How Software Vendors can protect their Maintenance Revenues by elevating Effective User Adoption practices.

Over the past several years, maintenance revenues have grown to now represent the lion's share of operating profits for many software vendors. Multiple market forces are aligning to threaten this industry cash cow.

If these threats are not addressed, leading software vendors stand to lose $billions of high margin maintenance revenue which will erode company profits.

The following discussion outlines the magnitude of this threat and proposes a solution for software vendors, which is to redirect operational investments towards services that elevate Effective User Adoption practices.

Maintenance Revenue Is The Software Industry's Cash Cow: But For How Long?

A recent study by IDC claimed that 41% of software vendor revenue comes from maintenance revenues and this amount is forecasted to grow as certain software verticals experience revenue growth falling back to GDP.

For the purposes of this discussion, we analyzed the financial reports of several leading software vendors in the ERP, CRM & ITSM verticals. For this sample, we found that maintenance revenue represents 46% of their total revenue, and due to the relatively high operating margin on maintenance, it accounted for 76% of operating profits.

Any economist will tell you that profit levels like these are not sustainable in free-markets. As the industry is beginning to realize, these profits are highly susceptible to new competitors and changes in the relationship between buyers and sellers.

The Threats to Maintenance Revenues Are Real and Present

Already market forces are mobilizing to attack the maintenance profit pool. Third party support providers (Rimini Street) are promising to halve maintenance price points. Rival vendors are building "backdoor" customer acquisition paths by offering discounted support for their competitors' products (SAP via TomorrowNow). Dominant software vendors (Oracle) and private equity firms are raiding maintenance annuities through acquisitions. And lastly, nimble SaaS providers (Salesforce.com) are starting to penetrate this revenue pool by presenting comparatively attractive subscription price points.

In addition to these supply-side pressures, there is also active movement from buyers on the demand-side of the profit equation. Enterprise software buyers are doing their part by increasing the sophistication of their software lifecycle practices to delay upgrades, increase usage visibility, bring support in-house and re-price contracts downward. These pressures from the CIO office will continue as long the majority of the enterprise IT budget is spent "keeping the lights on".

With these changing market forces, there is a significant financial risk for software providers if they do not protect the volume and margins of their maintenance revenue streams.

How Much Maintenance Revenue is Really At Stake?

Software vendors have a lot to lose if they don't address the threat of maintenance revenue erosion. If we accept that large software vendors are susceptible to the industry average of contract renewal attrition (research suggests 16% of maintenance contract revenues are not renewed each year), then approximately 9% of total revenue is currently being lost per year through missed opportunities to fully retain existing customer's business.

As the industry moves forward, increasing price pressure will be another leading cause of maintenance revenue erosion. The cumulative affect on total revenues of future price reductions on top of existing renewal attrition is significant. With potential price reductions in the range of 5% -15%, total cumulative loss of revenue would be in the range of 9% to 15%

For our sample of software vendors, the cumulative threat from both maintenance contract renewal attrition and future price reductions is in the range of $1.6BN to $4.8BN.

With so much at stake, Effective User Adoption practices are a compelling business imperative to protect maintenance revenues.

How Does Effective User Adoption Protect Maintenance Revenues?

Effective User Adoption (EUA) represents a triple play for software vendors as a way to protect maintenance revenues:

EUA increases a customer's transition cost of converting to competing alternatives

EUA increases the transition costs of migrating to competing alternatives by improving the breadth and depth of software utilization and by closely tying core functionality to operational performance. Although cheaper and more innovative functionality may become available, enterprise buyers will need to consider the total economic impact associated with changing products. Direct costs include data migration, user training, and process alignment customization. The less obvious cost is the productivity impact to the organization. Clearly if large user bases in critical operational roles are actively engaged with the existing solution's core functionality, then the challenging vendor's ROI pitch would be harder to justify.

EUA increases the size and likelihood of contract renewals

It is not uncommon for enterprise software buyers to initially buy more licenses than they eventually deploy and ultimately use. This leaves contract renewals exposed to erosion when usage is evaluated near renewal time. Active management of Effective User Adoption can often expand license footprints and at a minimum maintain them. Clearly "shelf-ware", software with non-deployed licenses and/or very low end-user adoption, has a lower probability of being renewed. On the flip-side licenses fully deployed and actively used make for satisfied customers and give vendors a much stronger position to maintain or increase their renewal volume.

EUA can maintain or enable price increases

Effective User Adoption moves the focus of price discussions toward value - that is, business results produced from software. Software providers that cannot sustain the "value dialogue" will be left discussing price reductions, especially in mature verticals where functional parity has been achieved. If buyers can be convinced that desired business outcomes are directly connected to the software solution, they are more likely to pay a vendor's asking price. Taken to the extreme, EUA can enable value-based pricing which is the only viable option to prevent maintenance revenue erosion over the long-term. Some providers are already experimenting with value-based pricing versus the traditional cost-based method. For example, Computer Associates cites pricing on customer's operational metrics and business growth.

Maintenance contract renewal rates and prices should not be taken for granted. Historical renewal rates are no guarantee of future renewal rates, especially in light of increasing competitor and customer pressures. Software vendors need to redirect their operational investments towards Effective User Adoption practices to guarantee these critical profit streams.

Software Providers Need to Rebalance their "Operational Investments" Towards Effective User Adoption

We all know that generating additional revenue streams from existing customers is more cost effective than efforts to acquire new customers. Although this is obvious, it appears that software vendors have allowed their historical allocation of operational investments (customer acquisition / retention / harvesting) to persist even though their vertical-specific growth rate and profit mix has changed.

As we have seen, software vendor's operating profits are largely affected by maintenance revenue. Yet, if we take a look at the operational investment portfolio allocation of our sample group of large software vendors, we see that investments in efforts to protect maintenance revenue by delivering higher business performance through Effective User Adoption are unbalanced given the importance to their bottom line.

In fact, investments directed towards Effective User Adoption, which for this sample is primarily represented by user training, account for only 1.5% of total operating investments. To qualify this definition, product support costs have not been included in Effective User Adoption investments because customers consider uptime from support to be a mandatory feature of their software solution, not a source of business value. Furthermore, R&D has not been segmented to account for investments in new functionality for existing customers. This may seem questionable for developing verticals, but for mature verticals current end-user adoption rates suggest new features have a limited impact on improving a customer's business performance. To the contrary they may even pose a negative impact from increased application complexity and user's "feature fatigue".

How Much Should Software Vendors Re-allocate to Protect Maintenance Revenue?

We estimate that investments in Effective User Adoption practices should be closer to 4% of the total operational investment portfolio. This estimated re-allocation of funds has been developed using the assumption that it is five times cheaper to retain a customer's revenue than to acquire it new.

Rather than increasing total operational investments, re-allocations should be made from research / development and sales /marketing to cover the increased Effective User Adoption investment target. This rebalancing of the operational investment portfolio has an extremely compelling ROI. For no change in the cost structure a potential lift of 2% to 8% in total revenues from improved renewals and an insurance policy to prevent a potential 2% to 6% revenue downside from price reductions.

The reallocation of the investment portfolio towards Effective User Adoption is clearly a sound business decision. However, it will also require leading providers to elevate the goal of driving value realization for their customers.

Industry Leaders will elevate Effective User Adoption (EUA) to drive higher levels of business performance for customers

For most software vendors there is currently no adequate position or team that promotes on-going Effective User Adoption and by definition customers' business results. More established vendors do have Customer Relationship Managers or Account Managers. However, these individuals and/or groups do not have the necessary skills and solutions to solve the user adoption challenges that plague their customers and threaten maintenance revenues. Consider for instance the following end-user adoption statistics:

• 50 percent of software functionality paid for and licensed by organizations is not actually used, Butler Group, Exploiting Enterprise Applications, March 2006



• Less than 40 percent of the firms implementing CRM systems have end-user adoption rates above 90 percent, CRM Magazine, July 2006 (from CSO Insights' 2006 Sales Performance Optimization Study, 1275 companies)



• Only 27% of CPOE deployments achieve greater than 61% physician adoption, 2005 Hospitals & Health Networks' Most Wired Survey and Benchmarking Study

Obviously software vendors cannot take full responsibility for these results. However, there is a significant opportunity for vendors to build a new profitable service practice focused on helping customers drive Effective User Adoption to achieve higher levels of business performance.

Existing services should be expanded to ensure that the software solution is measurably connected to operational performance and adequately deployed to the majority of targeted users. New methods of developing ongoing user capability will be required to meet the realities of transient and temporary workforces.

Arguably the biggest area to address is the customer's organizational commitment as it relates to the product. Providing customer's with a roadmap for higher levels of effective usage, realigning competing user expectations, marketing value to end-users and enabling executives / managers to fulfill their change leadership responsibilities are all critical to ensuring Effective User Adoption.

New services will not be enough to deliver the desired result. A dedicated EUA senior management position needs to be created. Reporting to the CEO, this new position should have top line responsibility for protecting and growing maintenance revenues. A senior executive is critical for this role, not only because of the important connection between maintenance revenue and operating profit, but because activities across the entire software vendor's organization (sales, product development, implementation consulting and post deployment support) have an impact on customer's end-user adoption rates. In addition, if software vendors are to take control of the "value dialogue" with their customers, up-front positioning, sales messages and marketing efforts need to be revisited.

At its best, the EUA Executive role would represent the ultimate customer advocate and redefine the relationship between providers and their customers.

Conclusion

The business imperative is clear. The most profitable area of a software provider's business is at risk from real and present shifts in the market. Vendors need to realign their operational investments toward new practices that mitigate maintenance revenue erosion. Effective User Adoption practices are a cost-effective option to solve this challenge and more importantly elevate the relationship between providers and their customers to a more strategic partnership. Effective User Adoption ensures that customers achieve their desired business outcomes and as a result become increasingly satisfied with their enterprise software purchases.

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