Demand for SaaS solutions exploded over the last year in response to the pandemic and the need to quickly pivot to accommodate work-from-home. The top five SaaS vendors – Workday, Microsoft, Adobe, ServiceNow and Salesforce-- reported year over year sales increases ranging from 25% to 70%. In light of this SaaS spending spree, it’s more important than ever for buyers to understand the risks associated with SaaS.
SaaS solutions are touted as “low code/no code platforms”, meaning they do not require technical expertise for purchase and implementation. This distinction has enabled vendors to sell directly to the business units, resulting in multiple contracts and myriad pricing schemes across a given organization. In addition, unlike the perpetual licensing model of yesteryear, buyers of SaaS sign subscription agreements and find themselves locked in at renewal time.
How should you buy SaaS solutions, and what are the main risks?
SaaS licensing increased financial risk to the buyer for the aforementioned reasons, but they also made the solution irresistible: initially, suppliers charge about a quarter of the price of a perpetual licensed product. And yet, customers end up paying significantly more for SaaS solutions than for their old perpetual, on-premise licenses down the line. How does this happen?
The answer is “value based pricing”, which means vendors figure out how much the solution is worth to the buyer, not what it costs to make and deliver. Let’s look at an example that involves Adobe, a supplier that moved from perpetual licensing to cloud-based subscriptions.
Up until 2016, a perpetual license for Adobe’s graphics and media software suite cost $2500 per user per year. If you moved to Adobe’s Creative Cloud, you could access the same products for $600 per user per year – a 76% savings. What we’ve seen since is a significant increase in Adobe revenue. Here’s how:
The vendor – in this case Adobe, but all SaaS suppliers do this -- uses the perceived value of a product as the benchmark for pricing. In general, the supplier works to show that their solution will significantly increase your productivity and marks up their prices accordingly. This is highlighted in the graphic below.
What you can see here is the vendor’s practice of demonstrating to a client that they'll get at least 10 times as much “value” as the price paid for the solution they propose. When this is done effectively, a supplier is extremely likely to win the business.
This happens in almost every cloud-based pricing proposal, which includes a slide indicating your return on investment after you adopt the solution. This slide helps justify costs and is completely removed from any volume tiers or discount thresholds; it simply ensures the highest price they can charge based on how valuable they think the solution is to you. This tactic works well because the vendor is driving the value story. In order to have a more successful outcome, the buyer must shift who's controlling this narrative.
There are two things that consistently make an impact on better SaaS deal outcomes: the buyer’s understanding of the metrics and SaaS licensing, and the creation of a conservative, detailed demand model. Getting a grasp of the licensing is not easy: it's constantly becoming more complex and ever-changing. Most organizations cannot keep up with the pace of these changes, and the suppliers are counting on this -- it enables them to obscure pricing, justify price increases and inflate demand to “maintain compliance”.
ServiceNow is notorious for licensing changes. In the following graphic, you will see some of its major products, and the license types or metrics associated with them. Right away you’ve got a variety of different metrics to unravel -- even within a specific product like IT Service Management, which has a number of license types for different functionality rights. As you grow with ServiceNow, licensing becomes much more complicated and difficult to track across your environment.
We counsel clients to get ahead of license changes to understand how they may impact your business, and how they can be leveraged to your advantage in a SaaS deal. It might be as simple as pushing back on changes. The sales teams are highly motivated to sell you products after a licensing change, so creating an aligned internal message conveying your disinterest in that change can provide leverage for you.
Before we get into building a conservative demand model, we must reiterate how critical it is to understand licensing metrics: If you don't grasp the specific licensing metrics of a specific supplier, it will be extremely hard to estimate your demand, and you will most likely over- or under-purchase, and risk noncompliance.
Because building an accurate demand model is so complex, we recommend starting your deal preparation at least six months ahead of a renewal date. For more complex deals, you might need even more time. Be assured that all of your vendors are planning your renewal long in advance, so it behooves you to allow enough time for your process and the ability to go back and forth with the supplier during negotiations.
To help with your demand modeling, we offer the following SaaS roadmap.
This process ties back to the value based pricing narrative discussed earlier, where if your supplier can justify the value they're providing, they can better justify the pricing and the volumes in their proposal. When your internal forecasting process is underway, you can immediately bring down their starting point before any proposals and/or negotiations begin.
Also, we urge clients to create a ramp plan. Map out what additional licenses are needed and when, because it is unlikely that all the licenses are needed on day one. So, you will want to build out what your adoption will look like and include that in your message to the supplier.
Main SaaS Contractual Risks: Renewal Rights, Price Holds and Free Licensing
Each vendor has their own way of providing renewal rates. We’ve identified the top five risks that we observe in renewal-related contract language.
High increases. This is when companies provide protection, but quote increases that are higher than competitive rates (3% to 5%) over the previous pricing. Though these are better than no renewal caps at all, the high increases do present financial risk.
Renewal silence. Some SaaS vendors are silent when it comes to protections and quote high increases at the end of the term.
Product changes. Vendors frequently rebrand products and make you upgrade to the new version – which is not covered by your renewal protections. This plays out frequently with ServiceNow, forcing increases of 20% to 30%. Customers must work to ensure that their contract includes no loophole language that would allow vendors to bypass their renewal protections.
Volume commitments. Some renewal terms specify that customers risk losing protections if their volumes are not maintained. In these instances, we recommend trying to negotiate the volume commitment out of the contract, or move it to a lower level, like 80% of the licenses.
Annual vs. term. This is when increases apply on an annual basis, which compound over time and lead to significant additional spend in a multi-year agreement, even though they may initially appear competitive (e.g., 3% + CPI). With this risk, we suggest negotiating increases on a per term basis, especially when committing to a longer deal.
Having renewal protections in place can help, but it is just as important to read the fine print and understand where limitations may exist so you can work with or around them. Here’s a recent example, below.
In this ServiceNow agreement, the customer had renewable protections built-in, and a 5% increase, but it required a laundry list of criteria that had to be met by the customer to execute those renewal protections at the end of the term. As shown here, the damaging clause in the renewal was the commercially available restrictions, which the vendor was able to exploit and enforce 30% increases.
Price holds are the next key contract risk for buyers, and there are four types that must be inspected, discussed below.
Price holds for added licenses of product included in the agreement. Find out if you can buy current licenses at the same price as those in the current contract.
Cost of licenses not in the contract. This is the rate for new versions of the same license; the first two price holds listed here can provide some safety if demand changes and additional volume is needed.
Cost of upgraded/rebranded licenses. Customers can, with enough leverage, incorporate price holds for upgrades or for new products beyond the current scope. These holds allow for more flexibility and can help protect customers down the line if they want to add to their footprint, or if a new version is rolled out.
Price holds that extend beyond the renewal term. These enable the buyer to retain their price holds after the contract term expires.
Negotiating price holds is a great start, but customers must also make sure that the holds are competitively priced, meaning between zero to 10% of the contract rate.
The final risk to address here falls under free licenses. SaaS providers are experts at enticing customers with so-called free licenses that are often not really free. These are known as test drives, freemiums and bundles.
Free test drives can be presented as Proof of Concepts (POCs), where the customers get to test the solution without incurring any expense. This sounds good, but they work against your leverage. Vendors know that when the users like the product, the company will likely buy it, and they issue a higher price as a result. This can be mitigated by negotiating the price when the POC is initially being considered, or by running a competing POC alongside it.
Freemiums are a limited number of licenses provided at no cost, but carry price holds for additional usage beyond the initial phrase. This can seem like an attractive offer, but it is important to monitor usage and understand the competitiveness of the costs for utilizing those additional licenses.
The last bait-and-switch risk is when bundled licenses appear to be provided for free in the original purchase, but at renewal time or if changes happen down the line, vendors say they were not free, and the customer must pay for continued access to these now embedded tools. It is imperative to determine what is and what is not included in the agreement at its inception and delete or clarify language around licenses that could come back to bite you later.
For more information about making more strategic SaaS deals, download our webinar, SaaS Buying Traps & Trends, visit our website to view our portfolio of SaaS- and leverage-related content (under Blogs), or contact your ClearEdge representative.
- This article is based on a webinar of the same name delivered by ClearEdge Senior Analysts Dan Beyh and Lauren Savrin.