META Report: Subscription to Pain

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By William Snyder

Three major software vendors, Computer Associates, Oracle, and Microsoft, have announced or have in place subscription-type licensing agreements (also referred to as a term or leased license). Although this licensing method has existed in the past (from vendors including IBM and SAS), the three new vendors first established market dominance, then changed policy from perpetual licensing to subscription — with associated increases in cost.

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IBM licensing is also differentiated from these new subscription converts because customers have not suffered the high upfront cost of acquiring the products. (CA, Oracle, and Microsoft have forced customers to pay a large upfront fee for the perpetual license rights.) The distinguishing feature of the subscription model is the lack of any continuing right to use the product, which ultimately works against the customer’s best interests.

We at META Group believe that, absent severe customer backlash, subscription licensing will become the major licensing model by 2007. Through 2003, the first-generation conversion to subscription-based licenses will appear to be cost-neutral when compared to continuing maintenance payments. When first-generation agreements start to expire in 2004, customers will see cost increases of between 15 percent and 35 percent, driven by the inability to find competitive products and high switching costs. Through 2005, companies that proactively plan and manage software portfolios will achieve savings of 25 percent by implementing advanced negotiation techniques of contract terms and conditions.

Vendors are making a strong push toward a subscription-based license methodology as a means of enhancing and smoothing revenue flows. Beyond Wall Street profit expectations, the Unix/Win2000 platforms are maturing, and the addition of incremental features is failing to drive customer upgrades at the speed vendors would like.

The most intriguing rationale from vendors is the suggestion that customers are requesting subscription licensing (as well as software as a service). Our research indicates customers are requesting affordable (or alternatively financed) software, not subscription-based licensing. Global 2000 companies recognize the strategic value of these software assets and prefer the protection of long-term perpetual rights.

Why Care?
In a competitive market with low switching costs, the subscription licensing model is a low-risk proposition because customers can readily switch to a competitor (which is not the case in most data-center software markets). However, in a less competitive, high-switching-cost market (e.g., OS/390 environments), the choice to change products is a long-term process, if it is even feasible at all.

Therefore, most customers carry maintenance as a standard procedure to ensure patches, fixes, and enhancements are available as necessary. Vendors will attempt to persuade customers that the change to subscription-based licensing is a zero-sum impact, or even better than existing models. Although these claims initially appear valid, the true impact of the licensing change is at the end of agreements, when the rights to products are non-existent and customers must pay to continue use.

Additionally, as subscription licensing becomes more commonplace, we believe customers will find it more difficult to obtain price lists as vendors push customers toward “confidential” custom deals. This gives customers even less leverage at the end of the term, because the inability to calculate the alternative costs will make negotiations very difficult.

Some customers view subscription licenses as an improvement from an accounting perspective, but they must be cautious and separate the internal accounting benefits from the external vendor relationship. Although paying for licenses can result in beneficial corporate accounting, customers will ultimately pay increased fees for no incremental value without carefully developed long-term protections.

In the worst-case scenario, customers can find themselves shut out of using a mission-critical application due to the inability to reach terms with the software vendor. Although this will only happen in a small minority of cases, the threat is severe enough to weaken negotiations in all but the most litigious companies.

An additional weakness of the subscription model is that customers have no basis for demanding future product support in the contract. The rights to prolonged use of any particular version are entirely predicated on the vendor’s product support policy.

Additional issues with subscription models occur when required software upgrades increase ancillary costs (hardware, related software). This can challenge the already strained IT budget at a time when defining value to IT customers is difficult. In some cases, the new software will require training, thus increasing costs even further.

Prescriptive Measures
Although most customers will ultimately be forced (or lured) to accept subscription-based licensing, asset management tactics can be leveraged to prevent the most egregious offenses. The key to these strategies is establishing negotiation leverage during and at the end of the license term, including the following:

Building alternatives: Alternatives should be clearly defined and documented with respect to long-term options. These options should be communicated to IT customers to ensure clear understanding of potential costs and to solicit support on controlling costs (e.g., eliminating redundant desktops). Customers should revisit the alternatives annually during the contract term to validate assumptions.
Long-term rights: Customers contemplating architecture involving these vendors should ensure that long-term rights are established before a commitment is made. Passcode delivery must be guaranteed regardless of license status (to prevent business interruption). Contracts should also clearly reflect the right to use or procure back-level versions of products at no additional cost.
Ensuring continuing rights: Customers should include rights to run products during disputed periods until legal proceedings are finished. In the event that the customer is ultimately found to be out of compliance, existing licenses should not be impacted.
Establishing incremental and end-of-contract costs: Alternately, the vendor should be required to attach the current price list (with appropriate CPI escalation) to ensure cost predictability. Attached pricing should include an established discount schedule.
Building five-year cost models: Five-year costs should be analyzed and well defined in proposals to eliminate ambiguity. Renewal costs and any associated costs (e.g., hardware upgrades) should be included.
Incorporating business-flexible terms: Contracts should include provisions for implementing capacity on demand for short durations without incurring additional costs or breaching the contract (e.g., an annual true-up with an interim 10 percent variance).

Business Impact:IT departments must work with lines of business to identify business processes that may be impacted by licensing difficulties. Proactive measures should be implemented to identify and prevent these issues.

Bottom Line:Asset management tactics are crucial to ensuring that subscription-based licensing does not materially impact budgets or mission-critical applications.

William Snyder is an analyst for META Group, an IT consulting firm based in Stamford, Conn.