By Roger Burkhardt, CEO, Ingres

Here’s how the software business really works: A software company charges your firm an enormous upfront licensing fee and locks you into escalating costs for decades to come, often using a set of hardball tactics.

But with the growing popularity of pay-as-you-go and subscription-based software and services, the old way is being exposed for the unfair financial model that it actually is. And the new open, more flexible models are starting to make the old ones look downright deceitful, especially when you show them against the backdrop of a deep recession.

Many companies have been forced to downsize to make it through these tough economic times. And as information technology and C-level executives examine the financial books together, many are discovering the unfortunate news that their Big Software contracts are harming their business’ bottom line and cannot be downsized – at least now without a fundamental change of approach.

Perhaps it’s not always intentional, but if you’re an IT decision maker with several of these licensed-based software contracts on the books, it’s very likely you’re getting duped.

How the duping works

Big Software Goliaths like Oracle (ORCL), Microsoft (ORCL), Sybase (SY) and SAP (SAP) use multi-year enterprise license agreements that lock you into annual fees that go up, but can almost never be reduced. They encourage you to make large upfront purchases of software licenses by providing significant volume discounts. Volume discounts are common in the software industry and help you achieve a lower price-point on your software licenses and annual support fees. However, encouraging you to purchase larger quantities than you need often leads to “shelfware”, i.e., owning a whole lot of software you don’t use.

What if you want to downsize? Because annual support fees are tied to the net license price, the discount is tied to the original volume of license purchased. Therefore, the Big Software companies argue that you lose the discount originally granted on the contract. Their typical tactic is to re-price right back to list price, not a reduced discount, and with typical discounts in the 25 to 85 percent range it is financially infeasible to downsize. It’s this kind of aggressive tactic that ensures that Big Software’s revenue streams never go down, and in fact continue to go up as annual escalators are applied.

Duped and trapped

If you don’t need to downsize your usage but want to just hold steady and pay maintenance you’ll be caught in the renewal trap. When your multi-year contract comes up for renewal, you’ll find that your contract has no cap on subsequent increases to the annual support contract. The high-paid sales person will then warn that your original discount will evaporate if you don’t buy more licenses. It will be cheaper to buy more “shelfware” than to pay list price for your maintenance.

In addition, if you ever want to reinstate support on the unused portion of your licenses, you would be required to pay all the back-support fees for the period you cancelled. It would be like getting a large service bill for services never rendered from your former auto mechanic – the guy whom you haven’t taken your car to in two years because you found a better shop. No wonder Oracle’s margins on maintenance are over 90 percent!

More deeply duped

The enormous consolidation of the software market has created a few behemoths that have enormous pricing power over their customers because of their large market shares and a strategy of vertical integration, which raises customer-switching costs. If you try and get out of being locked-in, you’re likely to pay a big price.

Big Software players have demonstrated their power by raising prices during the worst economic period since the Great Depression – not exactly a tactic that supports the customers through tough times. In the last year and half, for example, Oracle has seen fit to raise overall software and maintenance fees by 15-18% and to raise prices on acquired technologies by 45%. Many companies locked in to an Oracle contract, for instance, have signed a contract where they agree to pay these unexpected price hikes, often without reading the fine print and realizing the true cost of what they have signed up for.

Many price increases are hidden behind additional fees that penalize customers for taking advantage of industry advances such as modern multi-core chips which reduce hardware costs or even just external access to your own data over the Internet. Yes indeed, even in the 21^st century Internet access is often excluded from Big Software’s standard licensing terms.

Meanwhile, contract consolidation and the co-termination of contracts further reduce options, as more software is covered under a single contract. You may ask for a consolidation, but more likely than not, the vendor will argue that the entirety of the new contract is open for re-pricing, if you attempt to modify one component of that contract. This is happening with increased regularity for product lines that have been acquired, as vendors consolidate the newly acquired product lines in single corporate purchasing agreements and use their increased leverage to extract more revenue and lock the customers in even more firmly in the future.

To learn more about how to get out of Big Software contracts and/or negotiate current ones to your advantage, stay tuned for my next article.

Burkhardt is president and CEO of Ingres. He previously spent six years as CTO and executive vice president of the New York Stock Exchange, where he and his team  transformed  the NYSE to a fully electronic model.