Unless you’ve been playing the role of Rip Van Winkle for the past 10 years, you must have noticed that most, if not all, of your enterprise software suppliers have moved aggressively away from traditional software licensing models to hosted, service-based subscriptions. Known in the IT industry as “X as a Service” – where X can equal infrastructure, platform or software – this new model has dragged many end-user organizations into a new sourcing paradigm.
Nearly every IT authority today encourages end-user organizations to move toward more modern service-based relationships and reduce their dependency on their own datacenters. And there is no doubt that enterprises gain access to many new innovations and modernizations in an XaaS model. Where there is doubt is in the process of contracting for these services. XaaS contracts are an entirely different animal than contracts for traditionally licensed software – and they dramatically change the dynamic between an enterprise and its software suppliers.
In a service-based model, since the transaction is no longer for a retained or perpetual software asset, the leverage at licensing renewal shifts significantly away from the enterprise buyer and to the supplier. This is important because, while most enterprise software suppliers provide multi-year agreements, end-user organizations should consider a longer-than-typical agreement term to secure more predictable future pricing and reduce the frequency with which they must negotiate a renewal.
Subscription agreements for hosted services that are negotiated for term lengths greater than three years should provide compelling financial concessions in return for prepaid services, as well as an increase cap on any renewal pricing. And such commitments always need to be balanced with considerations around flexibility and the rapid evolution of new technologies.
Most buyers begin their migration away from their datacenter and onto their provider’s datacenter with pricing discounts that are designed (by the publishers) to incent the buyer’s decision to proceed down the services-based path. And, while these discounts can make the current agreement appear favorable to the buyer, they are based on certain assumptions about the end user’s ability to deploy these services and align features with actual usage.
Service-based deals typically come in various configurations and bundles, and end-user organizations need to assume their initial order configuration will undergo refinement over time based on usage metrics they receive from their supplier’s administrative management portals. These supplier portals provide comprehensive usage data and reporting that may highlight potential training gaps that may be limiting effective usage of the enrolled services – or that demonstrate such services are not needed and could be downgraded to save money.
Most enterprise software suppliers hope to secure prepaid annuity revenue, so once an account is set up and the amounts associated with an agreement are in place, the supplier has little incentive to change the accounting. This means now more than ever an enterprise needs a long-term agreement that extends beyond the traditional three-year term. Long-term agreements should emphasize two critical areas: 1) future pricing and 2) annual review of the mix of subscriptions being invoiced.
Why is this important? Hosted, service-based subscription offerings in the market today overlap very little. Take Microsoft’s Office 365 service catalogue, for instance. There are few commercial alternatives to an Office 365 user subscription, and those that do exist may not be currently viable for most clients. Once an enterprise has rolled out its Microsoft online services to its employees, there is virtually no way to move to a non-Microsoft option or repatriate those workloads with traditional Microsoft software.
So, while there are many practical benefits to moving to the cloud, enterprises must prepare themselves for the fact that their cloud provider can dramatically increase pricing once customers are beyond the point of no return. All of this means enterprise buyers need to ensure they are not contracting for hosted services the same way or using the same agreement structure they used in traditional software licensing. Pre-paid service options can offer some financial incentives, but enterprises need to be confident they have the resources and means to drive the consumption of those pre-paid services.
The alternative to pre-paid agreements is to “pay as you go,” but enterprises need to understand that suppliers may indeed charge at or near “street price” for services paid in arrears. Moreover, “pay as you go” is best suited for small and medium-sized businesses and would need to be reworked considerably for organizations that employ more than 5,000 information workers.
Enterprises must be deliberate about how they manage their service-based subscriptions – otherwise they may find themselves facing an uncertain future when it comes to pricing. Contact ISG to find out how we can help.
About the author
Louis Pellegrino
Louis joined the ISG team in early 2014 after nearly 20 years with Microsoft Corporation. Louis has compiled a track record of Enterprise client success underpinned by customer focus, strategic thinking, organizational agility, problem-solving acumen and impactful knowledge transfer which has established his reputation as a Microsoft licensing expert.
During his time with Microsoft, Louis worked in both the Consulting Service Group as a Practice Manager and in the Worldwide Licensing and Pricing Group as a Director responsible for designing and negotiating Global Volume Licensing relationships. As a highly effective and influential communicator/negotiator, Louis has delivered consistent business results across both revenue and quality of service performance targets.
