Avoid costly price escalation in cloud software deals

Just like software buyers minimize costs, software sellers maximize profits. Their contracting departments have spent years perfecting their techniques. As a software buyer, you only do this occasionally. You are the amateur pitted against the professional. See how their "land and expand" technique works, and how to defend yourself against it.

By Phil Downe, Relations Management Group

The “land and expand” (L&E) sales tactic is common among professional services companies of all kinds, including accountants, consultants and, of course, technology vendors. It has many iterations. When you are negotiating for long-term cloud-software subscriptions — especially when your company’s future product alternatives are limited or difficult to implement — price-protection on many levels is a must. (I will delve into price protection for subscription agreement renewals in a future post.)

Without it, you could be wandering into several predictable price traps by an opportunistic vendor. Your future alternatives may be limited because of the software’s unique functionality, the scarcity of suitable competing applications or, more likely, because of the time and cost to swap-it-out and implement another vendor’s solution.

Let me walk you through a simplified scenario that is all too common among enterprise cloud deals. After a systematic selection process, your company selects a cloud application to be used by 3,000 employees over a 60-month period. Typically, benchmark list prices or volume-tiered discounts are never published or discussed. Your team feels like they did a good job negotiating and gets the subscription costs down to $15 per employee per month. The total five-year cost, assuming no growth, is: 3,000 x 60 x $15.00 or $2.7M. That would be paid annually, in advance, in five equal instalments.

Next, a professional services organization, typically a “certified implementation partner,” is engaged to help implement the solution by configuring the software, perhaps a few customizations and build the interfaces to the company’s other applications. Let’s say the cost of those services is $1M and the job, the build phase, will take one year to complete.

Everyone knows the company doesn’t need 3,000 subscriptions during the build phase, but the vendor can’t book all the revenue and get their quarterly bonus unless the buyer takes delivery of all the subscriptions. Plus, the vendor’s argument is always that the average monthly subscription cost over the 60-month agreement is already discounted in consideration of the build phase.

Still, the business case looks good. The total cost, (excluding company time and resources) is $3.7M and the company stands to benefit approximately $4M a year using the application. The five-year cost is $3.7M and the return is $16M, four years at $4M per year, excluding the first year of implementation work. That’s a five-year ROI of $4.32 for every $1.00 spent.

But while justifying payments for unused subscriptions (shelfware), what did the vendor really say? Did they just “telegraph” a 25 per cent future price increase? They said the real discounted net price, the price for 3,000 subscriptions for a full 60-month period, wasn’t $15.00 but actually $18.75, ($2.7M / 3,000 employees / 48 months), taking into account the 12 months of implementation time.

Mathematical logic would hold that the next individual subscription required after Go-Live, due to employee growth, would have a value of at least $18.75 a month for 60 months when you buy at least 3,000 subscriptions. Add-on subscriptions are always coterminous with the original agreement, so, in year two of the five-year agreement, you may only need to add 100 subscriptions and for a shorter 48-month period. A much lower quantity with a shorter commitment period is a harbinger for another significant price increase.

The lesson? Always insist on full price transparency up front — list prices, term-discounts, volume-tiered discounts — and build in some price-protection. The “land and expand” (L&E) sales tactic is in every subscription vendor’s strategic playbook. Beware of becoming a victim of a time-honoured tradition.

First published in Canadian Accountant on May 12, 2020.