The devil is in the subscription-licensing details

The transition to cloud-based services is ratcheting up traditional enterprise software costs and adding layers of complexity

David Steinour is at his wit's end with enterprise software cost increases. In each of the past three years, the CIO at GWU (George Washington University) watched his annual maintenance and support costs for Oracle Financials and related enterprise software jump by at least 10 percent.

"Oracle works very well, but at the end of the day we pay a huge price for that service," Steinour says.

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Today, 99 percent of the fixed-cost increases in the university's IT budget come from software maintenance price hikes. "That's just not sustainable," says Steinour, whose IT department supports 20,000 students and 1,600 faculty members.

Eric Robinson, CIO at Color Spot Nurseries, a $300 million, 4,000-employee wholesale grower that supplies plants to big-box stores, has been an SAP user since 2000. He says his biggest issue isn't the cost of the perpetual license for the outright purchase of on-premises SAP software, or the annual increases in SAP maintenance fees -- it's the fact that Fallbrook, Calif.-based Color Spot wasn't getting much in return for the money it spent on maintenance.

Robinson says SAP has been gradually raising support costs in annual increments from the initial 17 percent of the original software license price. In 2008, SAP had sent Robinson a letter announcing plans to gradually increase his rate to 22 percent plus an annual increase based on a cost-of-living index adjustment, and move him from Standard Support to a new Enterprise Support plan. In 2010, Color Spot was paying 18.1 percent and Robinson decided to drop SAP's maintenance plan and move to a third-party provider. At that time, SAP reintroduced Standard Support. In July, SAP raised the price on Standard Support from 18 percent of the original license cost to 19 percent for new contracts. Enterprise Support remains at 22 percent.

Rates started at 15 percent in the early 1980s, then gradually rose to 17 percent and stayed there until about 2005, says R "Ray" Wang, an analyst at Constellation Research specializing in enterprise software contract negotiations. They've since risen to 19 percent and now 22 percent, he adds.

Robinson acknowledges that Color Spot's SAP system is stable and that he didn't need to make many calls for support. But he points out that SAP doesn't support any of his company's customizations, and the support packs and major upgrades his IT organization was required to install to remain in compliance with the maintenance and support contract were expensive and delivered no value to the business.

SAP's top clients now spend $2 million to $5 million per year on maintenance and support contracts that average 20 percent to 25 percent of the original software cost, Wang says. "Every four years, they're paying the same amount they paid for the license," and most say that they're not getting the features they want for their money, he says. "They wonder whether they're better off not paying maintenance and just buying new software every four or five years."

For Robinson, the last straw came when he decided not to upgrade from Version 4.7 and SAP was about to require Color Spot to transition to its extended maintenance program, which is for users of older versions of SAP software. "At that time, SAP was 20 percent of the IT budget. It was ridiculous," he says. That's when he decided not to renew Color Spot's maintenance contract.

An SAP spokesman responds that, historically, standard support customers have paid an additional 2 percent to 6 percent for extended maintenance.

In general, however, "the way enterprise software is licensed today is just not meeting the needs of many organizations," says Patricia Adams, an analyst at Gartner. Organizations are fed up with the perpetual-license-plus-maintenance approach to enterprise software purchases, and they're tired of running on the upgrade treadmill simply for the sake of keeping their software maintenance status current. Organizations "struggle with the currency of the software," Adams says, "and, when negotiating, they still struggle with finding out how the vendor performed against the contract."

IT shops have been pushing back. When GWU's contract comes up for renewal, Steinour says he plans to look at more cost-effective approaches to enterprise software licensing and maintenance, including a gradual migration to a subscription-based software-as-a-service offering from Oracle or another vendor.

If the university commits to a change, it would consider moving to third-party maintenance as an interim step, he says. That would allow the IT department to continue supporting the software and receive bug fixes as well as tax and regulatory updates for payroll, but no software upgrades. Essentially, the university would freeze its two ERP implementations until it was ready to move off the old ERP system -- and that process could take a long time. "[Users] would be involved in the decision process of the future direction, [and] I am sure they would be supportive of our mission," Steinour says.

For his part, Robinson says he couldn't justify spending hundreds of thousands of dollars to upgrade to SAP ECC (Enterprise Core Component) 6.0 just to keep maintenance costs down. "I looked at ECC 6, and I found nothing that made sense for us," he says. So Color Spot went with Rimini Street, a third-party maintenance provider that offered maintenance and support services for less than half of what SAP was charging -- and it included support for Color Spot's customizations, something SAP didn't offer. "Our maintenance is now 9 percent of the IT budget; initially it was 20 percent," Robinson says. And while he no longer receives software upgrades, he says he can still buy additional modules and add users. The software vendors are "still happy to take your money," he says.

Third-party maintenance providers such as Rimini Street and CedarCrestone have incurred the wrath of Oracle's lawyers -- and for good reason, says Frank Scavo, president of Strativa, a management consulting firm that advises enterprises on business and technology decisions: The vendors' lucrative contracts carry profit margins as high as 90 percent. (Oracle didn't respond to several requests to comment on its licensing policies.)

There's a reason why traditional ERP software costs are rising. Sales of core ERP systems have slowed, with projected growth of just 5.8 percent through 2016. And much of the new sales are of cloud-based services, which are seeing double- and even triple-digit growth, says Christine Dover, an analyst at IDC.

"These companies are under earnings pressure," Scavo says, and while traditional ERP software vendors are moving aggressively to compete, they have lost market share to SaaS providers like Workday, Salesforce.com, and NetSuite. And the transition to a cloud service model, where a deal might bring $100 per user per month versus several million upfront and a 22 percent annual maintenance fee, is a difficult one for traditional ERP vendors to make because the money comes in gradually rather than in a big lump sum.

So vendors have been pursuing ways to get more revenue from their existing customers while they make the transition. "Both SAP and Oracle are being very opportunistic in accounts where they already have a strong presence," and that's being driven from the top down, says David Blake, CEO of Boston-based management consultancy UpperEdge.

One way they're doing that is by extracting additional maintenance and support fees, Scavo says. His clients have also seen an increase in the number of on-site audits.

Yet another gotcha for SAP users in the past year or two has been the vendor's aggressive enforcement of its indirect access fees, which are additional licensing charges for users of other applications that access SAP applications or data stored in SAP systems. Scavo says the practice represents a potentially large liability for the unwary, since SAP systems are often integrated with third-party applications on the edge of core ERP systems.

The language describing indirect access charges in the general terms and conditions in SAP contracts has been "quite vague and ambiguous," Scavo says, so some enterprises customers that have purchased non-SAP systems have been exposed to unanticipated charges. "It's more of a Trojan horse approach," he says, explaining that once a user brings in third-party software, SAP comes in looking to enforce its indirect access charges.

Lynn Costa, former vice president of shared services at Scholastic Inc., a $2 billion children's book publisher, says she faced such a situation when she discovered that one of the publisher's enterprise software licenses was tied to hardware that was shared with other programs.

Such problems could be avoided by isolating the hardware in its own environment, but that may not always be possible. Costa's advice: It's not enough to have the lawyers and procurement people review these contracts. "Have multiple people on the IT staff read through all of the details," she says. "And push back. If you don't negotiate it at that time, you're never going to get it later."

Steinour says he doesn't want to get caught with last-minute surprises, so he's especially cautious when it comes to renegotiating contracts. "We start talking a year and a half before the contract is up. If it doesn't work out, I still have a year to plan my exit strategy," he says.

The problem with that negotiating strategy is that the university is locked in. Steinour knows it -- and his software vendors know it. "Oracle is my biggest challenge because we don't have much leverage," he admits.

Like many IT executives, Steinour says he would like to take advantage of subscription-based cloud offerings to avoid paying a separate maintenance bill and making capital investments in major software and hardware upgrades every few years. But the university is bound to an ERP implementation that's highly adapted to the ways in which the organization likes to conduct business. "We're used to buying software and customizing it to death," Steinour says.

"When you put in a $40 [million] or $50 million ERP package, it's difficult to have an exit strategy without causing a lot of pain. They know that, and so they increase our costs every year," he says. Therefore, Steinour says he would like to lay the groundwork for a more strategic approach.

"With cloud, you need to adjust your business processes to align with the software," he says. That model will require an expensive business process redesign, and that kind of change won't come easily. "The hardest part is getting the business areas to readjust their business processes, which add overhead to whatever we do," he says. But in the long run, he adds, "we will be more sustainable going forward."

A new era?

At Red Hat, 40 percent of the enterprise software runs as cloud-based services under a subscription model, but the vendor of open-source software also has a traditional implementation of core ERP applications running on premises to support its 5,600 employees, according to CIO Lee Congdon.

To Congdon, the key to moving forward is to create a viable option for moving off of those platforms. He worries not just about cost but about being locked into a vendor's software with a highly customized implementation that might lead to inflexibility -- and competitive disadvantage. "What happens when your competitors move to new systems with different attributes?" he asks.

Congdon is worried about the potential competitive threat from startups that aren't tied to legacy on-premises ERP systems. And IDC's Dover says that's also a valid concern to have about global competitors in emerging markets. "In places like India, they didn't buy traditional on-premises systems, and they're going right to cloud," she says.

Congdon says Red Hat is "creating the option to move [by] working to keep our business processes straightforward and minimize customizations."

But the SaaS model has its own potential pitfalls, IT executives and analysts say. "My worry is that the SaaS vendors are going to do to us exactly what the big vendors did to us," Steinour says. "We have to make sure we have a rock-solid contract and an exit strategy."

From a vendor's standpoint, moving customers to a subscription-based service should be more attractive because software maintenance costs can be rolled into a single monthly fee. For the customer, however, a move to SaaS simply means maintenance fees are hidden within monthly subscription fees.

"You can't go off maintenance with Salesforce.com," Scavo says. And while subscription-based services can get IT off the upgrade treadmill and allow it to replace multimillion-dollar capital investments in software and hardware infrastructure with subscription fees, they may not be cheaper in the long run.

Already, Scavo says, "cloud vendors are able to charge a premium because of the limited amount of competition in some markets." For example, Salesforce.com already dominates the CRM market. While today the cloud is cost-competitive, vendors such as Salesforce.com could become tomorrow's SAPs and Oracles.

As cloud usage grows more common, there will be increased competition, Scavo says. But IT should be prepared for the possibility that a few vendors may dominate some markets.

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