Software licensing is becoming increasingly complex with the rise of virtualization and changing pricing models from vendors. Virtualization allows more efficient use of servers but can violate existing software licensing agreements. Vendors may exploit opportunities created by virtualization to increase prices and change licensing metrics. For example, one vendor changed their licensing from per-user to per-employee and raised prices 170%. Negotiation expertise is needed to avoid risks from opportunistic vendors and unclear pricing structures. Buyers must protect themselves by negotiating flexible agreements that allow cost savings from virtualization and do not penalize reductions in licenses and support.

1. 22 purchasingb2b MARCH/APRIL 2010 Article Reproduced with Permission of Purchasingb2b Magazine, A Rogers Media Publication
NEGOTIATION By Phil Downe
In fact, in a recent transaction with
one of the 800-pound gorillas in the
software industry, the sales team could
not explain the licensing requirements
and pricing on what should have been
a fairly standard transaction covering a
migration, upgrade and addition to the
existing software configuration.
To even consider the sales rep’s
statement—that “this is what our pricing
people came up with”—would be folly.
It would create a completely avoid-
able risk presented by an opportunistic
vendor or, even worse, set up negotia-
tions on relative pricing positions that
neither party can quantify.
The situation is about to get a lot
worse with virtualization. It’s not
exactly a new concept. As early as the
1970s, the virtual machine (VM) plat-
form allowed you to partition a single
physical machine into multiple virtual
machines, allocating one or more
partitions and memory resources to an
application, all under a single cover.
The term virtualization has now
taken on a new life and it adds another
layer of complexity to the negotia-
tions and how technology buyers will
pay for software licenses. There are
now multiple flavours of virtualiza-
tion: machine, application, storage and
network, to name but a few.
Benefits of virtualization
Let’s take a server farm as a practical
example of some of the benefits of
virtualization. Roughly 90 percent of
the server market is composed of x86
architecture servers. Based on a tra-
ditional model of one application per
server, 80 to 90 percent of the comput-
ing capacity is unused at any one time.
With a virtualization strategy you
de-couple the operating system (OS)
from the hardware (machine virtualiza-
tion) and the OS from the applications
(application virtualization) that run on
multiple physical devices. When a job
needs more resources it isn’t confined
to its physical cover; it instead seeks
out unused capacity across the server
farm and relinquishes it when it’s done.
When you need to roll out a new solu-
tion you simply configure a file instead
of adding another physical device.
By taking this approach, your speed
of deployment is slashed and your
work is consolidated onto fewer
machines. Your hardware assets are
more efficiently used. You also save
on data centre space, energy costs and
system administration requirements.
What’s more, each new generation of
servers will have greater speed and ca-
pacity, which will increase the demand
for virtualized environments.
However, by choosing this option
you likely also breach the compli-
ance conditions of every established
software pricing and licensing model
known today. You’re going to need
software licensing expertise in-house
(or to know where to find it) to avoid a
risky leap of faith with your vendors.
Look to recent events in the soft-
ware licensing marketplace to see that
vendors will indeed exploit oppor-
tunities to increase revenue as more
companies turn to virtualization.
Opportunities for exploitation
One example that comes to mind
involves a software oligopoly that
acquired two major competitors over
the past few years, both of which
offered alternative time and labour
(T&L) license agreements. Originally
these two companies required a license
only for each person that used the
software. Then after the consolidation,
with a firm grip on the T&L market,
the expanded company changed the
metric to require every employee,
whether he or she used the application
or not, to have a T&L license. It then
raised the list price 170 percent.
What were the vendor’s customers to
do when faced with having to buy ad-
ditional licenses, plus the unnecessary
licenses, all at these exorbitant prices?
Should they have risked a vendor
swap, with the related costs of migra-
tion and another RFQ process?
No! Most did what they could to
avoid risk and negotiated based on the
inflated license price, plus 22 percent
of the net cost per year in techni-
cal support charges. Adding insult to
injury, they had to pay a specious mi-
gration charge to convert the old T&L
person licenses to the new employee
license metric.
This is just one more example of a
powerful software vendor taking ad-
vantage of a captive client with limited
alternatives because no protections
were built into the original agreement.
Virtualization and other licensing pitfalls
Smart negotiation can keep you from getting burned
“This is just one more example of a powerful software vendor taking
advantage of a captive client with limited alternatives because no
protections were built into the original agreement.
”
S
oftware licensing negotiations are getting increasingly complicated for the
buyer. Who on the buy side can be expected to understand all the combina-
tions and permutations of many of today’s software license metrics when the
concepts confuse most sales teams?

2. MARCH/APRIL 2010 purchasingb2b 23
Server license pricing
Now, under today’s common rules,
when it comes to a server license you
pay by the server, right?
Actually it’s a little more complicated
than that. First you multiply the number
of physical processors per server (some
now have as many as eight), by the
number of cores (some OEMs now
have quad-core systems) and then
multiply again by a factor of 0.25, 0.5 or
0.75, depending on the OEM, to come
up with a result. You then round up to
the next whole number, and that’s how
many processor licenses you need to
buy for that server.
Adding to the confusion are those
vendors that have a named-user license
charge as an alternative or in addition
to the processor license charge. Many
of these vendors also have 25-user
minimums per processor. You may
only have three users working on a
development server, but if that server
has the same four processors you
would be required to pay for 100 users
(four times 25) due to the minimum
requirements.
Imagine the additional complexity
of multiple named users accessing ap-
plications on multiple processors across
the entire server farm in an amorphous
virtualized environment. The OS and
applications “float” across the entire
server farm, and the user is indifferent
as to where the work is being done.
What new licensing rules apply?
What are the new support charges, and
how do they affect the existing licenses
and support charges?
What if tapping into previously
unused capacity results in significant
reductions in the number of physical
servers you need? What happens to
the excess processor licenses you have
already bought? It’s probably a safe bet
that you’ll get no credit for the license
fees if you end up stranding licenses
following a virtualized consolidation.
You paid for them, so you’ll likely keep
them and reassign them—if your agree-
ment permits you to.
Support charges
It’s difficult to plan a defensive soft-
ware negotiation strategy when so little
is known about some of the arcane
pricing policies of some vendors. You
may have little choice in some matters.
In others, forewarned is forearmed;
there are some precautions you can
take regarding support charges if and
when the opportunity presents itself.
Software vendors are reluctant to
give up support dollars. With annual
increases, it’s a cash cow that just keeps
producing. In some cases you can’t
even reduce your support charges
when you retire licenses. Let’s pull the
covers off one support policy that I
find particularly predatory.
Say you bought 10 processor licens-
es, each with a list price of $50,000, on
a single order five years ago. Assume
your purchasing department did an
excellent job and got a 50 percent
discount for a net price of $250,000.
The annual support cost for these
licenses is 22 percent of the net price,
or $55,000 per year. After five years
your support charge is probably closer
to $64,000 because of annual increases.
Following a server consolidation in
a virtualized environment you now
require only six processor licenses.
Wouldn’t you be surprised to find out
that after cancelling 40 percent of your
excess licenses your support charges
didn’t decrease at all? If you cancel a
subset of licenses on a single order, all
the remaining supported licenses go
back up to full list price. In this case
your support charges will be recalculat-
ed to 22 percent of the latest list price of
the six remaining licenses ($300,000, as-
suming no increases) and your support
charge is re-calculated to $66,000—more
than you would have been paying be-
fore the consolidation. You’re left with
no cost savings and a higher overall
support charge per license.
So what can you do? You can protect
yourself, lower your risks and set up
opportunities for future cost savings by
negotiating away the offensive de-sup-
port and reduced-support clauses. You
can build in price holds on additional
licenses that will likely be required.
You can also build a clear reduced
license and support formula into your
agreement.
Another alternative of course is to
split your software order into logical
groupings over multiple orders to
enable you to retire blocks of software
on single orders—along with their
support charges—without incurring the
re-pricing penalty on the remaining
subset of software licenses. b2b
Phil Downe (phil.downe@itnegotiations.com)
is an independent IT contract negotiator, the
founder of Relations Management Group Inc
and a member of the Purchasingb2b editorial
advisory board.