META Report: 14 Warning Signs of Poor ELAs

Mar 25, 2002

Mike Egan

The combination of a March 31 fiscal year end (Computer Associates, Compuware), low OS/390 MIPS growth, and a tough economic climate will generate an increased percentage of poor independent software vendor (ISV) enterprise license agreements (ELAs) this quarter (and throughout 2002).

Although most large ELAs are straightforward, approximately 30 percent will contain poor pricing or terms and conditions (T&Cs) that users must avoid. In addition, ISVs are deferring advance ELA renewal negotiations to the last minute, which further aids an ISV's negotiating position.

Given these factors, plus the increased tendency of individual sales representatives to employ deceptive practices in a tough economic climate, users must manage enterprise ELAs more carefully, refusing to sign until fairness and value analyses are complete.

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One of the costliest pricing structures is one that binds all product pricing to total MIPS capacity. Although equitable where systems management products use all MIPS, independent software vendors often bundle lightly used products (e.g., those that operate on one to two logical partitions into capacity-based pricing. This generates a 200%-500% price boost for limited-use products, lasting three to five years. Some ISVs may try to push these schemes near term, because capacity pricing will begin disappearing after 2004. The emerging IBM License Manager (ILM) product (generally available in the second half of 2003) contains a Sub-Capacity Reporting Tool that will ultimately include ISV product usage reporting (2004/05), enabling users to better negotiate ELAs with light-use product pricing based on accurate usage statistics, not capacity MIPS.

Where users must negotiate large ELAs now (e.g., expirations), we recommend two tactical approaches. Users can negotiate steep $/MIPS discounts (e.g., 50%-90%) that reflect partial usage (10%-75% of MIPS) or can exclude these products from the ELA, offering to pay list price (based on used or tiered MIPS). By 2004/05, as sophisticated IBM and third-party monitoring tools evolve, these tactical strategies will be unnecessary.

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14 Warning Signs of Poor Enterprise License Agreements

We recommend examining enterprise license agreements for the following pricing, usage, or contract clause conditions. Where users uncover problems or questions that cannot be resolved quickly or to mutual satisfaction, they should postpone negotiations (if applicable). The primary characteristics of a poor ELA include:

  • Capacity-based product pricing: Many products use 100% of capacity, but numerous ones do not. Users must exclude partial-use products from ELAs based on capacity pricing (flat-rate $/MIPS) to avoid a substantial overcharge for light-use products.
  • Annual 10% or greater price increase:This price-gouging tactic implements a 10%-15% annual price increase throughout the five-year ELA (61% increase, compound rate). ISV product pricing rarely increases more than 3%-5% per year.
  • Higher than list price: Many ELAs (15%) are priced above list. Some ELAs are based on single-CPU rates and fail to include the ISV's 25%-60% secondary CPU discount, which generates a rate lower than the ELA's $/MIPS rate. ELAs should not be signed until the ISV provides full pricing information enabling users to independently calculate the discount.
  • Restricted usage: The ELA may offer price improvements, but might contain restrictive usage clauses that force users to pay multimillion-dollar charges when unexpected change occurs (e.g., mergers, divestitures, application-specific outsourcing, agency consolidation). Users must ensure the ELA does not restrict business and computing change.
  • No declining or volume discount rate:Cost must decline as MIPS volumes increase (e.g., 20%+ less for an added 1,000 MIPS, another 20% less at 2,000 MIPS). Other acceptable pricing benchmarks include annual declines (10% $/MIPS reduction per year). Without this protection, pricing is linear and can be especially costly in one-time merger- or acquisition-based MIPS growth.
  • List or then-current pricing on expiration: If the vendor increases pricing 50% or more during a multiyear ELA, users may owe whopping charges at expiration. Wise users negotiate one-year extensions if both parties fail to agree on ELA renewal terms, with pricing increases capped at roughly 10%-25%.
  • No capacity separation for operating-system-specific usage: A 2,000 MIPS user installing 200 MIPS of OS/390-hosted Linux, Microsoft, or Unix can potentially be charged for a 2,200 MIPS implementation of the new environment, due to total MIPS pricing structures that do not differentiate whether MIPS are dedicated to a separate operating system or LPAR environments.
  • Charges for first-year's maintenance: Users receive the first year's maintenance free with new purchases, but not with upgrade purchases made during a multiyear ELA. These charges can add up; users should try to negotiate immediate upgrade maintenance out of an ELA.
  • High maintenance/upgrade percentage: Some vendors discount upgrade charges attractively, but associated maintenance rates might be extremely high (25%-40%), negating any savings. During periods of low growth, users with these clauses pay maintenance rates at 100%-150% of list.
  • ISV "do-nothing" scenario confusing: The multiyear pricing scenario ("do nothing" or "business as usual") shows attractive savings, but the vendor's underlying calculations are difficult to analyze. This can be a deliberate tactic; no ELA should be signed until users can recreate the ISV's calculations.
  • Multiyear product lock-in: ELAs rarely allow users to delete products (and lower ongoing payments) during the term. Users must negotiate advance price reductions or exclusions for products that may later be dropped; otherwise large overcharges can occur.
  • The deal is best if signed quickly: Some ELAs are offered with quick-sign bonuses. Although many fiscal-close "quick sign" deals are legitimate, the tactic is most frequently deployed to hide the complex deal's many underlying weaknesses.
  • ISV-supplied growth estimate: ISV-prepared, multiyear MIPS growth estimates often contain "fluctuations" increasing costs in the vendor's favor. Users must prepare their own long-term growth/cost scenarios.
  • MIPS capacity ceilings: No ELA should contain charges or penalty payments for growth above a specific total MIPS ceiling, unless MIPS growth is free until that limit. Some vendors try to insert both; this becomes a duplicate and excessive upgrade fee, especially in mergers.

Business Impact: To achieve optimal software cost reductions, users must implement a supervisory asset management office, with dedicated personnel handling scheduling, staffing, and vendor negotiation responsibilities.

Bottom Line: Users should negotiate ISV enterprise license agreements cautiously in 2002. This practice can reduce ISV costs simply by identifying, minimizing, and even eliminating poor or deceptive ISV enterprise license agreement offers.


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