When software demand management and strategic sourcing opportunities are addressed, the potential benefits can be dramatic, ranging as high as more than 40 percent in cost savings. Equally important, as technology continues to proliferate and become highly fragmented across a broad range of products and services, the need to manage software expenditures effectively continues to grow immensely.
Software – A Highly Profitable Industry
Software providers are among the most profitable companies within the S&P 500, with a five-year average gross margin of 78 percent, an EBITDA of 35 percent and a net margin of 21 percent.
The outsized margins are enabled by front-loaded product development costs, nominal variable production costs and complex pricing structures.
Once a solution is deployed, respective margins are further protected by high switching costs that are complex to navigate, allowing vendors to charge high annual maintenance and subscription fees for services that often lack clarity and can be difficult to measure. The annualized fees will often exceed the original license or upfront costs over the asset lifecycle.
A Complex Set of Challenges
Unfortunately, many customers are relegated to the role of “price taker,” largely accepting terms imposed by vendors, versus addressing internal opportunities that allow companies to manage a situation more effectively. Common, underlying opportunities that can be addressed include: immature software asset management capabilities, organizational silos, insufficient strategic planning, weak enterprise architecture, thinly staffed procurement and IT functions, misaligned incentive structures, staff skill-set/capability gaps, and unstructured communication protocol with vendors.
While software buyers rarely wield the same buying power as commodity product buyers, they can generate significant savings and cost avoidance, while increasing operational efficiency, by employing a strategic, structured category management approach.
The aforementioned operational and functional gaps often are compounded by disruptive sales tactics. Vendor sales staff will often “divide and conquer” across an organization, fragmenting internal communication and coordination. In many cases, the vendor has a clearer, more comprehensive view of ongoing internal conversations than the client, because few companies monitor vendor conversations centrally.
How Software Vendors Grow Revenue and Protect Margins
To generate new sales, vendors will deeply discount or provide software at no cost, to generate new revenue via recurring maintenance or subscription fees. In competitive product segments, this strategy is employed both by non-incumbents, who are trying to “get their foot in the door”, and by incumbents trying to keep that door closed. This approach is also often used to navigate budget constraints. In all cases, vendors are keenly aware that once software has been tested and deployed, most organizations are reticent and resource-constrained to switch. Hosted and cloud-based platforms can enable companies to reduce implementation time and effort, but switching costs can also remain high.
Both unit-level pricing and clarity of product value are often unclear. Some vendors employ multi-year, enterprise agreements under which all products are bundled, but the discount is applied at an aggregate level, so visibility into unit-level pricing is lost. Others bundle and discount products at an individual product level, but will re-price the entire set of products at a much higher level, if a customer wants to remove individual products or licenses. Vendors may also periodically rename products and/or encapsulate them into broader product suites. In addition, it is common for vendors to change licensing metrics and increase rate of product decommissioning to accelerate conversion to either a new product or licensing metric.
Comprehensive, Consistent Approach Required to Address Challenges
Cost containment of enterprise software products requires a comprehensive approach to be administered consistently on an ongoing basis by a strong, cross-functional team. The staff resource structure is common to other IT initiatives or projects. It begins with a team of qualified, cross-functional team members, well-defined roles, and an executive sponsor and decision-maker, along with an effective governance process to address any issues or challenges that may arise.
Strong collaboration among the C-suite will enable the process and is highly effective at driving value. A key role is the primary team leader, who needs to understand the respective requirements of software users, and the ability to influence internal and external stakeholders. This role is often filled by one of the cross-functional team members and is dependent on staff capabilities, competencies and skill-sets. The team will then be augmented by relevant processes and systems; most common are a software asset management system and function, along with a robust, balanced scorecard to manage the vendor on a recurring basis.
Demand management will be a core means to achieve software cost reduction. To do so, the team can initiate several primary activities such as reconciliation across contracted software entitlements versus installations, as well as current and forecasted requirements. In parallel, the team needs to inventory and prioritize requirements across a broad range of attributes; such as technical, operational, data security, legal and most importantly, business goals and objectives.
In addition, the team can begin shaping the initial negotiation strategy by understanding the competitive and technical landscape, its current and potential market impact, and your relationship with the vendor. In some instances, there are opportunities to leverage all elements of vendor spend to develop and execute “mega-vendor” sourcing strategies.
A final and key attribute, especially for an incumbent vendor, will be tight control and management of vendor access to your staff, along with a well-orchestrated and closely managed, communication strategy comprised of rules of engagement and communication protocols that have been reviewed and agreed to by your vendor.
New technology purchases, especially those that displace existing incumbent applications, provide companies with significant leverage that can often be extended to other incumbent vendor products. Important elements are financial analysis and scenario modeling to evaluate the total cost of ownership and total cost of switching, along with negotiation of commercial terms that both protect and provide flexibility to adjust the cost structure against changing requirements over time.
Other opportune attributes are to review and rationalize requirements for non-revenue generating, non-business critical, secondary requirements across data security, regulatory, disaster recovery, test and development. Although these needs are important, they often come at a significant cost as a result of over specified requirements and “gold” plating.
Finally, all these aspects should be considered and integrated within the context of your enterprise architecture, supporting infrastructure and most importantly, business strategy.
Expect Significant Cost Control and Reduction, Along With Increased Operational Efficiencies
A vast majority of the aforementioned approach will result in significant cost reduction opportunities across a broad range of demand management opportunities. Common initiatives are: rationalization of entitlements, controlled entitlement deployment, competitive displacement, increased asset utilization, specification and requirements rationalization against technical and business requirements, and rationalization of redundant products with common functionality. In some instances, you will identify compliance gaps, but the recommended approaches will allow proactive mitigation of respective risks and costs.Depending on the appetite and capabilities of your organization to act, the opportunity to achieve dramatic cost savings can range 5 percent to 40 percent or more.
Samir Khushalani was instrumental in the evolution of KPMG’s Procurement Advisory team and leads the Americas Procurement Advisory network.
Mark Elsner is a director in KPMG Operations Advisory.
John Dluzak, manager, KPMG Operations Advisory, contributed to this piece.