Digital Transformation » Systems & Software » The hidden costs of software licensing and how to avoid them

We are operating in an increasingly digitalised world. This shift to cloud solutions has seen an erosion of market share for some traditional software vendors. Their response? Exploring alternative ways to generate additional revenue streams. This can represent a real risk and substantial cost to businesses unless the appropriate steps are taken.

One recent trend, increasingly well publicised, is for software vendors to seek to generate income from indirect licensing. These are licences for users of third party applications that interact with a software vendor’s system. This could be third party logistics providers, or stock or customer ordering interfaces (retail or end-customers) where access is via a software interface rather than by issuing a log-in to a business’s central systems. This could lead to claims that additional licences are needed for all those additional users (warehouse staff, sales reps and/or customer).

In 2017, a court case brought this issue out in to the open. Tier 1 software vendor SAP alleged that £54 million worth of additional licences and maintenance fees should be paid by one of its customers owing to third party software integrating with its own solution.

Addleshaw Goddard (AG) has unique knowledge of this case, having advised that customer and having since acted successfully for other clients to defend a large number of unreported claims.

Even if a business does not have a formal claim, its software licensing position needs to be kept under review if there is a change in the IT architecture. For example, if an interface is added to a new software system, such as a website ordering or supply interface with customers or suppliers.

The difference between the quantum of the vendor’s claims (often £multi-million), and the reality of a customer’s liability to pay such licence and maintenance fees, can be vast. In AG’s experience across many sectors, such liability (when investigated) is frequently very limited or even non-existent.

Understanding how indirect licensing works (from a legal, commercial and technical perspective) is essential for every organisation in order to avoid or limit unexpected costs.

Why should you care?

To put it simply, understanding your licensing requirements could save money now and in the future.

It is important for CFOs and finance teams to ask themselves the question: If our business was audited by its software vendors tomorrow, what would the outcome be?

The negotiations AG has supported show that a business first needs to understand how its software systems interact. That understanding can then be applied to the licence T&Cs to assess the number of direct and indirect licenses that are needed. This can be both a defensive play – seeking to protect the business against a potential claim – or an offensive play – seeking cost savings.

By doing nothing, a business faces the considerable risk of overpaying, unexpected bills or settling invoices that have been rendered improperly.

How do you save money?

Negotiating the T&Cs of the licence

When negotiating or renegotiating a licence with a software vendor, it is important to have a full appreciation of the T&Cs before entering into an agreement. This is easier said than done – many software vendors have standard T&Cs that incorporate a multitude of ancillary documents often containing hidden risks, or rights that the software vendor can use to create commercial leverage to squeeze the customer.

For example, is it clear what restrictions there are on use of or access to the software? Are there different types of licence, each with a different pricing point? Do you anticipate any use or access that is not covered by one of the specified licence types? Are there rights for the software vendor to increase the price? Does a minor breach entitle the software vendor to suspend all access to the software, while the customer is still under an obligation to continue to pay the fees in full? Are the T&Cs locked down or does the software vendor have unilateral rights to vary them?

Even when T&Cs have been agreed and signed, the risk does not end there. During the life of the contract it is just as important that a business proactively manages it. Again, this can be both a defensive play – to mitigate the risk areas and ensure the software vendor does not incorporate additional T&Cs through change control or future order – and an offensive play – driving cost savings by reorganising IT systems for more efficient licensing.

Pricing models

It’s essential to engage with a software vendor’s pricing model. Many software vendors are changing the financial make up of deals in response to the digital revolution, looking at both human and digital use of and access to software. With contract value and levels of liability often intrinsically linked, pricing negotiations take on a whole new dimension.

A recent example from April this year is SAP, which introduced a new document-based pricing model, with fees based on documents processed by the solution. Existing customers have been given the choice to remain on the traditional pricing model, where licence fees are associated with use, or move to the new one.

While many software vendors take a positive and constructive approach to customer relations, there are others that are much more aggressive. Some vary their approach from customer to customer. For example, offers by software vendors to ‘consult’ for free may be intended to help customers operate more effectively or efficiently, or may simply be fishing exercises to assess opportunities to generate additional fees or encourage a shift to new pricing models.

A business should internally assess its licensing requirements in light of new pricing models before opening its doors to software vendors. They should not be afraid to take the time to understand how a software vendor’s pricing model works and how it will apply operationally. Careful consideration of whether lawyers should be involved in that process, rather than just technical consultants, given both the contractual nuances and the protection of privilege that internal lawyers or an external law firm can provide, is key.

Horizon scanning: where might you be caught out in the future?

Software vendors often have the right to conduct an audit. Before this happens, it is important to make sure the permitted scope of the audit is clear, and that the software vendor does not stray beyond it. In AG’s experience, a business that has assessed its systems, the number of relevant users, and the licences it has, can engage constructively and positively with the software vendor. By not being prepared, businesses can find themselves in a complicated position of misunderstandings, mistakes and, ultimately, unexpected costs.

Likewise, when developing systems, adding new software, or linking systems to a third-party solution (a customer or supplier), it is best practice to fully appreciate the technicalities of the interfacing software, to apply that to the contractual T&Cs, so that consequently the impact on the pricing is known (avoiding any hidden and unexpected costs).

Mergers and acquisitions are another area to be aware of. Whether a business is acquiring another company or being acquired, it should be mindful of systems interactions and licensing numbers. Can licences be transferred? Are additional fees triggered by a divestment? If the buyer or seller intends to migrate the other to its systems, are new licences required?

Organic growth also provides risks and opportunities. A business should work out how many employees use software systems and not overpay for licenses it does not need. Negotiating flex and/or transfer options into licence T&Cs can save the business considerable sums if they are managed proactively.

Looking after the pennies

This article has just scratched the surface and the digital revolution is moving at a fast pace, so new challenges are expected to arise for customers and new approaches from software vendors.

Those clients AG work with to assess their technical solutions, licence T&Cs, number of users and potential risk areas, engage more successfully with software vendors who come knocking for additional fees. There are many examples where businesses reveal they have paid additional fees to software suppliers for licences that are simply not required.

Businesses should always read the small print and shouldn’t be afraid to negotiate software vendors’ standard T&Cs, and proactively manage their IT ecosystem and portfolio of software licences. With advice on these issues at an early stage – the return on investment can be substantial.

 

Simon Lofthouse and Bill Gilliam are Partners at Addleshaw Goddard.