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.
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 equates to 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 forms 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.
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 never implement. If you think you'll implement it later, buy it later. That will encourage the vendor to be sure you are 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 are not 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.
Paying close attention to software maintenance agreements during the sales cycle, and monitoring their costs after the sale, can save companies significant dollars over the long run.
This Research Byte is based on research by Frank Scavo, President of Computer Economics, as part of his work at our sister consulting firm, Strativa.