Saturday, February 05, 2005

High software maintenance fees and what to do about them

There's an interesting side note to Oracle's takeover of PeopleSoft: it turned out that PeopleSoft's software maintenance business was even more profitable than Oracle realized. Once Oracle found out how much money PeopleSoft was making on its recurring maintenance business, it justified a sweetened offer that closed the deal.

If you're a corporate buyer of software, you might want to take a look at what you're paying for software maintenance.

What is software maintenance?
Maintenance fees pay for two services from the vendor to the customer. First, they pay for ongoing product development that provides new product features, regulatory updates (e.g. tax table updates), and bug fixes. (That's right. You pay for the software, and then you pay the vendor to fix defects in it.) Second, maintenance fees pay for phone and Web-based support for times when you need help with the system.

One little secret of the software industry: the maintenance business is really profitable for vendors. It's somewhat analogous to the situation when you shop for a big screen TV at Circuit City. You may be impressed with the terrific bargain you're getting on the sales price. But when you go to sign the deal, there's a lot of pressure for you to sign up for the extended warranty--where the store, and the salesman, make most or all of their profit. Buying enterprise software is similar, with the key difference being that you don't really have the option to forgo the maintenance contract.

I've long thought that software buyers are too focused on the up front license price and not paying attention to how much they are paying on the back end--in software maintenance fees. Buyers forget that when they pay a dollar for a software license, they pay that dollar once. But when they pay a dollar on software maintenance fees, they pay that dollar again and again, year after year, as long as they stay on maintenance. Over the life of the system, most customers pay far more in maintenance fees than they ever pay in up front license fees.

Software vendors understand this, and as new sales continue to be hard to come by, they are turning their attention to increasing revenues from their maintenance business.

Vendor tactics
Vendors are working to increase maintenance revenue in two ways. First, they are increasing maintenance fees directly. A few years ago, 15-18% of the software license fee was a typical benchmark. Now, I'm seeing vendors quoting 20% or even more. It might not sound like much, but run the numbers out three or four years and see the impact. On a $500,000 license deal, a five percent difference in maintenance fees is $125,000 over five years. That's like a price increase of 25% (not factoring in the cost of money, of course).

Second, vendors are tightening enforcement of existing agreements. In the past, vendors might not aggressively pursue customers that exceeded user counts, which usually form the basis for software pricing. Today, it's no more Mr. Nice Guy. Vendors are enforcing their contractual rights to audit customer usage of the software and are charging customers license fees for additional seats, plus the maintenance fees on those seats.

Balance of power
Why are vendors squeezing customers? First, it's a sign that, although we're not returning to the heyday of tech spending in the 1990s, business is improving. Vendors are finding that they don't need to make as many concessions as they have in the past. And, as we just saw, the easiest way to increase revenue is through maintenance fees.

But more significantly, vendors are increasing maintenance revenue because they can. Implementing an enterprise-wide system is a huge undertaking for most companies. Few customers are going to select a new system and go through the pain, risk, and expense of another implementation just because they are paying a bit more in maintenance fees than they had planned on. Customers are a captive audience--to a point.

My feeling is that if vendors continue along this path, there's going to be a backlash. There's a limit to what the market will bear, and I think some vendors are starting to reach that limit. A study by AMR last year found that because of maintenance policies, 22% of customers are considering switching vendors, 21% intend to stop taking upgrades, and 12% will discontinue paying maintenance.

Practical tips
If you are concerned about high software maintenance costs, there are several steps you can take to keep costs in line.

If you have not yet purchased the system, understand that your negotiating power will never be greater than before you sign on the dotted line. Maintenance fees as a percent of the license cost are not cast in stone. Everything is negotiable. For example, ask for a lower percentage. Ask for maintenance fees to be based on the discounted price of the software, not the list price. Ask for maintenance fees to be locked in, not allowing the vendor to increase fees from year to year.

Furthermore, don't buy software you don't need, even if the vendor offers a tremendous discount on additional modules. There's no free lunch. If the vendor is charging maintenance fees based on the list price of those modules, you'll likely be paying for software that you won't implement. If you think you'll implement it later, buy it later. That will encourage the vendor to be sure you're successful with the modules that you do buy.

If you are already a customer, your negotiating power may be diminished, but you still have options. First, check whether you are using all of the modules you purchased. If not, consider canceling maintenance on the modules you aren't using. Second, look hard at whether you are using all of the user seats that you originally purchased. Vendors will tell you if you exceed your user count but probably won't let you know if you have excess seats. Finally, if you plan on buying additional software from the same vendor, see whether you can negotiate a better deal on your existing modules in exchange for buying additional modules.

If your vendor is still not showing flexibility, consider whether more hardball tactics are warranted. Third party maintenance and service providers, offering lower fees, are one alternative. Canceling maintenance ("going naked") for older or less critical systems might be another alternative, especially if you seldom use the help desk and are not planning to upgrade in the future.

Then there's always the nuclear option: looking to other software providers. For some applications, open source software might be an alternative, with maintenance either provided in-house or through a third party.

Computerworld has more on trends in software maintenance. CFO magazine has further analysis of what vendors are doing to squeeze more revenues from existing customers.

Related posts
Customers pushing back against enterprise software maintenance fees
Software customers learn to just say no
Customers pushing back against Microsoft licensing program
Customers to Microsoft Licensing 6: thanks, but no thanks
SAP to provide maintenance for PeopleSoft products
Microsoft Software Assurance: no bang for big bucks
Software buyers turn cheap


pblavallee said...

While maintenance and support can be highly profitable for companies over critical mass and large enterprise software vendors, there are thousands of small and up and coming vendors who rely on these revenues to continue to improve their products. Often these vendors, due to their size, are the ones squeezed from both ends. Buyers squeeze them on price then expect the maintenance fee% to hold or even be reduced while then being applied to the net license fee. Commentary such as this spurs them on to believing the situation you describe is true of all software vendors. Cut the small guys some slack - plenty of value is often delivered for the resonable fees charged by many software companies.
Paul Lavallee

Anonymous said...

Have you ever run a small software product company and seen how hard it is for niche software product makers to survive. Your commentary does encourage large enterprises to squeeze those people it can...not the Ciscos of the world, but the small companies. We personally believe in leasing and not licensing and charge very low fees each year...period! Yet our customers want to lower the upfront cost and yet pay only 20% of even the lease. The same software would cost the company more than twice as much to develop or maintain internally. Your commentary is totally lopsided and unfair.

Aparajit Agarwal
TrendWorks Data Analytics, Inc.

Anonymous said...

I am a software executive and I've been seeing an interesting trend towards boilerplate contracts with large end users quoting "12%" and mandating that with their vendors.

Normally I charge 20%, and for that 20%, I have 3-4 feature releases per year --- a very aggressive schedule, but one that delivers high value to my customers and speed-to-market for new business opportunities.

So to me, 12% vs 20% is fine. I just re-jig the contract to load the license with the difference in cost over five years, and I get more upfront rather than giving the option for the customer to spread the TCO over a longer period. It actually works to their disadvantage, but if they want to be inflexible about the 12%, I can make that work too.

You see, there is EBITDA for the company to consider. We price our products fairly, and we're industry-average for our profit line, which says that we're not taking any more than we deserve.

There may be companies taking more from the customer, but for the most part, companies aren't able to make enormous profits over and above their competitors. The marketplace abhors anomalies and creates competition to control outrageous profit.

There may be near-monopoly situations where that is possible (e.g., Oracle, Microsoft) but for non-monolithic vendors, your premise is generally false. By definition, smaller vendors HAVE to offer more value for the dollar otherwise they can't break open new markets in the first place.

Sorry for the anonymity, but my marketing folks would kill me if I slap my name on this.

Frank Scavo said...

To the previous commenter, thanks for the feedback. I am a big believer in the free market and agree with you that software vendors have the right to charge whatever they want. If the price they charge is out of line with the value they deliver, they will be at a competitive disadvantage.

But...that doesn't mean that customers shouldn't look for ways to lower software maintenance costs. You'll notice this was a 2005 post of mine, and there has been a lot of water under the bridge since then. The problem of software maintenance cost versus value has only gotten more pronounced since then, as you know, with some vendors.

The other problem, which I only touch on briefly in this post, is the issue/rights for third-parties to offer maintenance. I believe there needs to be a robust third-party maintenance industry to support the products of some large dominant vendors in order to restore some competition to the market place. It may take some anti-trust rulings to make this happen, similar to the IBM ruling back in the 70s that forced IBM to unbundle the OS from the hardware and led to the IBM plug-compatible industry (Amdahl et al).