A License to Software Should not be a License to Print Money

by Pillsbury Global Sourcing Practice

It pays to closely read the payment terms in your software license. Or rather, it costs if you don't read them closely enough.

I was reviewing a software license for a client recently and came across this term:

"We may increase the license fee in a renewal term by giving you notice at least 60 days prior to the commencement of that term by an amount considered by us to be reasonable if we determine that the existing license fee does not give us an appropriate return when compared to returns from other of our customers, but in no event will any such increase be greater than 10% of the renewal License Fee."

I'm not joking. That was in the contract. On my reading, it's a 'Most Unfavorable Customer' clause. If we have another customer who pays more, than we get to put your prices up. And that was additional to a CPI increase, an increase for any additional users and an increase passing on higher charges imposed by the licensor's third party suppliers. A license to print money.

What about the principal that the cost of technology should diminish year-on-year. How is it that software vendors get to reap more profits year-on-year? Do they demonstrate any additional costs to provide the software to their customers? Does the price bear any relationship to the actual research, development and production costs of the software? Are they giving you more for the additional price you are paying? Probably not. More likely, it's based on a simple supply and demand curve - "how much can we get away with charging for this product before customers turn elsewhere". Software houses will have done the number crunching and determined what they can charge while still maximizing sales.

Software is not something that is in limited supply. Software licensing is not, for example, like real estate where, in a tight market, landlords can raise rents. Real estate is a limited resource; software isn't. The licensor can generally license as many versions of the software as it can find customers willing to take it. The theory of scarcity doesn't come into play in the software market - the licensor isn't going to run out of copies of the software. Apart from their selling, general and administrative (SG&A) expenses of selling more licenses, it's not likely that the licensor incurs any significant costs to produce more copies of the same software. Having a customer continue to use the software for another year probably incurs little or no SG&A expense, yet the licensor usually demands more money.

For example, software license fees that are charged on a periodic or annual basis (rather than as a one-off fee) will often include an annual price escalator. It's generally not the Most Unfavorable Customer clause above - it's more likely to be a fixed escalator (perhaps 5%), or a set amount plus maybe a little extra (3% plus CPI increases). It doesn't seem a lot, and many Customers therefore don't take too much notice of it. It would attract much more attention if it was set at 25%. Customers would be asking the licensor to justify a price increase of that magnitude, but don't often ask for justification of a smaller increase. However, as a customer, you should be asking that question no matter how much the increase is. Why are you paying more for the same thing if nothing else has changed?

Pay attention to those clauses, and ask that price escalators be removed. Some licensors will agree without too much protest, while others will hold firm. Obviously, the size of your business and other factors will come into play, but the basic principle applies here - you won't get what you don't ask for.


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.

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