Strategic CIO // Executive Insights & Innovation
Commentary
1/21/2014
12:10 PM
Bennett Quillen
Bennett Quillen
Commentary
Connect Directly
RSS
E-Mail
50%
50%

Software Contracts 101: What To Look For

Before signing on the dotted line, evaluate these contract provisions. First of a two-part series.

You're about to sign a software contract for a core application. You've already done your homework on the software itself: thoroughly reviewed its current and future capabilities, performed due diligence on the depth and knowledge of the vendor and its staff, and checked references and assessed the vendor's financial stability.

Now you're ready to sign on the dotted line. Do not minimize the importance of this step. Your job -- and even the future profitability of your company -- could be on the line.

Even if you implicitly trust the vendor you've chosen, you'll no doubt seek legal assistance, preferably from attorneys familiar with computer software contracts. Still, you must re-read the contract to be sure you understand all of its clauses. Is the contract straightforward and easy to understand? Does it include all of the negotiated or agreed upon issues?

[Converting critical systems? Follow these best practices: Core System Conversion: Dos And Don'ts.]

One or more of your lines of business must review all the provisions of the contract, whether it covers on-premises or hosted software. Below I'll discuss the major terms and conditions. In a subsequent column, I'll go over the other three major provisions of a software contract: warranties and maintenance liability; training and education; and testing and service-level agreements.

Payments and term
The schedule of payments and the term of the contract depend upon each other. You can negotiate for a lump-sum payment or an installment schedule. The amount you wish to pay depends upon your cash flow needs (with appropriate present value analysis) and the term of the contract. If you select a longer-term contract (more than the standard four or five years), insist on substantially lower annual payments.

It's important that the contract distinguishes between payments to buy the software and payments to maintain the software. Some vendors will aggregate the purchase and maintenance amounts. However, for you to properly evaluate the cost of the software and its future maintenance compared with similar software, the contract must spell out these two components separately.

Whether you purchase the software in a lump sum or under an installment plan, the contract will require an up­front payment, usually one-half of the first year's payment. The other half will usually be due 30 or 60 days after you sign the contract. This is an important point to resolve with the vendor: The balance of the up­front payment, whether on a lump-sum or an installment basis, shouldn't be due until after you complete acceptance testing. More on this point later.

Licensed machines or servers
Make sure you may operate the software on more than one machine. Even if you have little intention of expanding your centralized mainframe processing, you may have future needs for remote or even correspondent processing. Either of these circumstances could require multiple versions of the software.

If your software vendor won't provide this flexibility at the same price, ask for a compromise. Include a clause that provides the vendor with an equitable percentage of the proceeds, above some threshold amount, received from processing for external customers.

Price escalator
Many of today's software contracts include a price escalator clause, which lets the vendor increase the annual purchase installment (another factor to be considered in the lump-sum versus installment payment decision) and maintenance fees. The escalator is usually based on some well-known index, such as the consumer price index.

If you think your company's costs more appropriately reflect another index, such as the GNP deflator, discuss it with the vendor. In any case, compute a trend over the last 12 to 20 quarters of the proposed indexes to determine which might be the least costly to your company.

Discounts
Most customers receive discounts from the software's list price (sounds like buying a car, doesn't it?), provided they buy several applications concurrently or within a set period of time. Obviously, check that these discounts are true reductions in the price of the software and not just a means of striking parity with the vendor's competition.

Also, do the discounts apply only to the purchase of the software or to the maintenance as well? This is another point of negotiation, particularly if your company is acquiring several applications. Does the annual maintenance cost, usually between 15% and 20% of the purchase price, apply to the vendor's list or discounted price?

Identifying applications
This may sound like a no-brainer, but be certain that the contract specifically identifies the application or applications you're acquiring. Make sure that the modules or other interfaces you may assume are part of the application are indeed listed or described in the text or as an appendix to the contract.

Merger or acquisition
What happens to the vendor's obligations should it become the division of another company or get reorganized in some other major way? Your company may want to include wording in the contract that terminates, reduces, or modifies any further obligations should this change occur.

Legal expenses
Who incurs legal expenses in the event of a dispute between the vendor and customer? Are they borne separately? Is the software vendor limited only to the amount of its out-of-pocket legal costs and revenues received from your company?

These are issues you will need to resolve within your company and with your prospective vendor. In my next column I'll discuss warranties and maintenance liability, training and education, and testing and SLAs.

Bennett Quillen, a former CIO for a leading mutual fund processing firm, has more than 35 years of experience in financial industry technology, operations, cash management, and compliance. Today he provides financial institutions with project management and technology advice, specializing in system evaluation, development, conversions, and security and compliance management.

There's no single migration path to the next generation of enterprise communications and collaboration systems and services, and Enterprise Connect delivers what you need to evaluate all the options. Register today and learn about the full range of platforms, services and applications that comprise modern communications and collaboration systems. Register with code MPIWK and save $200 on the entire event and Tuesday-Thursday conference passes or for a Free Expo pass. It happens in Orlando, Fla., March 17-19.

Comment  | 
Print  | 
More Insights
Comments
Threaded  |  Newest First  |  Oldest First
D. Henschen
50%
50%
D. Henschen,
User Rank: Author
1/21/2014 | 12:50:42 PM
If contracts don't get you, audits will
Contracts are one thing, and now software audits are coming fast and furious. Audits of license compliance often come up when contracts are headed for renewal, so take the time to learn lessons from what you did right and what you did wrong in your last contract. Are you stuck with shelfware that you paid for but never used? Did you bet on saving with CPU pricing when per-user would have worked out better (or vice versa). The pointers above are helpful when you're signing OR renewing a license agreement. 
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/21/2014 | 1:32:45 PM
Re: If contracts don't get you, audits will
Absolutely agree! You have given me an idea for a future article on I/T audits.  I have had some auditors and examiners who actually knew their business and were helpful.  Then again, I have had federal examiners (not the OCC) who did not have a clue.  Bennett
TerryB
50%
50%
TerryB,
User Rank: Ninja
1/21/2014 | 1:11:21 PM
Size Matters
Absolutely nothing wrong with this advice but you may have trouble executing it unless you have some serious clout. Negotiating with Oracle as GM and doing so as Bob's Auto Supplies are two entirely different things.

I'm still laughing about a Corp purchasing guy we had a few years ago who was trying to consolidate our cell usage across several business units in North America. We decided on AT&T based on coverage, cost, etc. But when came time to sign on dotted line, he decided he wanted AT&T to change some of it's terms and conditions. Anyone care to guess how far that went and who won?
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/21/2014 | 1:36:36 PM
Re: Size Matters
You raise a good point.  Sometimes you need to look at what the overall strategy is of the vendor software firm.  If yur company is medium-sized market, you can leverage that position, particularly if the vendor is seeking to grow that share of market.  One can offer to be a "poster child" for a vendor if the contract is favorable and the conversion goes well.   Bennett
David F. Carr
50%
50%
David F. Carr,
User Rank: Author
1/21/2014 | 1:52:44 PM
Do CIOs really take software contracts too casually?
How common is it that CIOs (and others with the authority to sign software contracts) take them too casually? Who really needs to hear this advice?
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/21/2014 | 2:09:59 PM
Re: Do CIOs really take software contracts too casually?
It is not so much that CIOs (and auditors and CFOs) take software contracts casually, it is more nsufficient attention to the details.  By proper attention and asking detailed questions, a CIO can often extract more beneficial terms, improved SLAs, etc.  Bennett
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/21/2014 | 2:11:35 PM
Re: Do CIOs really take software contracts too casually?
I see that I did not pay sufficient detail to my typing: it should have been "insufficient"  Bennett
Lorna Garey
50%
50%
Lorna Garey,
User Rank: Author
1/21/2014 | 6:48:12 PM
Re: Do CIOs really take software contracts too casually?
Is a "price escalator" -- an automatic yearly increase even with a contract in place -- common? That seems like a disincentive to sign on for any length of time. Why not go year to year, so you can shop around?
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/21/2014 | 7:40:07 PM
Re: Do CIOs really take software contracts too casually?
I understand your question on the price escalator. On the face of it, it might seem unnecessary.  However, bear in mind that the vendor software support is for a major application or a set of core applications.  And, the vendor will usually require 5-year terms.  After all, the vendor is supporting a critical application for your company and you want to be sure that scheduled maintenance, application upgrades and regulatory changes are promptly and accurately tested and deployed.  That is why it is so important to negotiate all of the software features your company requires: near term and expected in the future, and the level of service (SLAs) you require, with associated penalties if not met.  Bennett
cbabcock
50%
50%
cbabcock,
User Rank: Strategist
1/23/2014 | 6:39:02 PM
In the back office, lots of software, plus lawyers
At one time, Oracle took an aggressive line with customers and conducted a customer audit as the contract approached renewal. If the vendor found in such an audit that usage had been higher than the contract allowed, does the company understand how the vendor arrived at such a conclusion. Does it have its own monitoring tools to challenge the conclusion, if necessary? If it does challenge additional license charges, does that run the risk of running up massive lawyers' bills? Even if there is no case in court, you'd still have to carefully document your information and construct a counter to the vendor's claim, wouldn't you? 
bquillen280
50%
50%
bquillen280,
User Rank: Strategist
1/24/2014 | 10:21:08 AM
Re: In the back office, lots of software, plus lawyers
Thank you for your comment. Yes, usage, whether via number of transactions or number of accounts, is critical, particularly under a service bureau arrangement.  That is why it is vital to monitor your firm's activity, especially as you come close to renewal with a service bureau operator.  Trying to forecast transaction or account growth over even the next three years can be tricky, depending uon whether the firm plans to grow organically or through acquisition.  Of course, that is why some companies operate their core applications in-house as that gives them more control over utilization.

Then, when or if it comes to de-conversion from one service bureau operator and converting to another, that can be a challenge.  The company really needs to have its ducks lined up, because the vendor from which you may be converting will try to extract every last farthing simply to provide conversion files to the new processor. That is why I recommend a company include as part of its initial contract a specific amount or percentage for de-conversion costs in the future.   Bennett

 
The Business of Going Digital
The Business of Going Digital
Digital business isn't about changing code; it's about changing what legacy sales, distribution, customer service, and product groups do in the new digital age. It's about bringing big data analytics, mobile, social, marketing automation, cloud computing, and the app economy together to launch new products and services. We're seeing new titles in this digital revolution, new responsibilities, new business models, and major shifts in technology spending.
Register for InformationWeek Newsletters
White Papers
Current Issue
InformationWeek Tech Digest - August 20, 2014
CIOs need people who know the ins and outs of cloud software stacks and security, and, most of all, can break through cultural resistance.
Flash Poll
Video
Slideshows
Twitter Feed
InformationWeek Radio
Sponsored Live Streaming Video
Everything You've Been Told About Mobility Is Wrong
Attend this video symposium with Sean Wisdom, Global Director of Mobility Solutions, and learn about how you can harness powerful new products to mobilize your business potential.