Negotiating Better Maintenance Terms

If there’s one thing that CIOs agree on, it’s maintenance fees. They’re a great value for the money; the upgrades that the fees entitle you to provide the right solution at the right time. In fact, most CIOs write that yearly check with a smile.

And pigs fly. CIOs put maintenance fees in the same category as death and taxes—dreaded yet unavoidable. Licensing a piece of software buys you only the right to use it; if your organization wants support, upgrades and patches, vendors demand an additional annual fee in the ballpark of 17 percent to 20 percent of the up-front cost. A company that purchased a million-dollar ERP package, for example, could pay $200,000 for maintenance every year. Well, that’s $200,000 for the first year of the contract, really, since rates often increase as the contract wears on. "We always have the 3 percent updraft, kind of a cost-of-living increase on all maintenance fees," said Mark Ain, CEO of Kronos, in a conference call discussing his company’s fourth-quarter results for 2002. Ain was explaining to financial analysts that the HR systems manufacturer’s revenue stream would grow every year because Kronos’s customers had no choice but to pay those fees.

It’s precisely that attitude that makes CIOs feel they’re being taken advantage of. "I don’t want to go to an extreme and call it extortion," says Doron Cohen, senior vice president and CIO of Canada Life Financial, searching for the right word to express his frustration. But he does, after an extra minute of stewing hardens his conviction. "I’m looking at extortion money, and I’m not happy about it," he says.

"Very often the focus of the people buying is more on ’How much do I have to buy, and What kind of discount can I get?’" says Scott Rosenberg, whose Leonia, N.J.-based company, Miro Consulting, specializes in helping companies negotiate contracts with Oracle. "There’s less focus on ’Now that we have gotten married, what is that marriage going to be like?’"

Until now. The frustration over maintenance fees has taught CIOs to focus on the terms that will shape the vendor-customer relationship before entering into a deal. While in the past those fees have been nonnegotiable, CIOs’ recent insistence on working out favorable terms—combined with the slumping economy—has changed that. They are negotiating better terms up front, renegotiating midcontract and, in some cases, running software without maintenance.

The Problems with Vendors

The problems start with the term maintenance fee, which implies that it covers help desk calls, tech support and other such expenses. The truth, however, is that most of the benefits to a user company are indirect. Twenty percent to 50 percent of the maintenance fees collected by the top 10 major ERP vendors actually go toward the development of future releases, according to a 2002 AMR Research survey of those companies. In this regard, "maintenance" is a misnomer, since the fees represent a steady source of income for software vendors. The annual payment helps them make projections and balance their budgets, both bottom-line boons. Furthermore, annual fees keep the licensing cost artificially low; if vendors charged for support and R&D costs up front, software would be prohibitive for all but the wealthiest of organizations.

With an eye toward increasing revenue and lowering up-front payments in order to spur sales, vendors have been raising maintenance fees every year. In 1996, maintenance fees on enterprise software accounted for about 18 percent of ERP vendors’ annual revenue, reports AMR. By 2000, that percentage jumped to 25 percent. And AMR predicts still another increase by 2005, to 30 percent (see "Your Money Out the Window," above).

Vendors insist that maintenance is a crucial part of what CIOs are buying. "As the pace of change increases, so does the cost to keep up," says Claus Heinrich, a member of SAP’s executive board. Maintenance fees allow vendors to make investments and upgrades that individual companies could never afford or have the time to do themselves. For example, Heinrich has a team of 430 (350 full-time) developers working on SAP’s human resources module. Ultimately, Heinrich says, the cost to individual companies to develop similar updates on their own would be much higher than that of maintenance fees. Vague, yet risky scenarios like that are one of the reasons CIOs rarely risk finding out how much it would cost to try it on their own.

In addition, after a system has been in place for a couple of years, most CIOs rarely use technical support. Then the primary return on investment is updates. "Yet [vendors] will not give you any clear indication of what the product is going to look like over the next five years, and [they] won’t tell you what will be in there," says Jerry Hale, vice president and CIO of Eastman Chemical. That updated product may turn out to be wrong for your business. Or worse, says Hale, "we get the feeling that the majority of the development fees are going toward products that we have to license for again."

All of this may have been fine in 1999 and 2000 when you could simply pick the money off the tree in headquarters’ new arboretum. But today, many of the maintenance contracts signed in the good old days hang around CIOs’ necks like a noose.

Negotiate with Confidence

Most CIOs will admit they aren’t financial wizards; their job is to use technology to drive the business forward, not figure out how much to pay for it. With this in mind, maintenance is a trap waiting to happen. Companies invest considerable energy negotiating licensing fees and implementation costs, and are then too exhausted to argue over maintenance. As a result they relent to things they should not. "These are things that [vendors] do that are standard and legal," says AMR senior research analyst Monica Barron. But if you are aware of the vendor perspective, you can avoid some of the common pitfalls that can swallow you during contract negotiations.

When entering a negotiation, simply be prepared to ask for things. In fact, most of the tips we’ve gathered from various CIOs hail from the you-never-know-til-you-ask-for-it school. For starters, the maintenance percentage should apply to the negotiated rate of the software—not the retail rate. Vendors may try to peg the rate as a percentage of the current list price. Most of the CIOs interviewed for this article, however, say they are paying a percentage of the discounted rate, which can be substantially lower—40 percent in some cases.

Second, make sure to lock in the rate for the length of the contract. Many times vendors will agree to a rate for the first or second year, only to shoot it up thereafter. To ensure this doesn’t happen to Dow Corning, CIO Abbe Mulders insists on the same fixed rate for three to five years. Plus she includes language in her contract that limits how much the fee can increase. AMR’s Barron suggests linking the increase to a standard economic indicator like the consumer price index or the prime interest rate. Perhaps the best way for a CIO to set up a good maintenance contract is to admit that he is not a professional negotiator and hire someone who is. "The software companies make the contracts so complicated specifically to put you at a disadvantage," says Luc Lafontan, director of information security at publishing company Primedia. "[They] aren’t going to guide you through it." Lafontan hired Miro Consulting to negotiate its contract with Oracle. Some of the tricks the consultancy employed include combining used and unused software licenses to get the best rate and waiting until the end of the vendor’s quarter—when the vendor is anxious to close any deal and scoop up every dollar it can—to improve Primedia’s negotiating leverage.

Lastly, the most important element CIOs can bring to a negotiation is patience. Before choosing a vendor—or even during a long negotiation—a CIO always has the option of walking away and hiring another vendor that will agree to his terms. Vendors may resist many of the requests initially, says D. Beatty D’Alessandro, but you can wait them out. In 2001, D’Alessandro, vice president and CIO for electrical products maker Graybar Electric, spent more than three months in contract negotiations before agreeing to terms with SAP. He says he was willing to wait as long as it took to get satisfactory terms. That experience, he says, reinforced his guiding assumption: Everything is negotiable.

Throw Your Weight Around

Once a company has spent millions of dollars on licensing and implementation with a particular vendor, it’s hooked. And vendors know it. But that doesn’t mean a CIO has no options when it comes time to renegotiate. Primedia, for example, conducts monthly software audits and quarterly reviews with business units to find out how many licenses it has for any given piece of software and how many it actually needs—oftentimes revealing different numbers. This information lets Lafontan determine just how much maintenance he requires.

Another strategy is to influence the design of the next upgrade, an effective tactic especially midcontract. Mulders says Dow Corning works closely with SAP to let it know where Dow is headed. "That gives Dow the functionality we need in a general-release product so that we don’t have to pay additional [customization fees]," she says.

Certainly large companies such as Dow Corning have more leverage when it comes to influencing the shape of future versions. But small companies can have an influence as well through user groups and vendor conferences. For years, members of the Oracle Application User Group requested that Oracle reduce or waive the $100 fee the software maker charged for each technical reference manual. In 2000, the vendor started providing the manuals to licensed users through the Internet free of charge.

Finally, and this may seem obvious, use the support you’re paying for. "You need to push every problem that you have out to this group," says Lafontan.

Know When to Cut the Cord

When all else fails, CIOs can let a maintenance contract expire and support the system on their own. Running major software without maintenance happens, says Canada Life’s Cohen. "This is the same thing as when it is no longer supported," he says. Cohen says the Toronto-based insurer won’t be intimidated into paying maintenance if it doesn’t make business sense. In fact, last year he decided not to upgrade a key industry-specific package. The current version is 6.3, and Cohen runs version 4.6, which the vendor no longer supports. "We have modified it to the point where you would not recognize it," he says, meaning that upgrading wouldn’t be a simple task. In fact, Cohen determined that customizing the upgraded software would cost between $2.7 million and $3.4 million—a price tag that greatly outweighs the potential benefits of the new version.

AMR’s Barron agrees that sometimes it doesn’t make sense to keep paying maintenance, such as when a company has no plans to upgrade or if a vendor doesn’t plan to add new features. A CIO may choose to let a contract lapse if he never uses the vendor’s help desk or an audit shows that an application doesn’t have enough users.

CIOs are often superstitious when it comes to stopping maintenance. "The day you take the insurance off your house is the day it burns down," says Lafontan. Last summer he considered letting a maintenance contract on one of his company’s systems expire. But Lafontan learned the vendor would tack on an additional percentage of the original contract to future maintenance if he later chose to resume the service, which was enough to dissuade him from stopping the payments.

Cecil Smith, CIO of Duke Energy, advises CIOs to determine who owns the source code before deciding whether or not to stop paying maintenance on an application. If you own the source code, you’ll have an easier time getting to the core of the software when a problem pops up. "Typically, this is part of your [initial] negotiation," he says. "Many times what they are doing is selling you the rights to use it for a one-time charge, with the idea that a lot of revenue will be ongoing maintenance fees." If the vendor owns the source code, organizations will have a more difficult time solving a problem.

Smith says that although his company does maintain a large amount of its applications, self-support is not the first option for most packaged applications. "Many companies have streamlined down to where they have little staff, which is why they buy packaged software in the first place." These companies should think twice before stopping maintenance, he says. Likewise, most CIOs warn that stopping maintenance on HR systems is not a good idea, since they often include tax updates that would be too costly to do on your own.

Eastman’s Hale dreams of a world where every dollar paid for maintenance returns a dollar of value. "There needs to be some kind of grassroots effort where companies start pushing back and insisting that the software vendors unbundle maintenance and support and give us more visibility into how those dollars are being spent," he says. Short of a great uprising, CIOs are resigned to paying the fees. But they are more careful, negotiating favorable terms up front and getting as much of their money’s worth as possible. And when they do not, they aren’t afraid to call a vendor’s bluff and run unsupported.

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Copyright © 2003 IDG Communications, Inc.

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