Top 10 “Gotchas” in SaaS Agreements

May, 2021

The Promise of the Cloud

Adopting “Software as a Service” (SaaS) has been a fast-growing trend in organizations to achieve innovative business processes, functions, and solutions.

SaaS offers a number of attractive benefits, including the promise of additional flexibility in license deployment, elimination of infrastructure oversight and maintenance, lower entry costs to use, and faster speed to market with always up to date solutions.

Though businesses today have adopted SaaS based on these benefits, many find that the reality of the cloud is much different than its expectation.

SaaS Selling Strategy

Unlike legacy perpetual software, SaaS products are typically more user-friendly, utilizing “low code/no code” functionality to access all application features. This reduces the need for technical expertise from IT to purchase these products, giving power to business units to procure software directly from the vendor. This creates a different buying dynamic and presents a different set of risks for organizations.

Contract Terms Lock You In

The benefits of SaaS are real, but they are diminished by contractual lock-in. SaaS vendors today use agreement language to limit customer flexibility and guarantee future revenue increases.

As a result, many customers find themselves entrenched with their SaaS vendors as they gain a reliance on their hosted solution. This “reliance” translates to a lack of leverage at renewal time, often leaving customers vulnerable to large price increases and locked-in annual costs.

It’s likely that you will encounter a SaaS engagement in the near future, either being pushed by your organization’s business units or by incentivized sales reps pressuring a shift to the cloud to capitalize on SaaS compensation bonuses.

Since you may be exposed to these types of deals in the near future, it’s important to understand the pricing and contractual risk associated with them.

Being able to identify and mitigate these risks will determine the success of your long-term SaaS engagement. Though specific risks vary from supplier to supplier, this document highlights the main “gotchas” that are common themes among any SaaS provider.

The 10 “Gotchas” You Have to Look Out For

Software-Advisory identified 10 SaaS “Gotchas” that pose risk for SaaS customers:

  1. Renewal Caps
  2. License Downturn
  3. Product Changes
  4. Free/Promotional Product
  5. True-Ups/Price Holds
  6. Suite/Platform Bundling
  7. Restricted Use Licenses (RULs) & Audit
  8. Service Levels (Uptime)
  9. Mergers & Acquisitions
  10. Divestitures

1. Renewal Caps

Not only are the standard increases for SaaS vendors high (7-10%), but there are a number of ways these vendors find loopholes to increase your price above this threshold. For example, it’s popular for vendors to require 100% of initial volumes to be renewed or your renewal caps are void.

So, if you decommission a quarter of your volumes in effort to cut costs, SaaS vendors who use this language can increase your costs proportionally by 25% to keep you at the same annual cost level. Suppliers like Microsoft, Salesforce, ServiceNow, and Adobe find similar loopholes in language to inflict larger than average increases at renewal.

Implement a 3-5% renewal cap that limits increases for all products, regardless if reasonable notice is given to the customer. In addition, any language that limits the ability to downturn licensing at renewal should be removed to preserve license decommission flexibility.

Customers who start negotiations early (6+ months to execution date), obtain viable deal alternatives, and have net new license growth hold the most leverage to dictate renewal rights against the vendor.

2. License Downturn

If you over-purchase on SaaS licensing, you cannot downturn any unused products until renewal. Even at renewal, the feasibility of decommissioning product without a penalty fee is low.

Since most customers agree to multiyear term lengths and SaaS costs are based on an annual recurring pricing model, it’s easy for shelf-ware costs to accumulate quickly.

The ability to downturn licenses during the term of an agreement is typically non-negotiable for most SaaS vendors. However, there are other terms you can negotiate into a contract to improve your flexibility and reduce the risk of shelf-ware.

A popular clause is the ability to swap licenses during the term. This allows the customer to swap out unused licenses for new products that may be needed, as long as the same annual cost level is preserved.

Additionally, the customer can also negotiate a “ramp” in license volumes over the course of the agreement to further reduce costs and commit to more specific and realistic timetables for deployment.

The most frequent cause of over-purchase is when customers attempt to roll out all licensing on “day one” of the agreement period.

On average, it takes 6-12 months for SaaS solutions to be fully implemented, so ramping deployments appropriately will reduce the chance of committing to shelf-ware.

3. Product Changes

SaaS vendors that enact consistent changes to functionality and solution offerings often possess the contractual ability to reprice their customers’ contracts and alter product rights.

Specifically, ServiceNow uses product changes and “end of life” to force re-negotiation on licenses for practically the same functionality. We have seen cases where SaaS vendors used product changes and re-brands to increase price by up to 30% above the original amount.

Implement contractual price protections for all existing functionality currently owned. This will protect against a vendor re-branding the same solution into new products, thus forcing customers to make new purchases or pay more at renewal for the same functionality. Ensure that enough price holds are included to cover all products currently accessed by your business.

4. Free Product

Free products are a great way for SaaS vendors to get their foot in the door, but also provide the ability to charge premiums for those same products at renewal.

In addition, free products are usually provided at very low volumes, so entitled capacity can easily be exceeded. The true-up/add-on rate for free licenses are typically priced at an extremely high level, thus locking customers in to noncompetitive pricing if free products are heavily adopted by the organization.

If products are included as free, but are not wanted by the business, remove them from your contract. It’s common for vendors to throw in free product that was not requested in hopes that the customer uses it and eventually pays for it.

For any free products that remain in your agreement, ensure that you negotiate competitive add-on rates, assuming at some point you will have to expand in that license family at those predetermined rates.

5. True-Ups & Price Holds

Ideally, true-up rates would be consistent with the pricing you achieved in your agreement.

Unfortunately, Software-Advisory sees true-up costs from SaaS vendors that include premiums up to a 100% increase over current rates (Adobe being the biggest offender). For large expansions in licensing, this can cause costs to compound and escalate quickly.

True-up/add-on rates should be negotiated and included in your contract prior to execution. This will reduce the need to re-negotiate rates for each add-on purchase.

This is especially useful mid-term, when the customer has less leverage over the vendor. To avoid expanding at non-competitive rates, aim for a 0-10% premium over your current contractual/offer price.

6. Suite/Platform Bundling

The issue with bundles is that they lump together products that may not be needed by every user. These bundles are priced by the vendor based on the assumption that the end-user needs all included products/modules, when that is rarely the case.

As a result, the customer essentially pays a premium for additional modules included in the bundle that aren’t needed. Additionally, the lack of transparency in a bundle works to the advantage of the vendor, with any bundle change giving them the ability to increase pricing with little or no justification.

Ideally, line item transparency should be achieved before executing an agreement with any vendor, but not all suppliers have offerings outside of their suite/platform bundles. If you cannot achieve line item transparency, mix and match different bundle levels to your user base requirements to cut costs.

Additionally, customers can negotiate the price of bundles based off specific modules they may need. For example, if you only need 50% of the functionality, sales reps can offer an additional 50% discount to accommodate for the customer use case. This tactic is effective in negotiating Oracle product bundles.

7. Restricted Use Licenses & Audit

Restricted-use licenses offer the same functionality as full-use equivalents. It’s up to the user to enforce proper use, as agreed upon in the contract. It becomes increasingly difficult to maintain user restrictions and compliance when multiple license types are deployed.

SaaS vendors have visibility into the customer’s usage at all times since they are hosting the software, posing a high likelihood of being caught for non-compliant behavior. Salesforce commonly sells these licenses and has specific audit-driven language included in its contracts to address them.

Remove language that states all licenses will need to true-up in the case of a violation. Additionally, only licenses that are out of compliance should be applicable for true-up, not the total pool of licenses purchased.

Negotiate trueup rates that align with the contractual full-use price for the same license. If a full-use license has not been purchased previously, negotiate a predetermined true-up rate below list price.

8. Service Levels (Uptime)

SaaS is a hosted platform by a 3rd-party vendor, so it’s important that there are predetermined service level commitments included in your master agreement. Without an uptime availability percentage and remedies for failed performance, there is no way to hold the vendor accountable for solution downtime.

Ensure you have an SLA addendum included in your agreement that has uptime commitments and remedies in the form of service credits for failed performance. Aim for an availability percentage above 99% (less than 88 hours downtime per year) for any vendor, since this is the industry standard.

For remedies, its competitive to achieve a full daily fee refund for each day your solution is down below the negotiated performance level. To protect against consecutive quarters of failed performance, the customer should negotiate the right to terminate without any early termination fees.

9. Mergers & Acquisitions

Having consent to assign your competitive pricing and terms to an acquired entity is not always a given. With larger SaaS vendors like Oracle, Salesforce, Adobe, and Microsoft, it’s likely that the acquired entity also has a contract in place with that supplier.

Due to the M&A contract language, you can inherit potentially poor pricing and terms from your affiliates, with little ability to right-size them to your price levels.

From a contractual standpoint, it’s very difficult to get around this M&A language. Ideally, you will want to remove any language that requires the vendor’s consent to assign terms or any that requires an affiliate to live out their contract term before assignment can occur.

However, you need extraordinary leverage to negotiate these terms out of your contract. An alternative measure you can take to right-size pricing and terms is to utilize any new growth between both entities and negotiate a consolidated/unified deal through an early renewal.

10. Divestitures

In this situation, the vendor is double dipping on license costs. The main entity is required to inherit the full contract with all entitlements, regardless if they need all the licenses that are included after the divestiture.

As for the divested entities, their leverage will be extremely low during negotiations for the new licensing needed for their respective business users. The vendor knows that license requirements need to be filled immediately, and the sales rep will charge as much as possible.

Negotiate language into your contract that allows for licenses to be divested alongside any divestiture that occurs. This should allow you to assign a proportional amount of licenses based on the size of the actual divestiture.

Some vendors will cap the amount of licenses that can be divested, so ensure your cap is high enough to accommodate any planned organizational splits.

Wrap Up: Ensure You’re Prepared for the Shift to Cloud

Contract terms and conditions are an integral part of SaaS vendors’ sales strategies. Suppliers will not concede to competitive terms without significant buying power, because its success is tied to maintaining their standard language. Managing leverage is key to achieving the terms you want in your contracts.

Contact us for assistance with SaaS Agreements.