The Fallacy of Discounts in Software Negotiations

One of the most common questions enterprises ask about software spend is whether they should benchmark the discounts they receive from software publishers. Whether they are buying from Microsoft, Oracle, SAP, ServiceNow, IBM or others, the presumption is that a higher discount is better, which is true to a degree. However, the sales approach taken by software publishers is highly sophisticated, with less-than-transparent elements designed to maximize spend. The truth is, a premature focus on trying to get a higher discount on a software license or subscription on the part of an enterprise buyer can lead to paying too much.

From the perspective of procurement economics, there is no question that negotiation leverage increases as spend increases. However, unlike many other areas of spend, when it comes to software, variable costs are much less significant as a component of the price paid, and, therefore, there aren’t any significant economies of scale to the software publisher associated with larger purchases, other than perhaps with account management or product support, and these economies are relatively modest. 

Software publishers understand buyer behavior – and the expectation of larger discounts. The most common pricing strategy by software publishers, therefore, is to inflate the apparent discount percentage by applying it to a combination of additional products, which increases the quantity of licenses, and selling higher level – and more expensive – license SKUs. This is not dissimilar to car dealers offering unsuspecting buyers the interior stain protection and anti-rust undercoating options.

The result of this kind of “upsell” is that clients often end up with a combination of “shelf ware” and higher-category licenses on top of what they actually need. Software publishers frequently make the case that the recommended package – including the add-ons – will provide greater convenience and flexibility to the enterprise buyer and mitigate risk in case of unexpected usage and future audit noncompliance issues. The financial effect is this: enterprises end up agreeing to an inflated bill of materials (BOM) with a higher discount percentage, which may mean they pay  significantly more money than what they would have spent if they more thoroughly analyzed, and stuck with, what they actually needed, at a slightly lower discount percentage.

Avoiding these problems is not as simple as it sounds, as enterprise technical teams can be susceptible to the tactic of inflated BOM recommended by the technical sales team. Because they are simply too busy and may lack the expertise to do a more detailed analysis, they often overspec the requirements as a faster and less risky option. 

Deferring to recommendations by one of the “Big Four” or other system integrators in the process of defining requirements also tends to inflate the BOM. Consider the incentives: software companies want to sell more and system integrators may receive a commission for software sold – or may simply add capacity in the software implementation to increase tolerance margins that essentially de-risk their own delivery obligations.

Instead of focusing on discount percentages, sophisticated buyers will look to an independent, buy-side expert to conduct a series of five essential steps: 1) review the organization’s current licensing entitlements and utilization rates, 2) meet with the technical and business stakeholders and review the solution architecture to more realistically assess actual demand, 3) develop options to reallocate certain licenses differently across users and processors, 4) identify any potential credits, and 5) develop an alternative BOM to that being proposed by the seller. This alternative BOM should then form the basis of negotiations, targeted discount levels, price locks, timeline for purchase of specific license volumes to align with timing of actual demand and other business terms. 

Don’t forget that compliance issues ARE real and need to be analyzed, not guessed at. Dealing with them proactively will get the enterprise buyer the best terms for what they truly require and will give them the opportunity to optimize and mitigate their requirements by looking holistically at their estate.

This doesn’t mean that the optimized BOM won’t ever change. The current agile business climate means that enterprise requirements will change over time. However, this is precisely what a strong software asset management (SAM) program is for. Enterprise buyers that structure their initial agreement expertly and that manage net new requirements and changes each year through their SAM program will, more often than not, pay a fair price and retain a significant degree of leverage in future years.

Taking the above approach commonly results in a 20 percent or greater improvement in deal pricing than organizations achieve by focusing first on discount percentages. Let ISG help you negotiate the software purchases that are right for your organization.