November 19, 2013, 9:37 AM — Something happened on the way to the cloud: Too many business customers got burned by bad contracts. It's not that cloud services can't deliver value. But in the rush to the cloud, enterprises often end up stuck with contracts that don't fully meet the business's needs, lack accountability and cost considerably more than anticipated.
There are several reasons for that, say people who make their living studying licensing issues and advising businesses on contract negotiations. Among other things, seasoned veterans of on-premises software licensing may mistakenly assume that cloud services contracts are just another variation on the same theme.
But as enterprise software vendors move to the cloud, software licensing has become so complex -- Microsoft's licensing strategy alone has ballooned from fewer than 50 options to more than 170 -- that even consultants and resellers are struggling to fully understand it. And even when expertise is available in house, businesses aren't always aware, or don't take advantage of it for political or other reasons.
For all their differences, cloud and on-premises contracts share at least one major trait: Once you sign on the line, you're stuck with the terms. And if you've committed to enterprise software such as ERP or CRM as a service, moving to another provider can be just as difficult as switching out on-premises software.
Computerworld asked four experts to talk about the most common mistakes that never should have happened, the consequences and what enterprises did to resolve them. If you really want to screw up a cloud service contract, they say, here are eight good ways to go about it.
1. Pay for all of your cloud services up front
You don't have to work in a small company to make this mistake. Frank Scavo, president of management consulting firm Strativa, recalls how a $100 million business that signed on with a cloud ERP provider got burned. The ERP contract included the monthly subscription fee plus implementation support and ongoing support.
The problem came about during the integration work required to connect the ERP system to the business's front-end e-commerce application. When that integration project got bogged down, the customer found that it wasn't getting the level of support it needed.
"But they prepaid, so the customer had no leverage over the vendor. It's a mistake to prepay for implementation services," Scavo says. Eventually the matter had to be escalated to the vendor's chief executive officer before the situation was rectified. "It shouldn't take a call to the CEO to resolve a routine implementation problem," Scavo says.
2. Sign a long-term contract without negotiating service-level commitments and penalties for noncompliance
In the early days of SaaS, businesses often paid for cloud services on a month-to-month basis. If the contract didn't work out you could walk away. But now it's common for SaaS providers such as Workday to pitch contracts that last three to five years, says Ray Wang, principal at Constellation Research Inc.
Unfortunately, most long-term cloud contracts don't state what happens if the service becomes unavailable for a day, a week or even longer. When do vendors notify you of what's going on behind the scenes? How will they work with you and other parties to diagnose the problem? To what type of compensation are you entitled if the system goes offline for an extended period of time?
If it's not in the fine print, there are no guarantees, and if you're locked into a long-term contract you can't just cancel. You're stuck.
That's what got one Constellation client, a Fortune 2000 manufacturer, in trouble. In the wake of Superstorm Sandy in 2012, the business's billing system went offline for five days. The company put revenue losses for the week at between $3 million and $4 million. Unfortunately, says Wang, "They didn't have any kind of recourse for that in the service level agreement."
While the provider did offer one month of billing credit to make up for the five-day outage, that didn't come close to making up for the monetary damages resulting from the outage. That contract is now coming up for renewal, and the client is looking for very different terms, Wang says.
While most vendors won't agree to conditions that require full compensation for business losses resulting from an outage, you can do much better than what's in the boilerplate. "In some cases we have been able to get the client access to new features, six months' worth of credit or a reduction in the renewal rate," Wang says.
That was after the fact. You're better off, however, negotiating these terms up front. If you can't get an SLA for loss of business, negotiate credit for months of service, new features and lower per-user, per-month pricing for the future. "All are possible," Wang says.
A related issue: Cloud vendors often try to bring their "low-touch" model -- of deemphasizing personal customer interactions -- to enterprise support and services offerings. But that just doesn't work for large-scale systems that provide ERP, CRM and supply chain SaaS. "A lot of that implementation requires higher touch, and many times the cloud vendors aren't set up to do that," Scavo says.
So it's important to vet the capabilities of the provider, and book enough implementation time to get the job done. And if the cloud service provider's resources aren't up to your standards, consider using one of its channel partners -- or go elsewhere with your business.
3. Don't vet the contract for hidden charges that might come back to bite you
Even people used to scrutinizing contracts for on-premises software can be tripped up by cloud service contracts, Scavo says. "Someone on your team needs to know what to look for, particularly when it comes to hidden charges such as exceeding a certain storage or bandwidth threshold. I've had a few customers get burned by that."
Someone on your team needs to know what to look for, particularly when it comes to hidden charges such as exceeding a certain storage or bandwidth threshold. I've had a few customers get burned by that. Frank Scavo, president, Strativa
Scavo consulted with a seasonal business that saw its monthly bills soar by as much as 20% when daily transaction counts exceeded the contractual threshold. "Vendors aren't typically going to call your attention to things like that during the contract phase," so it's up to you to think it through and push back, he says.
4. Sign off on the contract before shopping around for better terms
Cloud vendors take different approaches to licensing, and one plan may fit your needs far more cost effectively than another, says Scavo. While many vendors base monthly subscription fees on the number of users or seats, some offer variations on that model. For example, with cloud ERP vendor Acumatica the price you pay depends on the amount of system resources you use, such as projected transaction counts, "so a growing business can add users without buying additional seats," Scavo says.
This is especially important with large-scale CRM or ERP systems because moving off those isn't easy. "There's a certain amount of vendor lock-in with SaaS providers that goes beyond what you have on premises," Scavo says, so get the right contract terms in place before you start down that road.
5. Don't worry about how multiple SLAs will affect the end-to-end performance of your business processes
When businesses use a combination of cloud services within the context of a single business process, end-to-end performance is only as good as the weakest service level agreement. "We're just starting to see the proliferation of cloud service-oriented architectures where you're piecing together numerous cloud capabilities to deliver a business process. If your SLAs are not aligned across that, you may have a weak link in the chain," says Mike Pearl, partner and principal at PwC's advisory practice.
This has been a particularly painful problem for PwC clients that have allowed individual business units to sign contracts.
The biggest failure I see is [in] organizations with a technology buying pattern that doesn't go through IT. People think they have the background to negotiate these kinds of contracts, but often times they don't know what they don't know. Mike Pearl, partner and principal, PwCs advisory practice
One client, a CIO of a multibillion dollar corporation, received a copy of a SaaS contract, signed by someone at one of the business units, that contained no language pertaining to backup, storage or access to data stored by the provider. "The biggest failure I see is organizations with a technology buying pattern that doesn't go through IT," Pearl says. "People think they have the background to negotiate these kinds of contracts, but often times they don't know what they don't know."
Pearl thinks that IT will eventually see the rise of a new breed of external integration brokers that can stitch together the cloud services that make up an end-to-end business process and make sure the SLAs are aligned. "They will act as resellers, and overlay their SLA over the SLAs they're getting from various cloud providers," he says, adding that he's had conversations with some vendors that have expressed an interest in entering that business. Today, however, it's up to IT and its procurement partners within the business to do all of the contract spadework.
6. Let the salesperson talk you into adding services that you're not ready to use
If you're thinking of deploying a new service next year, buy it when you're ready to implement rather than allowing it to roll into a renewal contract. Microsoft's Office 365 -- a SaaS suite that includes back-office components for Exchange, SharePoint and Lync as well as the familiar desktop apps -- is a prime example, says Paul DeGroot, principal at Pica Communications, which specializes in helping his clients navigate the Microsoft licensing maze.
"Many customers have bought Office 365, but when I ask how they use it they say they don't," DeGroot says. There's no price benefit to buying the service early, and if it's rolled into a three-year renewal contract you're stuck paying for it for the entire contract term.
"If you're going to use it next year, buy it next year," he says.
In DeGroot's experience, only about 40% of businesses try to negotiate on new contract proposals from Microsoft. One reason may be the confusion businesses face when contemplating Microsoft's myriad licensing options. Three years ago Microsoft offered 46 choices for enterprise agreements. Since then that number has ballooned to more than 178, and most of the increase is cloud related. "It's insanely complex," he says.
Many customers have bought Office 365, but when I ask how they use it they say they don't. If you're going to use it next year, buy it next year. Paul DeGroot, principal, Pica Communications
But pushing back has another benefit: Microsoft has been willing to cut deals. One Pica client demanded that Microsoft remove a Yammer component worth $50,000 from a proposal, but later relented when the salesperson offered a $78,000 discount on something else.
"The customer has no intention of using Yammer, but the Microsoft rep got credit for selling it to him, and the client knocked $28,000 off his licensing bill," he says.
In another case a global Fortune 500 client refused a seven-figure proposal that included Office 365, but accepted the deal after Microsoft offered a discount on the rest of the contract that added up to three times what the vendor would charge him to add Office 365. "Microsoft is buying some of these agreements," especially for large firms that can serve as marquee customers, DeGroot says. "We have customers paying $1 a seat for Office 365 Enterprise E3, which is normally $20 a seat."
Microsoft licenses may not be the most expensive thing in the IT budget, so some large businesses may not give them as much scrutiny as they deserve. "Even if it's only 1% of the IT budget, that could be $1 million," DeGroot says. "Isn't it worth taking a closer look to save $1 million?"
7. Keep your on-premises systems running in parallel with the new cloud service
One of the biggest benefits of moving to the cloud comes from the reduction in on-premises management costs. For example, if you move to Office 365 you no longer need an Exchange administrator. But many organizations are slow to shut down the on-premises systems, or choose to migrate only a small subset of users, such as those in a remote office, to the cloud.
That's usually a mistake, says DeGroot. "I see a lot of companies with small amounts of Office 365, but it doesn't work in a small way."
Setting up just 25 people with Office 365 and then configuring those users to use Exchange email is quite a bit of work. And if you use SharePoint and Office 365, will you synch the Office 365 version of SharePoint with the on-premises SharePoint server? "That is not a trivial project," he says. If you choose to do the syncing, at that point you're duplicating costs and then some. "You're paying a premium to Microsoft to manage the servers and you haven't reduced your on-premises management costs at all."
If you're planning a transition to the cloud, scrutinize the licensing for the on-premises servers you'll be phasing out while negotiating on the cloud service. Do you really need Software Assurance for your on-premises software, which gives you access to the next upgrade, if you'll be off the platform within three years? Cancelling can save a lot of money, DeGroot says.
One client on its way to the cloud, a business with 10,000 employees, saved over $1 million by cancelling its Software Assurance contract.
Another client went even further. A global investment firm with 200 offices decided to run Office 365 in its smaller offices, and then refused to continue to pay Microsoft for maintenance on the on-premises servers that were supporting those users. "They said, 'We're not going to pay for the perpetual licenses and pay maintenance on those products when we're moving the whole thing to the cloud.'" If you're going big on cloud, cutting back on on-premises support makes good business sense.
8. Don't negotiate a volume pricing agreement that accommodates the best- and worst-case changes in your seat count
You may have 50 users on that CRM platform today, but what happens if you grow -- or suffer substantial layoffs? How much does each incremental user add -- or subtract -- from what you'll pay?
Chances are, if you haven't negotiated that into the contract, you will end up paying far more than you should. You may not enjoy volume discounts as you grow, you might have to pay for empty seats and you could even end up paying more to add a new user if the provider's offerings change. For example, Salesforce.com discontinued its unlimited edition, which gave the user full access to all features and services. Now you may have to pay extra to give that user access to some features, such as Premier Support or mobile access.
In other cases the subscription pricing models of cloud vendors, most of which got started with small and mid-sized businesses, may not scale to the needs of very large enterprises. "When you expand from 100 users to 10,000 users globally, the [cloud] cost model just falls apart," Pearl says.
In those situations, the relative total cost of ownership implications between cloud and on-premises options may be clear only when analyzed over a long period of time -- say, seven years.
The more established players do tend to offer enterprise-scale tiers. But that brings up another issue.
Get the tiering right because you need to be able to flex down as well as up. Ray Wang, principal, Constellation Research
"As you add licenses you should be able to add them to volume discount or user count tiers," says Wang. Rather than straight volume discounts, contracts can be constructed so that the business pays one rate for the first 99 users, for example, with a discounted rate for the second tier starting at the 100th user and so on.
The contract should be negotiated such that it will flex both ways, with per-seat charges changing accordingly as you peel away users from a given tier. "Get the tiering right because you need to be able to flex down as well as up," Wang says.
It's also important to negotiate on the ability to turn unused licenses into future credit, Wang says. "Typical approaches are to park licenses or return them for credit without impacting your discount levels."
Mergers and acquisitions create yet another set of issues. Consider the case of a professional services firm that started out with a 50-seat contract for its CRM service before acquiring another company and quadrupling the number of seats it needed. The business then had two contracts with two different rates, and the vendor demanded that the customer pay at the substantially higher rate after the merger.
The vendor wouldn't merge the contracts because the acquired business operated in another country, nor would it let the business renegotiate. "So they cancelled," Wang says, approached a new provider and negotiated terms that allow it to scale to as many as 1,000 users during the five-year contract.
Cloud-based services solve many problems, but contract complexity isn't one of them. As cloud services continue to proliferate, veteran negotiators say, businesses must build out or bring in the expertise required to avoid costly contract mistakes. Contract language is very different when you're leasing rather than owning the software, Wang says.
One great way to get up to speed: Attend workshops or bring in an expert to work alongside your own contract experts. Keep in mind that as the number of cloud contracts continues to rise, so too will the cost of failure. Cloud contracts represent an opportunity for a fresh start, says Wang. Perpetuating the mistakes enterprises have made with their on-premises enterprise software should not be an option.
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