Software deals--what's in the fine print?

Surprisingly, businesses spend little time pouring over the fine print of multi-million dollar software contracts. Do we know what's really in them? Just ask California.
Written by Dawn Kawamoto and John Borland, Contributor

In the high-stakes game of corporate software negotiations, the silver-tongued sales rep is not the biggest challenge: It's the language of the contracts.

Given the multimillion-dollar costs of today's software deals, customers often devote surprisingly little time and resources to scrutiny of contracts that are rife with obscure terminology, vague expansion charges, and mind-boggling license conversions. As a result, they end up paying in ways they had never imagined long after the deal is signed.

California, for one, is trying to extract itself from a $95 million software deal with Oracle that has collapsed into controversy amid allegations it will cost the state millions rather than save money. Toronto faces similar problems as it attempts to disengage from its $11 million contract with the database giant.

In those cases, the issues involved the purchase of more software than auditors later determined would be needed. But the controversies they generated underscore the need for customers to know exactly what they are buying, especially when the details of corporate software contracts are so complex.

"I can't say it enough: definitions, definitions, definitions," said Frank DeSalvo, research director for technology consulting firm Gartner. "An enterprise deal to a vendor is one thing--and to a customer it may be another."

Understanding those definitions, however, is easier said than done for the untrained. The unique nature of software makes it difficult to price: Products can be copied from one computer to the next, and a piece of software might be used through the Internet by many people around the world.

Despite such complications, customers can avoid costly mistakes by taking a few key measures. In interviews with CNET News.com, analysts and consultants offer the following explanations and advice for companies and government agencies negotiating large software contracts.

• "Standard" contracts are often one-sided agreements favoring the supplier. Customers should not sign these without thorough review by an attorney, even if the sales representative presents it as a way to get the ball rolling or is pressuring for immediate action.

Stephen Davidson, an attorney and chairman of the intellectual property and information technology law department at Minneapolis-based Leonard Street and Deinard, cited one case in which a company temporarily used licensed software on a computer that was more powerful than noted in the contract. That put the customer at risk of triggering an expansion charge of nearly $1 million and a threat that the license agreement would be terminated if the fee was not paid.

• "Basic coverage" is the bare-bones maintenance support. A shift is under way to charge premium fees for support levels previously considered basic coverage. When renewing maintenance contracts, it's important to ask what basic coverage now covers, rather than assume it's the same as before.

One of the biggest dangers in negotiating a software contract is not understanding a product's upgrade schedule, said Selwyn Goldberg, a partner with Palo Alto, Calif.-based law firm Wilson Sonsini Goodrich & Rosati, who represents clients on both sides of the negotiating table in corporate software contracts.

"A customer needs to know how many versions of the software will be supported and for how long," Goldberg said. "The biggest danger is (that) a customer may buy version 2.0 and spend a lot of (time and) money adapting the software to a particular environment. But then the vendor says they're moving to version 3.0 and won't support 2.0 in the next six months."

• "Perpetual licenses" allow customers to use the software for the life of the product, providing they continue to pay the contract fees. Yet suppliers will often discontinue maintenance and support of the product after several newer versions have been released--rendering the software useless.

Industry experts say customers need to know whether these licenses apply to specific individuals or computers and whether they include maintenance fees that cover support and upgrades to the purchased product. These fees can often cost far more than the original price of the product.

"People can get suckered by that," Goldberg said. "They'll spend millions of dollars on software, and it takes three years to get it where they want it, and then the support for their version is about to change."

• "Entity based" pricing or "right of use" clauses are used by most software providers and restrict software usage to a computer at a specific company or governmental agency. A license may apply to a customer's headquarters but not its subsidiaries, consultants or acquired companies.

"Back in the late 1980s and early 1990s, Computer Associates International received a lot of adverse publicity for springing things on its customers," Davidson said. Although "right of use" clauses were written into the contracts, he said, a number of the company's customers weren't aware of those terms or ended up in court to dispute their meaning.

That was the case with National Car Rental System, which signed an agreement in 1990 to use CA's software for internal operations and processing its own data. But after National used the software to also process data of such companies as Lend Lease Trucks as part of its business operations, CA threatened to sue the company and the two parties became embroiled in a lawsuit with multiple counterclaims before eventually reaching a settlement.

Stephen Richards, executive vice president in charge of Computer Associates' global sales, said much has changed over the years in the way customers work with CA and other industry players.

"Today, people have a much greater understanding about the way license agreements work and do a better job with communicating and knowing how to better align their software needs with their business objectives," Richards said.

• "Compliance or mandatory audit" clauses should be avoided at all costs. Suppliers will use these clauses to audit your systems--often finding customers out of compliance and maneuvering them to upgrade their current contract or pay hefty fees. In this weak spending environment, you have the edge in getting this clause waived.

Companies and governments tell countless stories of suppliers auditing their systems and finding them "out of compliance" with their original software licenses, sometimes years later--then requiring customers to pay more accordingly.

"You want to exclude all mandatory or forced audits," said John Meyer, an analyst at Giga Information Group. "It forces you to renegotiate on their terms."

• "Named users" usually means the software is licensed to a specific customer's computer. But analysts caution that the term is ambiguous and must be clearly defined by the supplier in terms of a contract.

"'Named user.' What is that? A named user can be anything. It could be a power user, it could be an individual, or it could be a machine that's loaded with the software," DeSalvo said. "And what is 'concurrent user?' It could mean using the same logon with different computers at the same time or using the same computer by more than one person at the same time."

• "Concurrent users" encompasses a set number of people allowed to access the software, without regard to who they are. Like the term "named users," analysts note there is much ambiguity and make similar recommendations.

• "CPU based," or "per processor," licensing is based on the number of microprocessors that power the computers using their software. A number of large software makers have switched to this pricing policy in an effort to avoid the ambiguity of named or concurrent users.

• "Warranty disclaimers," "remedy limitations" and "liability limits" need special attention. A contract should call for a timely correction of defects, not merely attempting or making a good-faith effort to correct them to meet the required standards of performance. If a business suffers as a result of this problematic software, then the supplier should be accountable for reimbursement up to the amount paid under the contract.

• "Estimated pricing" and "projected completion dates" are virtually useless, given projects rarely come in at or below original estimate. Cost and timing should be specified.

Many companies find themselves negotiating numbers in the dark because most suppliers do not make their price lists public. Commercial and government customers need to secure bids from several companies and shop for the best deal.

"I had one major financial institution client tell me they thought they got a great deal," DeSalvo said. "They said the vendor was giving them a 75 percent discount off the list price. But I told them that discount was actually more like a 10 percent discount off of list, based on what I knew others were getting. They're now in a whole new renegotiation effort."

A critical question customers must ask software makers is what happens at the end of a term license. Many buyers do not know if they must give back the software or what consequences they face if they choose to continue using it.

Software manufacturers will often try to persuade customers to upgrade their software to new licenses, but analysts say customers should think twice to make sure they are getting a good trade-in value.

Sometimes, however, a customer has little room to negotiate if a product is deemed an absolute necessity. As a case in point, many companies and agencies that use Microsoft software are bracing for a change that calls for them to commit to a certain level of annual spending.

Under its controversial licensing plan that takes effect this month, customers need to pay an annual fee that commits them to buying operating system and application upgrades ahead of time. The old system allowed customers to upgrade their software whenever they desired or when their budgets allowed.

Microsoft customers may face an increase in fees, ranging from 33 percent to 107 percent, if they do not sign aboard by the July 31 deadline, according to Gartner. The research firm is advising Microsoft customers to either join the program or use a provision in the older licensing plan to avoid a substantial cost increase should they miss the deadline.

That could present a no-win situation for customers, particularly in these times of economic uncertainty and budgetary constraints.

"In 1998, customers may have projected an increased need for capacity--but then suddenly, with the downturn, they don't see the same growth line going up," said Mike Chuba, an analyst with Gartner.

Others agree that the possible turns of the future are often overlooked.

"An overarching consideration is to provide for changing business conditions," said Barney Kantar, a committee member and former head of the Society for Information Management's IT Procurement Working Group Steering Committee. "One should try to anticipate as many contingencies as possible...Too many times people have found themselves in cases where the parties never contemplated the changing circumstances of their business or the particular uses of the software."

In such circumstances everyone involved could find themselves at risk.

"Vendors like to sell these things as partnerships and partner with customers--partnering means if I run into problems, you share my pain," Chuba said.

Such pressures are likely to escalate as software manufacturers make an even greater push to land a sale in this market downturn.

"All customers should read their contracts," Leslie Rubin, director of Oracle's global pricing communications, said. "When you buy a car...you read the contract...Same thing holds true with software. We encourage our customers to read their license agreements and ask questions of us at any time."

Industry veterans say customers must not be deterred from doing whatever they can--and more often than not, that means exercising common sense.

As Curtis Wolfe, chief information officer with the state of North Dakota, said simply: "The key to getting a good contract is knowing what you need to buy, defining it well, and then matching it up to the vendors that will fill your need."

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