by John Lamb

Smart CIOs can still create cost savings

Mar 18, 200911 mins
Cloud ComputingIT LeadershipIT Strategy

The price is right, or is it? When times are hard, prices come down: the logic seems inescapable. And yet software suppliers seem to have spent much of 2008 trying to buck the markets, with a string of major players including SAP, Oracle, IBM and Citrix Systems raising the price of some, or all, of their offerings.

The price hikes look completely at odds with the objectives of CIOs who are under pressure from their CEOs and CFOs to cut expenditure and postpone new projects. In many cases IT departments still have no agreed budget for 2009, but must prepare individual business cases to justify each and every outlay.

The round of rises began in June 2008 when SAP announced that the company would increase its annual maintenance fee from 17 per cent of licence fees to 22 per cent – nearly a third higher – from January 2009. The price increase would be phased in over four years. In exchange, customers were promised an enhanced service including 24-hour support and help with problems involving third-party software.

The same month, Oracle increased prices on a swathe of products in the US. Among the biggest increases were an 18.75 per cent rise in the cost of Oracle Database Enterprise Edition and an 18.75 per cent leap on Oracle’s Express Server.

Not to be outdone, IBM notified users of five per cent price rises for a number of its Tivoli and WebSphere products for the System Z mainframe, which were due to take effect in January. By September, server-based computing software company Citrix had padded its price list by an overall 10 per cent to counter, the company said, the increased cost of doing business around the world. Some prices have been adjusted but is this a case of market power cynically trumping economic imperatives or is there more going on than meets the eye?

Returns on investment

One of the drivers for price hikes by software majors, they claim, has been a desire to recoup heavy investments in new technologies such as service-oriented architecture tools and in enabling customers to access their products as hosted services.

SAPeven recently rejigged its software offering under the slogan ‘Best Run Now’ to concentrate on those applications, such as risk management, inventory and business intelligence, deemed most likely to help customers in difficult circumstances. But if the rises were an example of market power, it may well be that the high-water mark has already been passed.

“For those increases that are related to upfront purchase prices (of software), most had occurred prior to September 2008,” is how Ray Wang, vice president for enterprise applications and strategies at Forrester Research sees it.

“At that point in time, market power had a slight upper hand. Many users faced tougher negotiations. However, since the worsening and continued downturn, we do not see the price increases holding when compared to street pricing. In fact, pricing has fallen for many vendors.”

UK users have had an additional cross to bear: the cost of sterling’s weakness on world currency markets. At its peak, the pound was worth around $2, but by late autumn the rate of around $1.50 to the pound represented a 25 per cent increase in the price of software from the US.

“I am not aware of any good bargains,” says Alan Brown, business strategy director of value added reseller Panacea Services, which specialises in supplying City of London firms. “I have seen pricing going up because of the dollar. Even if software vendors wanted to bring prices down they can’t. And it’s going to get a lot tougher in the new year.”

The recent behaviour of virtualisation software supplier VMware is typical of the confusion over prices in the more specialised software markets. The US-based developer put prices to its UK resellers up by a full 10 per cent in September, only to reduce them by the same amount a month later.

The effect was dramatic. “They slashed prices to stay competitive,” comments Brown. “But that only negated the fluctuations in currency rates.” Panacea Services has seen customers pull out of projects, rather than pay the higher price.

One unfortunate effect of currency pressures is that suppliers’ quotes are very short lived, with some being valid for as little as 14 days. Nick Garlick, managing director of security and virtualisation firm Nebulas Solutions, says this makes it very difficult for users to plan and budget for next year.

One thing that is certain is that most software prices are unlikely to fall now or in the future.

“What we know is there is no such trend as a decrease in prices: [software companies] don’t intend to decrease prices of either licences or maintenance,” says Bernard-Louis Roques, general partner and founder of venture fund Truffle Capital, which tracks the activities of the 100 largest European software companies.

Roques says he has seen software suppliers increase their efforts to collect maintenance payments more effectively both because of the looming year end and because of the possibility of customer bankruptcies. “There will be pressure on sales in 2009, so software companies will want to preserve maintenance revenues. They are being very firm as the impact of the crisis takes effect. Recurring revenue is more important than one chunk of revenue,” he maintains.

European software firms have already seen customers postponing projects or investigating cheaper alternatives, but that has not affected prices, according to Roques.

“Price pressure on licence fees is not the major concern,” he says. “Companies are more worried about customers not placing an order or not paying for what they have ordered.”

Suppliers have not had it all their own way on what they charge. At the end of last year, outraged SAP users won a unique concession when the company agreed to hold off part of the price increase for support until it could prove that its services were worth the extra money.

User interface

Despite the fact that SAP planned to put prices up to 22 per cent because of new features including support for third-party software and because its rates were below those of rivals such as Oracle, the company bowed to user power.

“We’ve stepped beyond any other vendor and agreed key performance indicators and joint monitoring,” says David Keene, SAP’s vice president of marketing and competition.

“We have also agreed a charter and biennial meetings at our development laboratory in Palo Alto [in California].”

Representatives from SAP and the 12-member SAP User Group Executive Network (SUGEN) have been working on a series of key performance indicators which will be used to judge the value of SAP’s enterprise support.

“Our expectation is that if the key performance indicators don’t show value has been received, the price increases won’t go through,” says Alan Bowling, chair of the SAP UK & Ireland User Group and former CIO of Northern Foods.

The hard part is working out the yardsticks by which to judge the value of the support provided by SAP but they are likely to include customer satisfaction surveys, recording how long it takes to resolve problems and measuring the time that support service is available.

“If I said it was going to be easy I would be lying. It is a whole new way of working,” says Bowling. “But we aim to have something by the end of December.”

In terms of income, maintenance is becoming increasingly important to IT companies, particularly as a way of keeping up a flow of revenues from existing customers. Usually, maintenance is charged as a percentage of the list price of a software licence so it is unaffected by discounting.

As far as licence fees are concerned, the story is very different.

“Discounting in the enterprise application sector is the norm, to the extent that the actual price paid for software licences often bears little relationship to the list price,” says Angela Eager, senior research analyst at advisory company Butler Group.

“Over recent years, discounts have become more exaggerated due to the maturity of the market and the fierce competition by SAP and Oracle to increase their respective market shares,” she says.

“One way of alleviating the financial pain is to increase the software licence list price, enabling suppliers to offer what appear to be higher discounts without affecting their actual revenue.”

Cut-price deals

Discounting can take many forms, from bundling service fees into an overall price to offering fixed-price implementation or helping customers with finance by offering them deferred payments. Suppliers also provide customers with free training and education. They may even work with them on joint development. “We see many vendors offering ‘once in a lifetime’ deals,” says Forrester’s Wang. “Discounting has significantly increased this year over last year during the same time -period. Keep in mind [that] quarter four is the big quarter and accounts for up to 45 per cent of all software revenues for some vendors. “There are plenty of monetary and non-monetary options we are helping our clients with right now.”

Wang, who is working on a report .entitled Five Steps to Building a Recession-Proof Apps Strategy, claims that the next six to 12 months will provide a unique opportunity to negotiate better deals. And he expects to see continued discounts “until the credit markets stabilise”.

This year is likely to see conventional logic reassert itself with falling prices across the board. In the meantime, SAP users are not the only ones who will be concentrating on getting enough value from their software and support to justify the extra cost.

Cloud’s silver lining

While prices for traditional software licences and associated support remain high, alternative models for accessing software will look increasingly attractive.

Certainly, companies selling software as a service (SaaS) or charging for support only for software acquired under the open-source model are bullish about their price advantage, claiming savings of 25 per cent or more.

With SaaS, cost reductions are mostly obtained by cutting out up-front licence charges and eliminating in-house experts such as database administrators who are needed to handle upgrades, testing and support in-house. Users also avoid hefty consultancy fees, which can push up the cost of running complex software. “Old ways of managing someone else’s application in-house now seem crazy – it’s like Lewis Hamilton paying his mates to maintain his McLaren just because they are good at fixing cars rather than trusting the team that built the car in the first place,” is how Neil Smyth, chief technology officer at Statpro, puts it. Statpro supplies a hosted package, which costs up to £40,000 per year to access, that analyses portfolio data for fund managers and which is now playing a key role during the credit crunch. The software and an associated risk system data service allow managers to analyse the risk of an institution defaulting on its debts.

Customers pay a licence fee and an annual subscription on a three-year contract basis. Companies who may then want to customise the software and run it in-house actually pay a premium for the privilege. Companies such as Statpro, which recently launched a web-only implementation of its analysis tool, are convinced they offer a better deal than incumbent, established software developers that have in some cases dominated markets for decades.

“It’s a great moment for software as a service and open source,” says Bernard-Louis Roques of venture fund Truffle Capital. “Incumbents are not aggressively turning themselves into SaaS companies because it takes five years to make what you can currently make in a year. Sales people make less commission too.” There are plenty of analysts happy to back Roques. Gartner forecasts that SaaS will account for 35 per cent of software deployments in a little over two years, and that some 43 per cent of UK users already deploy open-source software.

“We are now seeing more distressed buyers,” says Simon Caitlin, a senior vice president at open-source software company Ingres. “Banks and manufacturers are saying ‘we can’t carry on with our plans’ – they are asking whether open source is usable and whether it will drive out cost.”

Ray Wang at analyst Forrester Research also sees SaaS firms as direct beneficiaries of the recession. “Many companies are fed up with expensive up-front licence fees, ongoing maintenance, upgrade fatigue, and ongoing costs of integration,” he says.

“Open source is gaining some traction but there is a fear that this will require more reliance on IT staff. In the case of companies considering staff reductions, this could be an issue.”

John Powell, CEO of open-source content management supplier Alfresco, says users regard firms like his as their insurance policy. “Stack vendors are in a strong position because they can parlay discounts for an interest in a customer account. People are thinking they need open-source tools to change that paradigm,” he says.