I've been coming down pretty hard lately on certain software vendors for escalating costs of software maintenance contracts as well as the lack of value and flexibility in maintenance programs. I'm not alone in this criticism, as other bloggers, such as Vinnie Mirchandani (aka, Vinnie Maintenance), Ray Wang, and Dennis Howlett have voiced the same concerns.
One thing that has puzzled me for a long time, however, is why vendors are not willing to negotiate software maintenance fees in the same way that they negotiate upfront license fees. One of my associates the other day referred to maintenance fees as the "third rail" of ERP deals--it seems you can't touch it. But vendors often discount the license fees to close the deal. Why aren't they willing to negotiate maintenance fees?
They easy answer is, because that's where they make their money. Although that's no doubt true, I've recently learned that there is another reason.
Issues with revenue recognition A Spectator reader, who will remain unnamed, recently contacted me about this matter. He is the CEO of a privately-held Tier II ERP company and a veteran of the industry. He'd been observing my rants about vendor maintenance fees and thought it might help me to see the situation from the vendor's perspective, specifically from the accounting side.
He points out that accounting standards for revenue recognition in the software industry have been evolving over the past several years. "Revenue recognition" simply refers to the policies that govern when a company can book sales dollars as earned revenue.
For enterprise system vendors, revenue recognition involves a number of issues. For example, suppose a vendor closes a deal for 100 users, plus implementation services, plus hardware, plus maintenance fees.
When is the vendor allowed to record the revenue for the software licenses? Does he count it all as revenue as of the date of the invoice, the date the software is shipped, the date the software is installed at the customer's location, or the date that the implementation is complete?
The implementation services are a bit simpler, as they typically are billed and recognized as revenue as of the date of service. But what if the implementation is performed as a fixed fee? When should the revenue be recognized?
What about the first year's maintenance fees? Should they be recognized as revenue at the time of sale, or amortized over the 12 months? Can the vendor recognize revenue for maintenance in months prior to the software being operational?
And what about the hardware? Should the sale of the hardware be recognized at the time the hardware is shipped, at the time it is installed at the customer site, or at the time that the complete system goes live?
A little thought about questions like this and you can see why the accounting for enterprise system deals can be difficult.
Potential for abuse Furthermore, if the customer wants to structure the deal differently (e.g. for financing purposes), can the vendor move money between different parts of the deal? For example, can he charge more for the software licenses and take it out of maintenance fees? Or, can he take money out of the implementation services and put it in hardware?
What if moving this money around also lets the vendor recognize revenue earlier than he would have been able to if he had structured the deal as he normally does? Isn't that cheating? It sure could be.
Because moving money from one part of the deal to another may affect revenue recognition (and therefore, tax obligations), a large body of regulations have been promulgated to provide accounting standards for software deals. The most significant of these standards is AICPA's Statement of Position (SOP) 97-2, Software Revenue Recognition (later amended by SOP 98-9). According to The CPA Journal, a publication of NY State Society of CPA's:
SOP 97-2 provides that revenue should be recognized in accordance with contract accounting when the arrangement requires significant production, modification, or customization of the software. When the arrangement does not entail such requirements, revenue should be recognized when persuasive evidence of an agreement exists, delivery has occurred, the vendor’s price is fixed or determinable, and collectibility is probable.
The rules get really complicated when contract accounting is not required. In such cases (which cover many enterprise software deals), the rules require that the vendor’s fee be allocated according to something it calls "vendor-specific objective evidence (VSOE)" of the fair value for each element of the deal. The CPA Journal article explains:
VSOE is limited to the price charged by the vendor for each element when it is sold separately. This requires the deferral of revenue until VSOE can be established for all elements in the arrangement or until all elements have been delivered. If PCS [postcontract customer support] is the only undelivered element in the arrangement, however, the entire fee can be recognized ratably over the term of the PCS contract. In addition, recognition of revenue must be deferred if undelivered elements are essential to the functionality of any delivered elements.
This brief explanation, as complicated as it is, does not do justice to the complexity of these accounting standards. Read the entire CPA Journal article to get an idea of the problems facing software vendors in accounting for sales. You can also read this article from CFO Magazine, which illustrates what happens when a company runs afoul of these regulations.
To further complicate things for publicly held companies, different auditors may have slightly different interpretations of the rules and may force vendors to restate earnings if they do not agree with the interpretation of previous auditors.
Why vendors resist negotiating maintenance fees But what does this have to do with negotiating maintenance fees? As patiently explained by my CEO reader, software vendors spend a lot of time structuring their pricing for each element of the typical deal so that it will pass muster with their accountants and auditors. Change the structure of the deal, and it is likely that the vendor will have a huge accounting problem.
Therefore, if the vendor appears unwilling or unable to negotiate changes to the maintenance fees, it's not just that the vendor is greedy. It is at least partly, if not largely, due to the accounting considerations.
I believe this explanation and think it is important to keep this in mind when negotiating with software vendors. It does not explain, however, why software maintenance fees are so high to begin with.
As confirmed by my source, rather than try to negotiate a lower percentage on maintenance fees, a better approach would be to negotiate harder on software license fees. As most vendors are now basing their maintenance charges as a percentage of the discounted price of the software, any discount won will pay off in terms of lower maintenance fees over the life of the contract. In addition, negotiating a maximum increase over multiple years is also advisable.
Update, Nov. 28. I contacted Stephen Guth, author of the Vendor Management Office blog, for his take on this post. He spends a lot more time on these matters than I do, so I was interested in his perspective. He writes back:
I think software account reps tick through an ordered list of reasons as to why they want to resist negotiating fees (high margin, annuity stream, etc.), and I think revenue recognition and having to deal with their Controller are somewhere on the list. I used to work for a vendor, and it was always easier for us to go to our special pricing folks than to go to our CFO/Controller. We avoided the Controller like the plague. We would be willing to do deals through our special pricing folks but rigorously resisted any deal elements that required us to go to the controller for approval. I suspect it's the same elsewhere and your contact's perspective confirms my suspicion.
I guess the point is that buyers need to look at the TCO and their own accounting treatment (e.g., capital of a license vs. the expense of maintenance). In some cases, and it sounds crazy, a buyer may want to (as a trade-off) offer to load a software license fee as a concession for a dramatically lower maintenance fee. Again, all about the TCO. And all you and I can do is try to equip people with our perspective so that they can make their own informed decision.
In other words, Stephen confirms that from the vendor's side there are some negotiation points that can be handled through "special pricing" and some that require sign off by the vendor's CFO/Controller. Knowing when you are treading into the second area is key to understanding why vendors resist changing maintenance terms, conditions, and pricing structures. These points may be well-known by those that work on the vendor side of the table, but they are not widely realized by typical buyers that I deal with.
To negotiate successfully, buyers need to understand the needs of sellers. At the risk of repeating myself: software revenue recognition issues are not an excuse for recent escalations in software maintenance fees by certain vendors. But the issues around accounting compliance do explain why, once maintenance program structures, terms, and conditions are established, vendors resist changing them on a case by case basis.
Dennis Howlett is reporting that the U.S. SAP user group (ASUG) has terminated its first full-time CEO, Steve Strout. Dennis speculates--with good reason--that Strout was not pushing back hard enough on SAP's recent hike in maintenance fees.
In related news, Societe Generale analyst Richard Nguyen put out a sell-rating on SAP's shares, on his forecast that SAP's fourth-quarter profit will come up short. The reason? SAP customers are pushing back on SAP's maintenance price increase.
Dennis Howlett attended Microsoft’s Convergence conference in Copenhagen, its annual gathering for users of its Dynamics line of ERP systems. He was favorably impressed with the user-centric nature of the event:
This was a modestly confident yet cautious Microsoft, happy to parade good customer stories. This is to be welcomed and a sharp contrast to other shows where the emphasis is often on ensuring the company’s message is not tempered by customer reality. As we move forward in an uncertain economy, these stories will become much more important to commenters and customers alike.
Read Dennis's blog post for the latest from the show on Microsoft's AX, NAV, and GP products.
by Frank Scavo, 11/24/2008 12:35:00 PM | permalink | e-mail this!
A Spectator reader informs me that Consona had an unannounced layoff on November 3. Sales, development, and corporate functions were affected. The number of employees affected is unknown. My source is a former Consona employee that maintains contact with folks who still work there.
Consona, which changed its name from M2M Holdings last year, is the parent company for Made2Manage, a well-regarded ERP system for small and midsize manufacturing firms. Consona has also acquired several other ERP and CRM systems for the SMB market, notably Intuitive, Onyx, Encompix, DTR, Cimnet, and Axis. Intuitive itself had previously acquired Supplyworks and Relevant. Many of these are solutions focused on niche industry requirements, an approach that I am particularly fond of.
Consona has not responded to my request for confirmation of the layoff.
If you have further information, please email me or post a comment below.
Update, Nov 24. A Consona represented responded this morning with confirmation of the workforce reduction, but claims they were movements of jobs from the U.S. to Consona's offshore development facility in India.
She writes:
We did recently move some positions to our office in Bangalore, India. We are leveraging our offshore development capacity during the economic downturn to maintain our ability to deliver solutions to our customers while keeping costs down. We also restructured our IT organization to provide 24 hour support to our customers and offices around the world by opening an IT support organization in Bangalore. Considering these positions were simply transitioned to another location, the "reductions" you note ... are insignificant.
Overall, Consona has a track record of being a stable company for our customers. Our strong financial performance is based on the fact that we continually adjust our business based on our results, near term projections, and state of the market and economy. This is not something all software companies are doing, as you know.
Just a few notes on our office in Bangalore...
Mixed onshore/offshore model that doubles development capacity and achieves a faster time to market (24-hour operation)
Similar structure in many other SW providers.
We have our own development center operating successfully since the 90s as part of Cimnet Systems.
Staff are Consona employees, have been successfully releasing both major and minor product releases
by Frank Scavo, 11/20/2008 10:56:00 AM | permalink | e-mail this!
On-demand enterprise system provider NetSuite appears to be bucking the trend these days. According to NetSuite CFO Jim McGeever, sales slowed in late September, but since then the flow of deals has become "much more predictable." He made these remarks today in a presentation to the UBS Global Technology and Services Conference.
"What has happened in October and so far in November is that when people said they were going to buy, they actually bought," McGeever said.
Going by the boards have been deals with small customers, who spend less than $10,000 a year with the company, he said. The deals with big customers, aka "elephants," are getting done. Elephants who didn't complete deals at the end of September, will complete them before the year ends, he said. "We don’t expect to lose any of them," he said.
NetSuite got its start by selling to very small businesses. In 2002, the average ticket was $447 per customer. Now, sales growth comes entirely from customers spending more than $10,000 a year. The biggest growth area: Customers spending more than $100,000. "The larger deals seem relatively strong," he said.
I spoke too soon on the previous post. A Spectator reader alerts me to layoffs announced today by Lawson Software.
The restructuring plan includes the elimination of approximately 200 employees, or 5 percent of the global workforce, with personnel departures expected to be substantially completed by Dec. 31, 2008. When combined with anticipated voluntary attrition and limited hiring, the total reduction in the global workforce is estimated to be between 8 percent and 10 percent by the end of the company's fiscal year on May 31, 2009.
The firm expects restructuring costs to be in the range of $9-12 million, resulting in savings of $40-50 million.
Expect to see more of these sorts of announcements. Investors will view not vendors in a bad light for layoffs in the current economic climate, and in fact may actually view such actions favorably.
It's another story for those let go, of course. We hope the best for them and their families.
by Frank Scavo, 11/18/2008 01:30:00 PM | permalink | e-mail this!
Update: See my latest post on Oracle layoffs, January 2009 As I mentioned previously, the Spectator is getting a surge in Google-referred traffic recently for search terms such as "Oracle layoffs." Oracle is not saying anything publicly, but I am getting some feedback from readers.
The latest is that there have been Oracle layoffs in November, but so far they are not affecting delivery people. There was a reduction in force, however, in August that did affect Oracle's consulting unit, which I reported previously.
Again, anyone with more information, please email me or leave a comment on this post.
Update, 1:10 p.m.Tom Steinert-Threlkeld points out that although SAP has not yet cut overall headcount, its employee count in the Americas, excluding acquisitions, has actually fallen slightly in the past nine months. He also quotes SAP's CFO, Werner Brandt, as indicating that SAP layoffs in the future cannot be ruled out. Brandt made the comment in answer to a question at a UBS converence in New York today.
No recent news to my knowledge on layoffs at other enterprise system vendors, such as Infor, Microsoft, IFS, Lawson, QAD, Exact, Glovia, Best, or JDA.
Update, Nov. 20. A spectator reader reports:
I spoke to one of my former coworkers that was just laid off [by Oracle] on Monday and she said that her understanding was that 20% of the Education staff was let go. They were notified by managers early Monday morning and by noon they had each received a packet at home via FedEx with a severance packet. By EOB on Monday email had been cut off. Typical Oracle. Still haven't found any articles on it.
by Frank Scavo, 11/18/2008 08:53:00 AM | permalink | e-mail this!
Ed does a great job summing up the key principles of software development, many of which go back decades. I studied many of them in college over 30 years ago and in my early years in corporate IT. Ed points out that these principles keep getting rediscovered by new generations of developers, using different terminology. The presentation, in PDF format, is loaded with links to external resources on each concept.
Do yourself a favor and download it now for future reference.
Ed is giving the presentation itself at a CompAid “Software Best Practices” conference in Chicago on November 13th.
by Frank Scavo, 11/13/2008 09:38:00 AM | permalink | e-mail this!
Epicor announced a new round of cost-reduction steps today, including headcount reduction, cutbacks in discretionary spending, and efficiency improvements. It said that expects to save somewhere between $16-20 million, with restructuring charges eating up $4 million of the savings during the fourth quarter.
Although Epicor did not note the number of employees affected, an Epicor employee in the firm's Newburgh, NY office informs me that the layoffs hit 10% of Epicor's headcount worldwide. Unfortunately, he was one of them.
The cost-cutting actions come at a key time for Epicor. As with all tech companies, the firm faces cutbacks in IT spending due to economic conditions. But Epicor is also battling a hostile takeover bid by New York hedge fund Elliott Associates. Epicor's board voted last week, for the second time, to reject Elliott's offer. Elliott already owns 10.2% of Epicor and is gunning for the whole thing. It originally bid $9.50 per share back in October, but last week lowered its offer to $7.50.
Cost-cutting will just take Epicor so far in improving the bottom line. If it wants to remain independent, it will need to improve the top line as well. But under current economic conditions--and intense competition from other players--it won't be easy.
Postscript: I am convinced there is a fresh round of layoffs at Oracle as well. The Spectator's web log is suddenly getting hammered this week by Google searches for the words, "Oracle layoffs." The only difference with Oracle is that they are not saying anything. If you have more information, leave a comment or send me an email.
Over at Computer Economics, we've just released the results of a special survey of IT executives, conducted in October 2008. In light of the current turmoil in world financial markets, the findings are a bit contrarian. According to the report's media alert:
IT organizations decidedly stepped up their cost-cutting measures in the third quarter of 2008. Nevertheless, as they head into 2009, most IT executives are not anticipating deep cuts in IT operational spending or staffing levels, according to a new survey by Computer Economics, an IT research and advisory firm in Irvine, California.
In the October survey of 159 North American IT organizations, one-quarter of the respondents anticipate spending reductions of at least 3%. But another quarter anticipate that their IT operational budgets will rise by at least 5%. At the median, IT organizations forecast that their spending growth will be flat.
IT executives are also focused on retaining their current employees. IT organizations at the median and 25th percentiles forecast no change in their headcount in 2009, while companies at the 75th percentile are actually forecasting a 5% growth in staffing levels.
In evaluating and selecting enterprise systems, software buyers often focus on the upfront software license fees, but neglect the recurring annual cost of software vendor maintenance fees. This is a mistake, as after a few years the maintenance fees can eclipse the initial license costs.
Stephen Guth has a good post on negotiating software maintenance. He first asks, how is it that vendors are now charging annual maintenance fees that are 20% of the initial license cost (or more, in the case of SAP and Oracle), where they were typically charging 15% a few years ago? The answer, in effect, is because they can. In other words, buyers are simply not pushing back hard enough.
He then provides a list of 18 questions you can use to push back on your software vendor when it comes time to negotiate. Here are a few...
Why do I have to pay you to fix your own bugs?
Why should I have to pay software maintenance in advance?
Can you separate the cost of actual maintenance from how-to / technical support?
I'm only able to install half of the total licenses in the first year, so why do I have to pay maintenance on all of the licenses?
I know I've been harping on this subject for a long time (see related posts below), as have other bloggers, such as Vinnie Mirchandani (aka, Vinnie Maintenance), Ray Wang, and Dennis Howlett. But things won't change until buyers start pushing back harder.
Or, antitrust actions are taken. But that's another story for another post.
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