Pricing Issues

In the contracting duality of terms and pricing, I spend the bulk of my time here talking about terms.  The reason is generally simple – terms are fairly common across contracts.  Pricing, on the other hand, appears deal-specific and too different to really discuss in detail.  I simply can’t tell you that a 30% discount is what you should be looking for all the time.  Sometimes 10% is good (for certain vendors) and sometimes 80% is good (for other vendors).  Without violating various confidentiality provisions – and without knowing other specifics about a particular deal (such as its size, duration, etc) – I’m a little boxed in.  But I did realize that there are a few things you can learn about pricing which will help you, regardless of which side of the fence you’re on.

First, you need to go read Joel Spolsky’s excellent article: “Camels and Rubber Duckies“.  This will give you the starting point for understanding how pricing should be created.  Eric Sink uses a similar breakdown to understand the economics of how software is priced.  Next, you need to understand the four basic ways software is licensed.  This article by Erik Keller from 2007 in Manufacturing Business Technology is a bit dated, but hits the fundamentals.  And even within the SaaS model (and, in fact, the traditional model), there are different metrics upon which the licenses can be measured.  Check out this optional article by Jason Rothbart from January 17, 2009’s ReadWriteWeb.

So armed with an understanding of how software is priced, we then need to move onto maintenance and support.  Let’s start with the basics from this 2006 Information Week article (still relevant data).  What we’ve got these days is a system in which we expect to pay a base fee for the license plus an annual support fee… or we pay the leasing/SaaS model of “license renewals” for each year of use.  Regardless of how you slice it, there’s an annual fee component to the deal.

Forgetting about the tax implications of mandatory maintenance in many jurisdictions, I instead want to focus on a very specific pricing issue – the increase. Yup, all of this build-up and what I really want to talk about is the language in your various license agreements and maintenance documents that allow for increases in license and/or maintenance fees year after year (you need to understand how license fees are created to really dive into increase language).  This is a hidden gem for vendors and is often overlooked by licensees, simply because people don’t think about its effect on price (because it’s an increase on future pricing and not today’s pricing, it’s sometimes not deemed relevant or worrisome).  I believe that license and maintenance fee increase language is dangerous at best and disastrous at worst.  Here’s why.

Assume for the moment that you’ve paid $1,000,000 for your license and that you have a 20% annual maintenance fee.  There’s no more “warranty grace period” so, interestingly enough, the vendor actually wants $1,200,000 that first year.  Well, to start, Vinnie Mirchandani over at deal architect will tell you that maintenance is overpriced.  I agree.  For $200,000, I would expect at least 1/5th the value of the license to come back to me that first year in maintenance and support.  In other words, is the software SO BAD that it requires 4,000 hours of support by a $50/hour technician for that year?  I hope not.  Or, alternatively, are you getting a 20% increase in features and functionality in the next release of the software that year?  My guess is that the answer to both questions is “no”.

So 20%, on its face, seems pretty unreasonable from the get-go (you can also just think about it in terms of re-licensing costs… do you want to have effectively paid to re-license the software in 5 years?).  Now let’s factor in the increase.  These range from 3-15% in most license templates today.  Even at 3%, that would equal a $6,000 increase in the $200,000 fee from Year 1 to Year 2 (at 15%, that increase would be $30,000).  The most common rationale given for increases is a cost-of-living (economic) excuse for the support people.  The second most common is the same argument, only this time, it’s the cost of goods and/or materials.  (My personal favorite counter argument is to agree that pricing should be tied to the economy, and then re-write the language so that “the pricing changes based on the CPI-U All-Items percentage for the prior year”.  This allows it to actually go down.  A savvy vendor won’t ever allow this.  But then their excuse evaporates, too.)  Thus, I’ve had to concede increases in many cases.  I’ve even said before that for 3-5 year deals, I try to get increases removed for the term of the agreement (it’s the trade-off for a long-term deal).

But what about increases not tied to the economy, rather the simple cost of doing business?  Should customers be saddled with the expenses related to having to change a product because the vendor’s industry is regulated by the government?  Should the end-user, mid-term on a contract, be expected to pay for changes resulting from something completely outside of the customer’s control?  I’m thinking specifically in the telecom industry (and others) – where federal regulations that result in fees typically find themselves trickled down to the customer.  I’ve said it before and I’ll say it again… the telecom vendors don’t have to pass along the fees.  They could pay them themselves.  But they don’t.  If you’ve ever seen a line-item for cost-recovery fees, that’s what we’re talking about.

So the question is – should you accept these pass-through fees?  Or, more specifically, should you accept increases in these pass-through fees?  I can understand that there is an economic argument (as above)… that it’s an increase in cost for something you thought was fixed or sunk before the contract was signed.  But isn’t it just a risk of doing business in any particular industry?  Don’t we, as automobile owners, for example, take the risk that gas prices are going to increase or that we may lose our jobs tomorrow?  And that if we decide to buy a car today, we accept those risks and have to deal with the consequences if the situations change?  Why should I have to protect not only myself, but also my vendors, from the risks (and costs) of doing business in their industry?

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