Software Maintenance Fees: Time For This Model To Change?

The slow economy plus alternatives such as SaaS and open source could pressure vendors into offering lower-cost options.

Rusty Gaston is one of thousands of CIOs who use Oracle software to automate their organizations' supply chain, financial, and HR operations. But she's one of just a handful who have decided to run those applications without an Oracle maintenance contract, giving up rights to software updates, full upgrades, and Oracle-trained service expertise.

Gaston, CIO of Santa Fe Natural Tobacco, a subsidiary of Reynolds that sells the American Spirit Natural brand of cigarettes, didn't think she was getting her money's worth on the contract, which charged the Oracle standard annual rate of 22% of the original cost to license the software. While Santa Fe Natural had paid for its software licenses once, the maintenance bill came every December.

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When Gaston told her Oracle reps that she wasn't renewing Santa Fe Natural's contract and instead would try a third-party maintenance firm called Rimini Street, which promised to fix the company's software problems at about half Oracle's yearly fee, they told her she was making "a horrible mistake," she says. Gaston would be cut out of the Oracle family, giving up her rights to innovative software updates and customer-only information on product strategy. But a year later, Gaston says she has just one regret: that she didn't drop the contract sooner.

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Not many CIOs are willing to take such a radical step to cut their software maintenance costs. But most understand Gaston's aversion to that yearly fee, and many question the value they get for it.

It's certainly not just a question about Oracle. SAP is trying to convince customers on older, 17% maintenance contracts that the new contracts they're required to move to this year, increasing to 22% by 2012, will give them more valuable services in return. A 22% rate means that for a $1 million software license, a company pays an annual fee of $220,000 for service packs, product enhancements, and some services. For those SAP customers on the 17% rate now, that's an increase of $50,000 a year on a $1 million license.

A $50,000 yearly hike on a $1 million license may not seem huge, but any increase seems unusual to CIOs who think the maturation of the software industry should mean they start to see their software bills go down instead of up--sort of like the Moore's Law of the hardware industry. Instead, the model of one-time licenses and ongoing maintenance fees remains strong across enterprise software segments.

Manjit Singh, CIO of Chiquita Brands, says he's been watching maintenance fees for the software vendors he uses creep up from an average of about 18% a few years ago to 21% or 22%. "And for that, what am I getting? I'm not getting to dictate product strategy, and I don't get premier support," Singh says. "I'm getting the right to code fix it and to upgrade."

With more pressure on his IT budget, Singh is looking at what maintenance contracts he can cancel--typically software nearing the end of its life cycle. With some other applications, he's switching to software as a service, bypassing the conventional maintenance fee structure altogether.

Not everyone thinks the system is broken. Ian Abramson, president of the Independent Oracle Users Group and a consultant who specializes in Oracle technologies, says maintenance costs aren't a particularly heated topic of discussion among group members. "I understand the price is high for maintenance, and Oracle probably makes a lot of money off of it," Abramson says, "but I guess that's the cost of doing business, like buying insurance for your car and wanting the best insurance when you're driving it."

Michael O'Dell, CIO at construction services firm Pacific Coast Cos., supports the premise of an argument Oracle and SAP executives make: IT environments have become much more complex, and customers typically call on Oracle or SAP services even if their problems originate with another technology, application, or human error. That means higher internal support costs for the vendors, which count on those maintenance fees not just for customer service, but also to fund future development. "We understand SAP's dilemma, and that it's no longer just an ERP system," says O'Dell, who's also chairman of SAP's user group board. "As a platform, it touches many different areas of our enterprise."

Good Fit
Find out where open source makes sense.
Yet there is undeniable discontent out there. And when there's discontent, there's an opportunity for disruptive forces. The industry is witness to rapid growth in alternative business models: SaaS; free, Web-based software such as Google Apps; open source software; and third-party maintenance firms. These forces could pressure conventional software vendors to develop a lower-cost model for customers.

Or, as the traditional software vendors maintain, those emerging vendors with new models will discover within a few years there's just one way to grow profits, attract talented employees, provide first-rate service, and keep innovating for customers--and that's to charge sizable license and maintenance fees.

A 'Broken' Model?
Chiquita's Singh doesn't buy the idea that there's no other way. He points to the minicomputer and mainframe manufacturers, such as IBM and Digital Equipment Corp., that lost footing in the PC boom because they refused to acknowledge the emergence of cheaper and easier systems for customers. "The software model is broken," he says.

As open source, SaaS, and other disruptive models continue to mature, Singh says, more and more CIOs will be comfortable with them. "That's going to be a wake-up call for the software industry," he says. "We're three to five years away from it."

Hold on, says Oracle president Charles Phillips. Oracle has experimented with various licensing models over the years, but "people keep coming back to the licensing model that's simple and has worked." For Oracle, that model is an up-front software license price, often negotiable, with a 22% annual maintenance fee that's never negotiable. "We are sticklers on that," Phillips says.

C Phillips

'There's no magic in [SaaS] costs. Someone has to pay for developers and maintenance.'
- Oracle's Phillips
But how much profit is too much? Blaming the slowing economy, Oracle reported in December that its second-quarter net income was about flat compared with a year ago, while license revenue was down 3%. Maintenance revenue, which makes up 51% of its total revenue, was up 14%. The operating expenses allocated to "software updates and product support" total just 9% of its updates and support revenue, though Oracle notes that that revenue also supports product research and development.

Oracle CFO and president Safra Catz assured stock analysts in a conference call that "update rights," or maintenance, continue to be a "very profitable part of our business, and as the number gets bigger and bigger it's really impossible for us to actually spend our way through it, and so in general that's the sort of overriding thing that guides our margins."

Phillips says Catz was making the point to analysts that thanks to maintenance, investors needn't worry about Oracle becoming unprofitable during a downturn. Those profits, he points out, are a good thing for customers. "Support dollars go directly into products. Those dollars go into high-priced developers you have to pay to keep around," he says. About 22,000 people update and enhance Oracle's products.

Maintenance fees also have funded Fusion, a forthcoming suite that integrates the best of some 40 applications Oracle has built or acquired, which it plans to start beta testing this year. "There is only one company saying, 'I'm going to take your support dollars and build a whole new product line,'" Phillips says. "These are modern apps natively built in Java for modern business IT."

Indeed, Abramson of the Oracle user group says there's much customer excitement about Fusion, which has been in development for four years. "The message is getting much clearer," he says, "and as a user, I'm much happier in the way Oracle is explaining to me and showing me how it's coming together."

Critics of the status quo abound, however. One CIO who spoke on condition of anonymity says he recently dropped Oracle maintenance because too often he was told his software problems with Siebel couldn't be addressed by the regular maintenance support staff. He says he was referred to more experienced consultants, who charged a high hourly fee for what he thought should have been covered under his maintenance contract.

Gaston of Santa Fe Natural also complains of "poor" service from Oracle's global support center. "It might be four to six weeks before you get a response," she says. "You may never get an answer."

Phillips says that's not typical, and Oracle usually goes "well beyond" what might be expected: "If there's an issue, we're going to fix it."

Sometimes the problem has to do with lack of employee training on the customer's part, he says. And sometimes support queries result from something that has nothing to do with Oracle software, such as a customer changing a network router. Phillips notes that JD Edwards, part of Oracle's 2005 acquisition of PeopleSoft, is the only software company to win the J.D. Power and Associates recognition for customer service, which it earned from 2005 to 2007.

On The SAP Front ...
Bill McDermott, president of global field operations at SAP, makes no apologies for SAP's decision, announced in July, to replace its two levels of support offerings with just one premium support offering, called Enterprise Support, with an annual price of 22% of the software license. "The real criticism you can make is, 'Gee, Bill, why did it take you guys so long to increase the cost of customer support, because you were five points below the industry benchmark of 22% all that time and giving up shareholder value?'" McDermott says. "That's a fair criticism I'll accept with open arms."

SAP's software revenue rose 7% in the quarter ended Sept. 30, while service revenue rose 14%, driving a profit margin of 14%. Services make up 72% of SAP's revenue.

McDermott maintains that customers don't have a 17%-type maintenance environment anymore. They have myriad custom and integrated software systems, all of which must integrate with SAP's core systems. "We're OK with that, but we're looked at as the company that needs to support that," McDermott says. "Customers expect us to help solve the problems that are very often taking place in [non-SAP] applications." SAP takes calls from customers 24 hours a day, he adds. "Are you comfortable when you go to sleep at night? That's the higher-ground issue. Nothing about our customer support needs an apology."

Bill Mcdermoot

'Are you comfortable when you go to sleep at night? That's the higher-ground issue'
- SAP's McDermoot
Even customers initially upset about the maintenance price increase are beginning to understand the added benefits through more communications, McDermott says. "We're innovating," he says. "And we have to have enough profitability to be able to do that."

User groups in Germany and Austria opposed to the fee hike have succeeded in getting SAP to hold back, at least for now, amid legal challenges. Three CIOs on the board of the Americas' SAP Users' Group--O'Dell of Pacific Coast, Rod Massey of O-I, and Anthony Bosco of Day & Zimmerman--are generally supportive of the increase.

"We've never viewed maintenance as a black hole you put your money into. Maintenance is part of the game," Bosco says. Customers should give SAP a chance to prove that moving to the improved Enterprise Support program will save them money in the long run, he adds.

SAP says customers will get more custom code support, better help with software testing, a recommendation report SAP will supply each year, guidelines for configurations, help in implementing enhancement packs, and answers to service calls 24 hours a day. "I can't be happy with a price increase, but if I have an issue, the first people I call are SAP," Bosco says.

Tips from Forrester analyst Ray Wang

Focus On License Discount:
Lower this, and lifetime percentage fees are lower
Audit What You Get:
Compare support requests, bug fixes, etc., against payment in making a case for lower fees.
Document Broken:
Compare support requests, bug fixes, etc., against payment in making a case for lower fees.
Use The User Group:
Push user groups to resist fee hikes, and get guarantees of percentage reinvested in product support and desired functions in future releases.
The Americas' SAP Users' Group, based in Chicago, walks a delicate line between serving as an independent voice of its members and maintaining good relations with SAP, which is involved integrally in the group's training programs and conferences.

Forrester Research analyst Ray Wang thinks customers--and the user groups that represent them--should be demanding that enterprise application vendors put a greater percentage of their maintenance fees back into their products. Wang estimates that 70% to 80% of Oracle's and SAP's fees don't go to maintaining and improving the products they're attached to, so even if the vendors' profits help build more innovative software companies, he says, calling them maintenance fees is a misnomer.

Station Casinos CTO Van Baltz found room to negotiate with some of his company's vendors. His team went to all the company's software vendors to renegotiate maintenance and support contracts over the past year, and was able to cut more than $1 million in annual fees. It got an average 9% reduction from vendors that gave rollbacks, Baltz estimates, while additional savings came mostly from lowered service levels, such as moving support for noncritical apps to 8 a.m. to 5 p.m. instead of round-the-clock. "If you don't ask, you're not going to get any concessions," Baltz says. "We found it very encouraging our vendors were willing to be flexible." About half its vendors were willing to make some concessions, including some giving discounts for longer terms.

No Room For Negotiation
What bothers Singh most is how many software vendors don't negotiate on maintenance rates. For example, why can't he pay, say, a 12% rate for some applications and get only the bug fixes but bypass the upgrades? "As I talk to Oracle and Microsoft, I'm telling them I'm moving toward SaaS, and why I'm such a proponent of it is that I'm sick of paying maintenance and not getting any results," he says. Much of Chiquita's business runs on Oracle JD Edwards apps, but it's using some software services, including HR, from startup Workday.

Oracle's Phillips notes that there are 1.7 million end users of its own hosted software services. Some of those companies pay conventional license and maintenance fees, and others, mainly Siebel CRM customers, pay a monthly subscription. But SaaS isn't necessarily cheaper, Phillips says. "There's no magic in the costs," he says. "Someone has to pay for developers and maintenance."

Every time Singh has crunched the numbers over a three- to five-year timeframe, Chiquita breaks even or saves money with SaaS compared with conventional licensing, he says. "And that's just the pure software costs. When I look at soft costs in terms of whom I didn't hire to do integrations or customizations, all of a sudden my payback becomes even greater," he says.

Rimini Street offers Oracle support at significantly discounted prices and plans to add SAP services this year. Seth Ravin, CEO of the privately held company, describes business as "booming." Rimini can offer lower prices on maintenance because it's not taking a cut out for future product development, he says.

Yet Rimini and the handful of other third-party maintenance providers, including NetCustomer and Spinnaker Management Group, are relatively small. Rimini, which focuses mostly on PeopleSoft and JD Edwards apps, has fewer than 100 employees, though Ravin says the company's finding plenty of independent consultants seeking "safe harbor and a paycheck" as it looks to double its employee size this year. He says revenue doubled in 2008 and predicts it'll approach $100 million in bookings this year. Rimini counts Pepsi America among its customers.

5 Fast Fixes

1. Open Source
You still pay an annual support fee, but lower up-front cost.Will you get new features and fixes fast enough?
2. Software As A Service
Again, still an annual payment and lower up-front cost. Customization, integration, data control can all be problems.
3. Third-Party Support
Cheaper, but usually a smaller company with less access to expertise, and you miss out on updates.
4. Negotiate New Terms
Tricky, since some vendors won't budge. But changing support levels and length of term may create flexibility.
5. Drop Support
Gulp. Can your inhouse team really handle any problems?
NetCustomer started in India as an offshore outsourcing firm for PeopleSoft customer support. After Oracle acquired PeopleSoft, NetCustomer went into the third-party support business, opened a San Jose, Calif., office, and expanded into JD Edwards and Siebel support. Spinnaker, primarily a consulting firm, added JD Edwards third-party support in August. Forrester's Wang says maintenance providers opening in China also might prove to be a viable option.

Pacific Coast CIO O'Dell says he called Rimini about its forthcoming SAP services and decided that forgoing the SAP updates was too high a price. "If you have a static environment that doesn't change very much, it might be interesting," he says. "But we're investing in technology every year and every month and every day, That's not going to support our dynamic environment."

The longer this economic recession grinds on, however, the more tempting lower-cost alternatives will look, and the more pressure software vendors will face to offer tiers of support prices.

Roger Burkhardt, CEO of open source database vendor Ingres Software and former CTO of the New York Stock Exchange, predicts the tough economy and more mature, commercial-grade open source software stacks will make this "the year in which open source competition drives proprietary vendors to begin changing their business models."

The reality, though, is that none of the alternative models to software licensing and maintenance has blown through to the enterprise mass market. Alternative models loom as threats, with considerable success in pockets such as CRM and operating systems, but there's nothing approaching the scale of conventional licensing.

Can vendors driving these new models create long-term, profitable businesses that can afford the talent and investment to keep innovating? Or is Oracle's Phillips right--that there's no "magic in the numbers" and buyers are getting what they pay for?

The challenge is before vendors trying to replace the traditional software model with something better, and before CIOs willing to stick their necks out.

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