The licensing and implementation of ERP software is a major long-term investment for any company. In addition to negotiating favorable upfront pricing for the software, it is important to build in pricing mechanisms that provide flexibility and predictability in managing the ongoing license and maintenance costs associated with the software. This is the first of two postings that outline key pricing protections that you should consider negotiating with licensors of ERP software.
Future Option Discount
A future option discount provides a right to purchase additional software licenses at a specified price or at a specified discount off the licensor’s then current list price. This right has a number of benefits:
- It provides predictability in licensing costs due to business growth and assures that the licensor cannot take advantage of you on future purchases when you may have little or no leverage in negotiating price.
- It may enable you to reduce the initial buy, thereby lowering maintenance costs during the period in which the software is being implemented. However, you need to strike the right balance here. Reducing the size of the initial buy may impact the discount level the licensor is willing to offer. As a result, you should seek to achieve the optimal balance between (1) high discount levels on the initial buy, and (2) savings on maintenance fees by deferring purchases until licenses are needed.
In negotiating future options discounts, you should seek the following:
- The option price should be the same or very close to the discount level as the initial buy.
- The option period should be at least 3 years and desirably longer given the long-term nature of the investment in ERP software.
- The option should apply both to the license of (1) additional units of previously licensed software and (2) existing and future software products of the licensor that are not part of the initial buy.
The initial buy of ERP software is usually based on a forecast of current and future demand for the relevant license metrics (e.g., named users, cores, annual revenue, etc.). However, demand forecasts rarely prove to be 100% accurate. Exchange rights provide the ability to swap licenses for which you have purchased too many units for licenses for which you have purchased too few units.
In negotiating exchange rights, you should seek the following:
- The ability to exercise exchanges across as many licensed products as possible.
- The ability to exercise exchange rights at least annually and desirably on a more frequent basis (e.g., quarterly).
- A period of at least 3 years and desirably longer in which to exercise exchange rights.
Maintenance Locks & Caps
- Maintenance – the “gift that keeps on giving” for licensors – is a significant cost in software licensing. For example, if maintenance fees are set at 22% of net license fees (which is the current standard among major licensors of ERP software), you are effectively paying the cost of a new license about every 4.5 years in the form of maintenance fees. The licensor should be willing to commit to a multi-year period – desirably at least 4-6 years – in which annual maintenance fees may not be increased and thereafter to some form of cap or limitation on subsequent annual increases, such as capped annual inflation adjustments.
In our next posting, we will focus on shelving and termination rights, acquisitions and divestitures, and successor products.