Negotiating with software providers requires business savvy and a knowledge of how technology can benefit distribution companies. This article will help progressive distributors understand the peculiar nature of the software deal.

by Stuart Mechlin and David Weidenfeld

Many people in distribution companies — from owners, to senior managers and purchasers — know how to negotiate deals with vendors that improve the bottom line. But when it comes to buying software, most distributors don’t tap this expertise as much as they should. They leave the job of negotiating software contracts to information technology (IT) managers or controllers.

Progressive distributors use a team approach, combining technical people with non-technical, business-savvy team members, to negotiate a better software deal.

What follows are some ways you can leverage your negotiating savvy with the technical expertise of your IT department.

Ownership vs. license
Most people (even those who have done numerous software deals) speak of “buying software.” At first blush, the phrase seems reasonable. In most software licenses, you have the right to use the software “perpetually” and you may even have the right to transfer it to someone else. That seems like ownership.

But software licenses are more like leases than purchases. They contain many restrictions on the buyer’s ability to use the software.

For example, many distributors use consultants rather than hire scarce IT help. A standard provision of software licenses authorizes that only the licensee can use the software. Even if the consultant uses the software for work the distributor would normally do, the license prohibits such use.

It is also common for companies to outsource certain IT functions. Under an outsourcing agreement, the distributor contracts with another party to perform services that otherwise would be done in-house. Software agreements almost always bar the service provider from using the software. This means your outsourcing costs may dramatically increase, since you may have to pay a new license fee in order for your service provider to use your software.

License agreements on large computers, such as servers or mainframes, commonly limit where, and on which computers, you can operate the software. These provisions also tend to prohibit you from moving software without consent from the software owner (the licensor).

This is a big issue. Computers become obsolete faster than virtually any other equipment you own. They become obsolete, in part, because software companies keep increasing software complexity, requiring more powerful machines to run. Under this circumstance, distributors face three choices: They can: 1) continue to operate the software on a computer that is no longer capable of performing adequately, 2) abandon the software; or, 3) pay a significant upgrade fee.

This limitation gives the licensor the ability to increase fees if you move the software to a larger, higher capacity or higher speed machine. In the mainframe world, machine speed is commonly measured in MIPS (millions of instructions per second). As you move to a machine with more MIPS, your license fee and support/ maintenance fees go up. This is true even if you paid for a perpetual license.

License agreements also traditionally limit the number of people or machines (users) who can use it. Currently, most software companies include provisions in the license agreement that give them the right to send auditors into your facility to verify compliance by inspecting your records and your computers. How effectively you deal with these provisions determines how cost-effective the license is to you.

Look for “wholesale” agreement changes
Watch out for provisions that allow the licensor to make unilateral changes to the agreement. For example, the words “then current” in a license agreement permit the licensor to change the contract by changing their support practice, policy or fee schedule, or any other term to which “then current” language might apply. These provisions eliminate your ability to control future costs or to guarantee a certain level of support.

Build in flexibility for growth
Try to build as much flexibility as possible to allow for future technological growth (and future growth of your business). Give yourself the ability to change as technology changes, without paying a fee. One way is to obtain the right to use the software on any platform on which the licensor certifies the software. This would benefit you, for example, if you plan to upgrade from a Windows NT server platform to a mainframe computer.

For those distributors that are actively acquiring new companies, negotiating the ability to integrate software at new sites at a low cost may help reduce the cost of future acquisitions.

Watch for hidden costs
Software licenses cover a variety of costs. First, there is the license fee itself. Next comes the maintenance/support fee (see "Techno Speak" sidebar at the end of this article for terms commonly found in software license agreements). This fee normally covers error corrections or minor software improvements, plus telephone support when problems occur.

Many distributors don’t realize that it is possible to negotiate license fees. The experience of an East Coast distributor illustrates how to benefit from negotiating these real but often overlooked fees.

When purchasing new software, the distributor negotiated a lower maintenance fee with a software vendor. But after an initial phase-in period, the vendor invoiced the distributor at the standard rate. So the distributor called the software provider to correct the billing error. A customer service representative said the vendor reverted to the standard maintenance fee by mistake because buyers rarely change maintenance fees in contract negotiations. The vendor fixed the error and charged future maintenance fees at the negotiated rate.

You will also incur “implementing” costs (the cost to install the software), and costs for consulting time to help make the software work in your operating environment. Do not underestimate these implementation costs.

A number of user groups studying this issue conclude that the license fee amounts to no more than 20 percent of the overall cost to implement a new software package. What makes up the remaining 80 percent? Many software packages require new equipment in order to run properly. You may need to buy extra storage devices (known as DASD, or direct access storage devices) for data you generate. You will require training so employees can use the new software. You may need new interfaces (software that allows one software package to communicate or exchange data with another) so computers can share data. The cost to create these interfaces depends on 1) the complexity of the packages, and 2) the total number of packages.

In addition to these items, add ongoing software and hardware maintenance costs, plus staffing costs. Some costs can be addressed in the license agreement. Regardless, every dollar saved on the license can be used for later needs and lowers the total cost of ownership (TCO).

Be aware of future costs
Vendors know that one way to get more money out of existing products is through “upgrade fees.” Vendors charge this fee when customers move to a newer version of the software containing new features or enhancements. Since vendors continue to support the older version even after the new version is released, vendors charge an upgrade fee for use of the new product. What they rarely mention is that over time the vendor discontinues support for the old version and customers must switch to the new one.

Because standard support isn’t adequate for their needs, many customers pay for more extensive support services either in the form of seven-day/24-hour support or for access to more skilled technicians. Both options demand higher fees.

One of the most effective ways to control hidden costs is to limit fee increases. You may limit (on a percentage basis) how much fees can increase in each 12-month period, or ask the licensor to freeze prices for some period into the future. If you received a discount, try to lock in the discounted price for some time period.

You should also try to get the vendor to include new versions of the product, however named, under a maintenance contract.

The following example illustrates how a company recently began looking for new software. The software vendor knew there was no competition for the business (a situation you should normally try to avoid).

The customer also did its homework, however, and knew that the vendor needed to finalize the deal to close its year-end books. Armed with that information, the customer negotiated a 24-month freeze on list price increases, a fixed discount on those prices for 24 months, a reduction in yearly maintenance fees and a 50 percent discount on service (consulting) fees for the entire project. This last concession was especially valuable because the vendor would not commit to the exact number of hours the implementation would take (in this case, the cost reached six figures). The vendor had an incentive to complete the project quickly because, at a 50 percent discount, the vendor barely broke even.

What you can do
Virtually all of the items listed above, and many others, are negotiable. You now have a solid foundation to understand the peculiar nature of the software deal. Marry this foundation with these additional ways to get better results: research similar deals and establish a benchmark; build a software-savvy team that includes purchasing, legal, technical and business people; be sensitive to the dual agenda caused by the very real needs of the business and the needs of your IT folks; determine your current and future performance requirements before the salesperson calls; and, finally, have the stamina to say no to the software vendor and to hear no from the vendor.

Techno Speak: Terms you should know
Software licenses often have terms that could easily be Greek (or geek) to you. While each vendor may define terms differently, this brief glossary will help you understand what your software provider offers and will help you ask questions to make sure you get what you pay for. It will also help in discussions with your own information technology department.

Maintenance - Maintenance means providing error corrections, or, as vendors like to call them, “bug-fixes” (implying the error was unintentional and unforeseen). Minor software improvements fall into this category. Maintenance used to include “support fees” (see below), but many vendors now separate the two, to show they provide more value than they used to.

Maintenance comes in two forms: 1) patches, which are small portions of software code installed on top of existing software, and 2) releases, which install a new copy of the software to replace the existing one. Be aware that it is possible the bug-fix contains errors of its own.

The maintenance fee is usually a percentage of the standard license fee.

Support - This is a vendor service, usually via telephone, where customers call to report problems. Some vendors provide a toll-free number; others require customers to pay for each call, which can get expensive if you are on the East Coast and the software vendor is on the West Coast. Each vendor has its own policy for prioritizing calls, so your problem might not be resolved soon. When the vendor thinks your problem is a minor annoyance, regardless of how you see it, you may have to wait until the next release or patch is issued. This could take weeks or even months. The fee for support is usually a percentage of the standard license fee.

Revisions/Updates/Releases/ Versions - These terms used to mean the same thing, but vendors use them today to distinguish between the amount of error correction and new functionality contained in the software. There are no industry standard definitions distinguishing one vendor’s “version” from another’s new “release.” Vendors have drastically different policies concerning whether revisions and updates are covered by maintenance fees.

Migration path - You will rarely see this discussed in the license, yet it is critical to your operation. From time to time, vendors decide their existing product is obsolete and write a new one, which you can obtain by paying a fee. How hard or easy it is to “migrate” to this new product (since your alternative is to bring in a completely new product) determines how much it will cost you in time, effort and money. Most vendors do not provide any assurance they will minimize your cost to do so.

Platform - This usually refers to the operating system you use, such as Unix or Microsoft NT. Most software is licensed for a specific platform and companies charge a fee to change platforms. Software such as Unix comes in several proprietary varieties and requires a separate license for each. The problem is that old platforms constantly become obsolete and new ones, with new fees, take their place.

CPU (Central Processing Unit) - This is the computer that runs your software. Many licenses restrict you to a specific CPU and require you to provide the vendor with the serial number of the machine. In some cases, vendors write software code that prohibits software from operating on any other machine. So, if you buy a CPU with greater capacity, you will likely need to obtain the software vendor’s consent and code to allow for the new serial number. Consent is usually given after you pay an upgrade fee to operate the software on the new machine.

Data Center - The data center refers to all CPUs at a particular location. This may not contain a serial number restriction, but your license fee is based on the total capacity of the data center, even if you do not operate the software on all machines in the center.

Site - You rarely see this in current licenses. In the past, mainframe software was sometimes licensed on a “site” basis. It didn’t matter what your capacity was at the site and, more importantly, you could increase capacity without paying upgrade fees. Even smaller data centers could save hundreds of thousands of dollars over a number of years with site licenses.

MIPS - Literally, “millions of instructions per second.” It’s a measurement of machine data processing speed. These are ratings provided by the hardware manufacturer and the software vendor (and do not always match!). It is becoming more common for software to be licensed according to the MIPS capacity of machines where software resides. t

Stuart Mechlin is vice president of the industrial division of Affiliated Distributors. Dave Weidenfeld is chief technology counsel for a Fortune 500 company and a founding member of CAUCUS, the Association of High-Tech Procurement Professionals.

This article originally appeared in the July/August 1999 issue of Progressive Distributor. Copyright 1999.

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