Price-Hike Surprise

It's been a buyers' market for years, but now some software vendors want to charge more. One CIO warns that the attempts could backfire



A sign of desperation or a rebounding I.T. market? Whatever the explanation, business-technology managers say some software makers, after several years of deep discounting to prop up declining sales, are trying to raise prices and fees--in many cases, without providing much in the way of new features or services. That's not going down well with customers, many of whom are still struggling under difficult business conditions and trying to stretch IT budgets.

Richard Hoffman -- Photo by Sacha Lecca

Hyundai CIO Hoffman suggests adding an escalation clause to software contracts.

Photo of Richard Hoffman by Sacha Lecca
Richard Hoffman, director of IT and CIO of Hyundai Motor America and Hyundai Motor Finance Co., has seen more than one vendor try the tactic in recent months. One supplier tried to change the contract for its proprietary Web software to reflect named users rather than concurrent users. Under the old contract, 50 people could use the software at any given time, but the vendor wanted to charge Hyundai for all potential users--more than 800 people, which would mean nearly a 1,300% spike in costs. Another vendor changed the way users are defined under its enterprise-resource-planning contract, pushing more employees into a high-use category with higher fees. That would have resulted in a more than 40% increase in software licensing costs. Hoffman resisted both increases.

Software vendors are "hurting for revenue, sales are down, and what's happening is they're redefining their contracts," Hoffman explains. And what they're offering in exchange isn't worth it, he adds. "They tell you, 'Now we're giving you all this extra stuff.' The problem is, it's all stuff you don't want."

Roger Berry, CIO at Walt Disney World Resort, has been hit up by vendors seeking higher maintenance fees. Such fees usually run 7% to 12% of overall license costs, he says, but some vendors have tried to raise them to as much as 17%.

Steven Buege, chief technology officer at Thomson Legal and Regulatory Ltd., a $3 billion-a-year publishing company, says one vendor proposed a license fee hike of almost 39% for a three-year contract renewal. It wants an increase in maintenance fees for the contract, which provided for unlimited use of the software by employees, because employees use the software so much. "If that's going to be the model for pricing," he says, "watch how fast I can reduce the need."

It's difficult to determine how widespread this trend is, partly because software pricing has always been complex. Customers interviewed for this story didn't want to cite specific vendors or products, in many cases because they still use the applications and want to maintain good relationships with the vendors. Software developers generally are reluctant to discuss prices of their products because they want to retain the flexibility to cut deals. Plus, there are so many factors that can go into the cost of software--number of users, number and types of servers, number of CPUs, amount of usage, and so on. It isn't always clear whether a proposed price hike is reasonable or even if it is a price hike.

Take Microsoft. The software company changed its volume licensing program last year, angering many customers who believed the changes would increase their costs. Microsoft argued that companies that upgrade frequently would actually save money with the new licensing plan. Still, in response to the backlash, Microsoft added more services to its software and maintenance contract. "They made it more palatable to customers," says Dwight Davis, an analyst at Summit Strategies. "They sweetened the pot by adding additional services."

Here's an example of how complicated the game can get: Microsoft says customers can use its new Exchange Server 2003 to consolidate servers. Exchange Server 2003 costs the same as its predecessor--no increase. To consolidate, though, customers probably need to upgrade from the $1,000 standard edition of Exchange to the $4,000 enterprise edition. Price increase? No. Higher price per server? Yes. Lower total cost of ownership? Maybe.

Many vendors have reported quarter after quarter of declining software license sales, so price hikes shouldn't come as too great a surprise. "Anytime there has been an economic downturn, providers--and not just software providers--try to figure out ways to get new revenue," says Ditka Reiner, president of Reiner Associates Inc., a consulting firm that helps businesses negotiate software contracts. "It's not that vendors are evil, it's just that vendors are trying to stay alive," she says.

Some observers question whether there's anything really new going on. Complaints about software pricing have been around as long as, well, software, they say. "Nobody's ever happy about pricing. You could charge $1.98, and people would still complain," says Aberdeen Group analyst Denis Pombriant. Any vendor trying to boost prices could face a nasty backlash. "A sure way to put yourself out of business is to raise prices when demand is slack," Pombriant says.

Others say price maneuvering is business as usual. "I haven't noticed any changes," says Dennis Hernreich, executive VP, chief operating officer, and CFO of Casual Male Retail Group, a men's specialty retailer with more than 580 stores, as well as E-commerce and catalog operations. "They're always trying to get you."


Daniel McNicholl -- Photo by Bridget Barret


Photo of Daniel McNicholl by Bridget Barret
True, but they've been trying harder recently, says Daniel McNicholl, chief strategy officer for Information Systems and Services at General Motors Corp. McNicholl says software vendors had eased off price hikes as the downturn in IT spending worsened, but he's seen renewed efforts in the past six months. Attempts to boost prices "get shot down pretty quickly," he says.

At the InformationWeek Fall Conference last month, Hyundai's Hoffman asked for a show of hands to indicate how many in the audience of several hundred attendees faced software price hikes. About half raised their hands.

Not every business is able to fight higher prices. Patrick Wise, VP of advanced technology at trucking and logistics company Landstar System Inc., faced increases in software maintenance when planning the budget for next year. The company's antivirus software vendor had increased maintenance fees 60% this year; Landstar decided to pay rather than rip out and replace the application.

Some vendors claim price pressures are still working in the customer's favor. SAP's CEO, Henning Kagermann, said in September that 40% of the deals that SAP loses are because it was beat on price. "If the whole industry starts to compete on price," he said, "price will never come back."

Computer Associates sees a software market that's "competitive as hell," says Greg Corgan, senior VP of North America sales. CA hasn't raised maintenance fees, which are around 17% of license fees, in 10 years, he says. "On an individual basis, do we end up discounting our prices? Sure. Have we taken an overall price action? No. When it's a buyer's market, which it is, the customer has the upper hand.''

But ongoing vendor consolidation may reduce customer leverage, GM's McNicholl says. "If [the industry] overconsolidates, the balance of power shifts back," he says. McNicholl believes the "magic number" is three, referring to the number of leading vendors needed to maintain competition in such critical areas as database and ERP software.

There are things business-technology managers can do to ward off unexpected software price hikes. Demand that vendors set one price for the software and services, says Casual Male's Hernreich. Landstar's Wise is trying to build closer relationships with fewer vendors, so the company can establish longer-term deals that it can monitor closely. Hyundai's Hoffman suggests demanding escalation clauses that limit future price hikes. "We won't do business with a vendor that won't cap the inflation increase [at] 3% to 5% for the next five years," he says. The best tactic is to convince the vendor that you're ready to walk if you're unhappy with the contract terms, he adds. (See informa tionweek.com/961/pricing_side.htm for more negotiating strategies.)

Any trend toward higher prices could hurt vendors and buyers, Hoffman warns. If all of his budget increase is eaten up by price hikes, it will limit his ability to buy new technology. "It starts this death spiral, because nobody's buying," he warns. "They're going to kill this industry, because everybody's in the same boat."

-- With Beth Bacheldor, Chris Murphy, and Rick Whiting

Continue to online sidebar: "How To Keep Software Costs Down"

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