with a mission critical supplier, in most cases it also means the CIO is embarking on a very long relationship with that supplier. As the system or platform is implemented and then put into operation, the customer may enjoy a good deal of flexibility and scalability within the confines of that system or platform. However, once the system or platform becomes embedded in day-to-day operation of the business and the term of original arrangement is over, the customer's options (i.e., ability to change publishers) may be significantly diminished. There are two primary reasons for this.

  1. Switching Costs
  2. Overcoming Organizational Resistance

Let's explore these constraints briefly.

With regard to switching costs, there are many cost categories that come in to play. One area that tends to be overlooked (or underestimated) is the magnitude and impact of the soft costs associated with moving to new platform or system. For example, operational change management can be disruptive and impact the bottom line if not planned and executed properly. There are also some cost categories, like the cost of capital, which vary considerably from one customer to the next. The simple example below demonstrates that the switching costs can be considerable and can pose significant barriers to change.

The example looks at the cost of new license fees compared with incumbent support fees and how it makes exiting (or significantly changing) the relationship with the incumbent difficult to justify. This applies to technology products as well as applications.

Simplified Fact Pattern:

  • An existing application runs on a four-processor machine and uses an XYZ database.
  • To go along with the application, five years ago you purchased the XYZ database license at a discount for $32,000.
  • Annual support on the XYZ database has been frozen at 20% of net license fees ($6,400/year) until next year when it will begin to increase by at least 3% annually.
  • ABC publishes a competing database that offers all of the functionality required by the application.
  • A similar sized license for the ABS database can be obtained for a net license fee of $30,000.
  • ABC agrees to an 18% annual support multiplier ($5,400/year), a freeze on support for four renewals and a 3% year over year cap thereafter.
  • Ignore the cost of re-platforming for the moment
  • Assume a 6% cost of capital.

Conclusion:

  • Despite the significant reduction (in percentage terms) in annual support with ABC, over a ten-year planning horizon, you are better off by more than 31% on the NPV by continuing to do business with XYZ.
  • The cost benefit of staying with incumbent XYZ would hold until ABC's net license fee drops below $22,700.
  • And by plugging back into the equation the re-platforming and transition costs (hard and soft), the business case to stay with XYZ becomes even more compelling.

The second constraint - "Overcoming Organizational Resistance" - recognizes that the effort required for change (real or perceived) is complex and usually viewed as daunting. Even if the financials are compelling, customers are often faced with the question of whether there is sufficient oversight and management bandwidth to implement and socialize the change. In short, the thought of the change-out may be so distasteful that, like the divorce of long-lived marriage, an IT organization may decide to simply live with a difficult relationship (and perhaps pursue more modest remedial efforts) rather than exit the relationship and pursue a new one.

These two factors afford the incumbent publisher with a distinct advantage over its competition for future business, which from the customer perspective introduces significant constraints on alternative (practical) options. With the upper hand on its competition, the balance of power, if you will, swings decidedly in favor of the publisher and hence diminishes the customer's leverage to control cost, address performance issues and pursue alternatives.

In summary, even if there are substantial increases in the incumbent's annual support fees, material reductions in scope of standard support services or less than stellar performance or support, the combination of significant hard costs and organizational resistance to change may extend a long-term relationship to a very long-term relationship.

Although there is no simple solution to these challenges, consider the following as guiding principles to contain the risks:

  • If the answer is "no," find another publisher.
  • If the answer is "no, but I have don't have an another option" or even if your answer is an unequivocal "yes", make sure you exploit upfront leverage before you sign by obtaining flexible exit rights and meaningful transition rights for the inevitable day when the relationship comes to an end.
  • In addition to fundamental diligence considerations (e.g., a good product fit and a defensible business case), the CIO should further test the viability of the relationship by forming a concrete view of the publisher's reputation, and factor that into the determination of whether the publisher is the right long-term partner.
  • Ask yourself, "Do I really want to be doing business with this publisher (potentially for a very long time)?"
  • Oh, and you will be well served by retaining a seasoned advisor who has been through this process before (many times, preferably).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Pillsbury Global Sourcing Practice | Attorney Advertising

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