Paul Stokes needed to go shopping.
Like many companies in the U.S., the chief financial officer for Indianapolis-based manufacturing company Calderon Textiles was using a rather basic enterprise software suite from a small “best-of-breed” software company to run his back-office and supply chain business. The only reason the company even bought into that software system was for Y2K compliance, when the clock switched from 11:59:59 p.m. to midnight on Dec. 31, 1999.
Two years later and Calderon was looking for a much more robust system to handle its customer relationship, supply chain and human resources management needs at his growing company. A team was assembled and Stokes and crew went looking for an end-to-end solution to meet all their needs.
“We wanted to get one package to run the business, as opposed to smaller best-of-breed products that you saw a lot of in the 90s,” Stokes said. “We looked at other vendors, like Epicore, but they didn’t have all the features they were looking for. We were looking for something with a strong up-front sales piece with CRM
Companies throughout the world are in the same boat: finding a software product for their business that doesn’t cost an arm and a leg. To date, software upgrades haven’t been high on the priority list for corporate executives, and the numbers show. A recent study by research outfit IDC shows the economy and a “good enough” software mentality have resulted in only minimal gains in IT spending, at a time when many companies would see long-term benefits to implementing the software out there today.
Those meager spending numbers are not good for big software companies in the business of selling their products. Low sales figures mean missed revenue projections and jittery Wall Street investors. With the economy on the ropes — as it has been for more than a year in the tech industry — getting a customer to sign on the dotted line becomes all-important, even at the risk of dropping the price on premium software.
That’s how Peter Moore, supply chain vice president at personal protection equipment manufacturer Bacou-Dalloz, got a deal signed in June with Manugistics to deliver software to its worldwide offices. Despite the weak economy putting a damper on its own revenues, the time was right for an investment by Bacou-Dalloz.
“We acted despite the economic slow down in order to meet our strategic goals,” Moore said. “When the economy is weak, that is the time for leading firms to act decisively in order raise the bar or service excellence in their markets. The weakness in the software market was a bonus to us.”
But it’s not only about economy, it’s about industry market share. A couple years ago, there were relatively few companies that had an overlapping product line. That’s all changed. When the economy went south, companies like SAP , Oracle
and PeopleSoft
went on an acquisition spree, buying up “best of breed” companies to expand and beef up their product lines. Suddenly, one-time peers become competitors for the same amount of customers.
“Companies are trying very hard to maintain their revenue numbers, and part of it has to do with the maturity of the industry,” said Jane Disbrow, a research director at Gartner Group. “Now you have more competition; so you have companies like SAP, which was normally an ERP, going to small- to medium-sized businesses. Now, they’re in competition.
“If software vendors see competition, they are going to go down in price,” she added. “Only when they see credible competition will you see them agreeing to terms and conditions they wouldn’t have two years ago.”
There are signs some companies are getting over-eager in their need to make a sale. According to a recent Deutsche Bank report, PeopleSoft “…has thrown caution to the wind with some bullish 2004 forecasts. They have nevertheless confirmed they will be offering the ‘customer protection scheme’ this quarter. We bet they will offer steep discounts too.” The same report also quotes Tom Siebel, founder and CEO of Siebel Systems, Inc. , “who spoke recently of ‘desperate’ pricing by some players in this market.”
Not everyone sees it that way, however, and argue that undercutting the competition has been the status quo for years.
“This has always been a market that has had ridiculous pricing,” said Jim Shepherd, senior vice president at AMR Research. “In contracts you hear about 40 to 50 percent discounts and in the big companies as much as 70 percent,” but “I don’t see anything that I haven’t seen in the past 12 months or so.”
When the market rebounds, he said, you’ll begin to see these same companies offering discounts start to get stingy in what they will knock off the final price tag. For the time being, however, the ball’s definitely in the court of those who are doing the purchasing.
“Buyers clearly know they have the advantage,” Shepherd said. “They hold out okay.”
Model Performance
If software companies are slashing their up-front licensing fees to sign up the customer, where are they making their profit margins? On the back-end, of course, a system that both rewards the software company (recurring revenues) and the company buying the product. Back-end costs range from implementation and consulting costs to service and support.
Back to Stokes at Calderon Textiles: His team eventually settled on PeopleSoft, and while they didn’t see the heavy discounts in the license price, they did notice higher costs on the back-end, which isn’t necessarily a bad thing.
“The implementation side was on the higher side,” he said. “We negotiated both sides, the upfront cost and the back-end for the best price. As a CFO, I would like to see it somewhere in between; from a financial standpoint, backloaded is more attractive, and more beneficial.”
Another business model — besides back-end pricing — used by software companies to pitch their products is leasing, which pretty much negates the up-front cost and instead puts customers on something like a monthly subscription service.
Fred Hoch, software division vice president at the Software & Industry Information Association, said he believes the up-front licensing model will eventually disappear and move to leasing in the next 18 to 24 months.
“What you’re seeing is a shift away from pricing in licenses and more towards maintenance, like a service agreement,” he said. “It avoids the huge up-front cost and spreads it more over the life of the contract.”
While it does free companies from paying a large amount of cash upfront, leasing doesn’t have much support in the industry outside the vendor community. Ownership is only part of the issue.
Gartner Research conducted a study on leasing vs. licensing in December, 2002, and found an overwhelming majority of companies were not interested in leasing.
“You don’t want to have to re-negotiate your lease every one to two years to use the software,” Disbrow said. “And when they come back, it’s always more expensive because you are a ‘captive audience.’ ”
Shepherd agrees, saying the leasing model has always been a “funky” arrangement and a difficult sell for software companies.
“Applications vendors would love to model their sales on a subscription basis,” he said. “That would give them a steady revenue stream. ”
Getting Your Money’s Worth
In the end, it all comes down to value. Sure, getting the best bargain should always enter the equation, but price shouldn’t ultimately dictate what software you eventually decide upon.
Deltek Systems has been in the enterprise resource planning business for the past 20 years, and has quietly amassed a clientele of some 8,000 customers. In that time, company executives have seen the rise (and fall) of dozens of enterprise application providers and still preach a mantra of value over price.
Rick Lowrey, executive vice president of enterprise systems at Deltek, said that since the 90s there’s been a shift in focus from smaller companies providing one service very well to the monolithic corporation that sports a jack-of-all trades solution. It forces companies to accept a pre-packaged solution that leads to inevitable tweaking.
“The monolithic system is going to struggle down the road,” he said. “When your software only fits 40-60 percent of what you need and you have to customize 40 percent of it, get a consultant of implementor to customize 40 percent of the software, that’s not a very strong return on investment.”
The pricing war we’re seeing today, Lowrey said, stems from the fact big companies have to find a margin somewhere for their customers because customization is taking up a much bigger part of the process than it used to. The feature fuctions have to fit in the companies business processes, he said.
“The biggest issue isn’t getting the cheapest price, it’s getting the software that’s right for you,” Disbrow said. “You’ll get a good price, but you might have to spend more money on integrators and customization. And once you buy a major system, you’re going to have it for a very long time.”
