3 keys to negotiating successful cloud agreements

Nowadays it is both impossible and impractical to avoid the cloud. Regardless of whether your organization is a growing SMB or finds itself within the Fortune 500, it is highly likely a cloud solution is currently under serious consideration or has already been implemented. Many different types of cloud offerings are available – such as software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS) – as companies have been drawn to the cloud’s promises of agility, flexibility, reduced costs and faster time to benefits.

Software as a service

In the SaaS category, vendors such as Salesforce.com have been quite successful in gaining significant market share in customer relationship management (CRM), as organizations and their respective sales branches have often led with CRM to start their journey into the cloud. In the human capital management (HCM) space, vendors such as Workday, SAP (through its acquisition of SuccessFactors), and Oracle (through its acquisition of Taleo) are aggressively pushing their cloud-based offerings to the market.

Salesforce.com and Workday continue to sell based on a best-of-breed approach while developing and broadening the capabilities of their respective platforms. SAP and Oracle, on the other hand, are laser-focused on their installed base, leveraging their pedigree and vast resources to push their customers to integrate their respective cloud solutions with existing on-premises environments. If performing due diligence on a cloud solution, make sure to:

• Spend ample time conducting reference calls while assessing the likely cost-benefit ratio of the solution against the more intangible agility and flexibility benefits.
• Balance reference calls coordinated by the vendors with those provided by more impartial sources (i.e., sourcing advisors, research firms, your peer network, etc.). 
• Once comfortable with the solution and model, approach the negotiation with the same attention and rigor that you would apply to any other enterprise agreement.

Three key items should be addressed to ensure you execute a best-in-class cloud agreement.

1. Ability to scale

Many cloud agreements afford you the ability to purchase additional user seats or services as your need increases during the term of the agreement. However, it is also important to have a mechanism in place to adjust the economics should your actual demand (i.e., usage) decreases. Since most cloud agreements require upfront annual commitment levels (e.g., user counts, defined scope of services/capacity), there are too many cases of “shelfware” and/or “shelf services.”

It is critical to ensure your vendor affords you the contractual right to reduce your commitment level and receive a corresponding reduction in the go-forward fees.

• If you agree to include an upfront payment schedule, require a refund or credit toward future use.
• If your cloud agreement permits you to purchase additional user seats or services/capacity, ensure the prices and fees for such additions are clearly stated in the contract.

Without this certainty, you may find yourself hit with numerous incremental and unbudgeted price increases.

2.  Renewal terms and pricing

The nature of certain cloud agreements fosters increased vendor dependency and heightened scenarios for vendor lock-in. In its simplest sense, cloud agreements are subscription arrangements that require renewal if your organization wishes to continue receiving the services or functionality delivered by your chosen provider. Once an organization and its user base are up and running (hopefully with increased agility and productivity), it is very difficult and often impossible not to renew. Doing so would require extensive upfront resources, time, transition planning, migration execution, and renewed change management.

The cloud vendors know this is exactly why they love selling cloud solutions. Given the risk of dependency and lock-in, it is important to negotiate the length of your renewal term(s) (i.e., terms/durations beyond the initial term) as well as the associated price/fee protections in advance of signing the initial deal.

Most cloud vendors want you to renew for multiple years. A multiyear renewal term means multiple years of renewal bookings that eventually convert to recognized revenue. But if you negotiate the ability to renew in one-year increments, this ensures you have appropriate options and reinforces the mindset that your cloud provider must earn your business every year.

When it comes to the prices and fees associated with the renewal term, most cloud agreements will include a stated price increase after the initial term, generally effective on the renewal date. This may come in the form of a stated cap on the increase, for example 2% or CPI. Not having a stated price increase and/or cap on the increase further enhances your exposure to price/fee increases, as the lack of clarity could make you susceptible to midterm as well as renewal date increases. The impact of these increases tends to be compounded as the magnitude of the increase is unknown and typically unplanned. Companies should negotiate no price/fee increases until three years from the first renewal date.

By way of example, if the initial term of the contract is three years, then the price/fee afforded the organization over the initial term should be available and applied to the next three one-year renewal terms. Essentially, you are asking your cloud provider to invest in the relationship by providing you the same discount they used to win your business once they have secured your business. After this price/fee flat-line period, all price/fee increases should be contractually limited to CPI or another measure to which the parties agree. Incorporating a cap at this point limits your cloud provider from trying to make up for perceived lost revenue.

3.  Termination rights and obligations

A cloud agreement should provide your company with the ability to terminate for convenience with no associated penalty or “termination fee.”In addition, the ability to terminate for serious or continuous failure to meet committed service levels (e.g., uptime, response time, resolution, etc.) must be included in the agreement. Service-level adherence is critical when dealing with a cloud-based solution, especially when the application and/or service is critical to the business. Having the ability to terminate should there be service-level non-conformance is one way to ensure your vendor is standing behind their service levels rather than simply providing you with “objectives” and/or “targets.”

A vendor’s reluctance to provide this trigger for termination should be a red flag. Ensure the vendor’s obligations upon termination are clearly stated. This includes the return (in both the vendor’s data format and a platform-agnostic format) and removal of data (i.e., certification that your data has been removed from the vendor’s servers) as well as an obligation to provide appropriate transition services.

Finally, do not permit your cloud provider to have the contractual right to terminate or suspend services other than for cause. If it is a business- or enterprise-critical application or service, you can’t afford to have the vendor choose when it wants to walk away from the relationship.