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Subscribe Now, Pay Later?

CIOs need to protect themselves against the unforeseen price increases that often accompany subscription licence deals. If customers aren't careful to negotiate protection against steep price jumps, they could end up with ballooning software costs

When Subscriptions Make Sense - and When They Don't

A year and a half ago, Mercury Interactive approached Mike Conlon, director of data infrastructure at the University of Florida, with a new kind of licensing offer. For a year, Conlon would rent Mercury's case tracking and load testing software, which monitors and improves performance of the university's enterprise applications, at a relatively low cost. Then, he would have the option to renew at the same price for three years. Conlon decided to take the leap because he saw little risk in renting this type of software. "We didn't have a big outlay up front, and we didn't have the burden of thinking we would have to stick with it," he says.

Since then, Conlon has renewed his deal with Mercury and says he is open to subscription deals for other software licences. The biggest advantage, he says, is the freedom to change his mind. In the 90s, he recalls that the university had a terrible experience with several perpetual licences it bought for e-mail software from various vendors. In one case, university officials had to abandon the licence; another time, they spent lots of money on fixes because of user complaints. "If we had a subscription licence for those e-mail packages, we would have saved a lot of time and money," he says.

Conlon admits that the subscription model isn't for everyone, especially those who believe they will be using the software for a long time. "There are a lot of people who believe (rightly or wrongly) that they will own the software for 10 or 20 years," he says. In that case, they should go with a perpetual licence. He advises CIOs who are tempted to try subscription licences to start with an application that they could imagine having for only two to three years. Michael Overly, a lawyer at the Los Angeles firm Foley & Lardner, also advises clients that subscription arrangements can be useful from a budgeting perspective because of low up-front investments. But if they believe they will be implementing the software for a long time and will need extensive customization, it is less appealing because subscription costs can mount over time. In those cases, forking over the money for a perpetual licence and paying up front for customization would be a better investment than paying a subscription fee year after year. CIOs also need to consider how strategic their systems will be. "When you're talking about sophisticated supply chain management that could give you a competitive advantage, then it wouldn't be the best candidate for a subscription," says IDC's Konary, adding that customers should be wary of signing up with a vendor that may not survive over the long term.

Wayne Bennett, a partner at the Boston law firm Bingham McCutchen, sees the debate over whether to go with a subscription licence as a simple financing question. "It's really the same way you would buy a car," he says. "It's a financing determination driven by usage. I have an 11-year-old car, and it's no question that I got a better deal from buying than leasing." If you use your software for as long as you might drive a car, then perpetual licences make more sense.

However, Bennett adds, "If you call your usage pattern wrong, you can get screwed." If you buy a subscription based on the number of people who will be using the software, the software vendor can increase its rates if the number of users goes up. With a perpetual licence, the customer generally pays a hefty fee up front that often covers a large number of users, so there are fewer surprises down the road. In fact, it is common for companies to overbuy software and end up with more than they actually need.

How to Protect Against Price Shocks

Jim Trupiano, manager of IT contracts and vendor relations at Southern Company, a Georgia-based utility, has used data analysis software under subscription licence for more than four years. Each year, he carefully picks the number of employees who will be using the software in order to determine the price. "Your risk is in making sure you don't have more people using it than you've paid for," Trupiano says. "If you become dependent on the software and the cost begins to double, you will find yourself in trouble." Trupiano says it's of utmost importance in the subscription licensing arena to make sure you have a flexible contract that allows for growth at reasonable rates.

In addition to the usage question, CIOs must comb their contract to make sure they are getting some sort of price protection against outrageous yearly increases as well as warranty coverage. "It's essential to negotiate with the vendor to make sure there is price protection in there," says University of Florida's Conlon. "You can't have an escalator in there."

According to lawyers who work on subscription contracts, those just now signing up for subscription deals may have some nasty surprises down the road. It's still early to point to a lot of cases in which enterprise software customers have run into trouble with subscription licences; the number of CIOs who have gone this route is still small. But the first major problems are emerging. One large national company, for example, signed a subscription deal for ERP software without negotiating price caps. The vendor, which had agreed to keep prices stable for two years, came back with a 30 percent increase in the third year. With the new fees now kicking in, the company has no time to transition to a new system. The CIO at that company, who had not been involved in the original deal, is now scrambling to negotiate with the vendor to limit the price hike, but he has very little leverage.

Attorneys advising clients on subscription deals encourage them to seek as much price protection as possible; some say to ask for seven years of price caps in any subscription licensing deal.

Most vendors won't give price protection forever, however, so software buyers need to be sensitive to the approaching end of a protection period, says attorney Overly. A year ahead of such an expiration, he says, CIOs should start exploring options with the current vendor and others to minimize the risk of the subscription agreement. Instead of getting stuck with little time to change systems, CIOs should start renegotiating while they still have time to look for possible replacements.

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