Do you know how to protect yourself and stay in the driver’s seat during contract negotiations so that you won’t be held ransom by your ERP provider?
In this article, we’re going to outline the top things you need to take into consideration when negotiating contracts with Oracle, SAP, and any other ERP system.
We’re going to share with you the key terms to clarify in your contracts to avoid extra costs and substantial frustrations down the road.
What to Look for in an ERP
While no company has a crystal ball to know exactly what the future will look like, you do need to identify how you’d like your business to function over the next 10 years.
Why 10 years?
Typical business roadmaps project as far as 3-5 years in the future. Most ERP systems relationships last a minimum of 10 years.
You need to know how your business will function in order to know what you’d even need an ERP for and what it would need to do. You need to be risk-averse in your contract negotiation in order to cover your bases for what could happen.
Once you have your future vision in place, you’ll look at the supplier landscape. Compare what each of the top ERP systems providers offers and how it’ll meet your needs outlined above. Create a Supplier Decision Matrix and stack each contender against it to determine which is the best for your corporation.
Once you know which ERP software is right for your corporation, you’ll need to dig deep to really figure out the total ownership cost. This is the tricky part and is best handled through thorough careful contract negotiation, financial analysis, and service management.
Key Things to Consider When Negotiating an ERP Software Contract
The contract is the most important factor when determining the total cost of ownership of the ERP and there are generally only two triggers for renegotiation once a contract is in place.
These triggers are: mergers & acquisition activity and contract renewals.
Providers know that you don’t read ERP contracts every day. They design contracts in complex and ambiguous ways, which leads to more revenue for them - and more fees for you.
Each of the following points needs to be specifically addressed and outlined in your contract to prevent your ERP from holding you ransom at various times over the course of your relationship.
Pay Attention to Intellectual Property Ownership
Many ERP contracts will state that any systems or processes developed while using the ERP are now Intellectual Property (IP) owned by the ERP provider.
We worked with a customer recently in the manufacturing industry. They had developed a process for creating their materials more efficiently going through the production line. According to their contract with their ERP provider, it shows that any process that you develop using the ERP software can be considered ERP owned IP. As such, we needed to carefully negotiate the situation with the ERP provider so as to not cannibalize the newly found process improvement which led to millions in positive P&L impact (new revenue and cost savings).
In a contract, you need to be very clear who owns the rights of process improvements as far as when it may directly or indirectly utilize an ERP system.
Your ERP is the backbone of your business. As such, if properly set-up and integrated throughout your organization, it touches most if not all aspects of your business. Naturally, this complicates any opportunity to disentangle from that ERP.
If Oracle, SAP or any other provider wanted to play hardball, they could say any process improvement that utilizes an ERP system could be co-owned or sole-owned by that ERP. If this is the case, the provider could take that process and then go sell it.
In fact, one of our recent clients had this happen to them based on not properly reading the contract years ago. They needed to retain our expertise and a major law firm to seek litigation with that specific provider.
Make it very clear who owns what when negotiating your own contract. It needs to be clear that the client owns all IP that are developed for the benefit of their company.
Be Smart About Your License Cost Model
Everyone knows ERPs cost a lot. New contracts with smaller providers will often undercut themselves for the first year or two but will see a massive uptick in years 3-8 because the ERP knows it’s incredibly difficult to leave an ERP once you’re integrated into it.
The cost models of ERPs vary depending on the makeup of the customer’s business and what will be the most profitable for the provider.
Some of the pricing models include:
Generally speaking, seat-based pricing is the most cost-effective for companies looking at ERPs but this depends greatly on what your 5-10 year plan looks like to know which would be the most beneficial to you.
In addition to your unit cost, there could also be annual maintenance expenses. The annual maintenance acts like an annual expense and is generally a percentage of your perpetual license fee/net spend with the ERP.
There are 2 ways to host an ERP system:
Either way, you need to be careful on how you license a product because if you don’t have control of consumption and volume-based, it can skyrocket your costs.
Know Your Audit Rights
This is one that gets people in trouble a lot. Generally speaking, Oracle and SAP will not proactively limit access or connectivity to your ERP. This almost always is the responsibility of their customer, based on their unique needs.
As such, these providers will contractually allow themselves unfettered access to your ERP environment with the intent of auditing the usage of their software. Typically, they are validating you are licensed appropriately based on how you originally licensed the platform (seat, volume, value-based, etc.) .
The most common areas of audit risk are:
Depending on your unique situation, you may be subject to all three (or more) risk areas. It’s important to know there is intentional ambiguity by the software providers in how one could interpret contract language related to permissible use.
Furthermore, we find that clients have no intention of noncompliance within any area but find it most difficult to monitor and govern the area of architecture compliance. A common example of routine noncompliance when a client links their ERP system to both development and production environments.
Similarly, if an ERP is connected (in anyway) to a client’s CRM system it may also trigger a non-compliance event for both architecture and license compliance due to the fact that a client almost always has more active users within a CRM environment. Those CRM users may be somehow benefiting from the ERP and well, we’ll leave it to your imagination based on what you’ve already learned from this article.
Over the last 10 years, large ERP providers like Oracle and SAP have been focused on audit rights within a client's environment. Specifically, when an ERP is living within a client’s infrastructure (on-premise) it’s technically infeasible for the provider to proactively monitor license compliance.
As such, these providers are inserting audit right language within to client’s contracts (both new and old) providing the legal authority to conduct random audits of a client’s environment. The providers deploy both human and technical based tools. The technical tools include running scripts that “listen” to your environment.
These scripts are developed by the provider themselves and are programmed in a way to identify every single endpoint. The output of the script’s analysis is a single report that identifies ways in which the client is potentially non-compliant. This automatically places the client in a defensive position leading them to try and disprove any sort of non-compliance allegations.
These guys make huge revenue by running these audits and identifying non-compliance. Architecture based non-compliance is most often the most profitable audit for a provider. In addition to what we’ve already stated, another risk area is when your ERP is connected to other systems outside of your current infrastructure.
In a nutshell, every time you make a connection between your ERP and another outside platform (often done through APIs), the ERP provider may identify this as a missed charge and will charge you retroactively since the connection was initiated. This can easily develop into millions of dollars of new revenue for the ERP providers (with very healthy sales commissions).
Not only with the ERP provider monetize the API connection with an API charge but will also try and push value-based pricing.
For example, a client is connecting different systems together (using APIs) - this is the backbone of how their systems work. It is going to help them go to market faster.
The ERP provider is arguing the fact that “you are going to get an extra 20% increase in value from the system now vs what we quoted you. As a result, we are going to increase your fee by 20%.”
Value-based pricing is risky because these providers can charge for new API connections, new acquisitions, product launches, and/or the output of the tool and how it can help you run your business. It’s based on potential and not necessarily even realized revenue!
Don’t let a provider run a script inside your environment. If they don’t have access to your information, you’re in control of it and you remain in the driver’s seat.
Have Clear Merger & Acquisition Language
Put specific clauses in the contract that make it very clear what happens if you are acquired or if you acquire someone else.
More often, it is the provider who offers this language. These companies will put in very loose language to say ‘if this happens, we will talk about it’ which leaves a lot of area for ambiguity.
To best prepare yourself for any situation, we recommend you place specific and measures or language in your contract that outlines the cause and effect for the most common situations.
Specifically, you’ll want to identify what happens if you are acquired or if you acquire a separate entity. Within any of these situations it’s important to have clear legal language regarding the rights of your company. From a commercial perspective this means having specific pricing thresholds.
Simply put, If you are acquired, you take the better of two prices. You take the best price of both until you, as the newly combined customer, want to renegotiate.
If you are acquiring a company, it’s important to insert legal language allowing you to renegotiate the contract immediately or rather simply adding the newly acquired entity into your existing contract with only a reasonable increase in fees. From a commercial perspective it’s important that you outline what (if any) additionally fees would be subject to the transaction.
You want to eliminate ambiguity. From a pricing standpoint, you want to make this as clear as possible.
Set Expectations About Subsidiaries
You also want to know the specific parties of the agreement. What is a common hiccup for companies is that they don’t have subsidiary language in their ERP contracts. A common example would be a company like Coca-Cola. Each of their product lines acts as its own subsidiary and runs its own P&L, etc. If they didn’t have subsidiary language, then you could be in default of your contract by letting this subsidiary use your system.
This is something people don’t think about until your provider comes to you and says ‘Hey, by the way, your other subsidiaries are using this ERP software. Happy you are doing it, but that is not part of your contract so here is a bill for another million dollars.’
Third parties - suppliers, vendors, non-employees - need to be defined in the contract as well. If 3rd parties are allowed to act on your behalf, there shouldn’t be any additional fees for them to use your system.
Be Sure to Outline Price Protection
Another thing you need to consider when negotiating your contract is price protection. Generally speaking, companies don’t write in any sort of price protection year-over-year.
What that means is that over the contract term, your ERP provider could change the price points of your unit costs at any given time. Most people assume that a provider would never just change the cost of their services but they do and is more common than you would imagine.
It is not just about being clear about locking in your price at contract term, it is also putting a cap on the amount of increase that can happen at the next contract renewal which needs to be aligned to the Consumer Price Index (CPI).
A general rule of thumb is that the increase shouldn’t exceed 3-5% at renewal.
Include Clear Terms Around Your Service Level Agreement (SLA)
An ERP is a critical piece of software for any corporation and yet we often don’t negotiate Service Level Agreements (SLAs). If ERP systems go down, it can shut down governments and grids. It is a critical software within companies for good reason.
Make sure that you have the best service level agreements and governance agreements by specifically outlining them in your contract. Including these will ensure that your provider keeps their service at 99.99% performance.
In addition, there needs to be penalties for an ERP provider not meeting or exceeding their Service Levels that you agreed upon in your contract.
Most contracts will put in language about penalties but most companies don’t catch ERP providers when they are starting to fail. There are hundreds of thousands of dollars left out there because no one said “Hey your service was down over the weekend. That creates a $200k payment because it has been down for X hours.”
If a big company hires an IT governance professional to monitor that, that professional will likely be ROI positive. You pay them $130k salary and then get $250k-400k in fees coming back from the ERP provider.
Along with keeping an eye on the service levels internally, you need to put the ownership on the ERP provider to send you reports of the performance versus making you have to monitor if it was working correctly. You should put the onus on the ERP provider versus on your employees.
The big providers won’t allow this very often but the smaller ones will. Make it the obligation of the ERP provider to know that there has been a breach in the SLA.
The big ones, like SAP and Oracle, will send automated reports and humans have to look into them to see if there is an issue.
Don’t Forget Cybersecurity and Intrusion Detection
You need to be careful that if you get hacked, you don’t owe your ERP provider or are legally obligated in any other way to pay a hacking fee. You want to make sure you are not liable. This is called indemnification.
In matters of cybersecurity and hacking, your contract should stipulate that the ERP provider should be accountable, if possible. There should be financial and legal obligations and your ERP software provider should be responsible for any sort of intrusion into the system - especially if it’s located in the cloud and not specifically uploaded onto any of your in-house servers.
The concept being that if someone hacks your environment, the source code from the ERP could be opened to the black market for rip off and resell.
People don’t look out for this enough and hackers are getting more sophisticated every day.
Know the Rules About Implementation Partners
Implementation partners are third parties that will help develop custom code on top of the ERP system for your business. A lot of companies use them, frequently hiring freelancers and contractors to build the code.
Most of the time, your contract states that any implementation partners have to be registered as “Preferred Providers” for your specific ERP software.
You can’t have just anyone build custom code on top of an ERP system, it has to be an approved vendor.
It is a contractual risk to your company if your contractors are not certified by your ERP provider.
Your ECommerce System Needs to Play Nice
If your company is in eCommerce, you need to make sure that there is an active and working connection between your ERP provider and your eCommerce provider.
Many ERPs will tell you “Don’t worry, we will make a connection.”
What they won’t tell you is that the connection they make will cost YOU more money. Your contract needs to dictate who is accountable for paying for any connections that are required for your eCommerce platform and your ERP system to play nicely together.
We always make the new piece of software that is connected to the ERP system pay for the API. It is the third party’s cost.
We just had a client that we saved about $500k for this very point!
They have an ERP system and they were working on getting set up with an eCommerce platform.
There was one sentence in the contract that made it ambiguous on who pays for the cost of being able to have different systems to talk to one another.
The ERP software provider was planning to charge it back to the client and the client didn’t even assume that would be their cost.
That basic API connection should not be your cost to maintain and pay for - stipulate in the contract who is responsible (ideally the third party) ahead of time so you aren’t stuck with a huge bill.
Make Sure You Have Coterminous Contracts
Another big thing to look out for is coterminous contracts. In most large companies, each department will have separate contracts with an ERP provider and these contracts won’t align on the same termination date.
If you have multiple business units in a company, the provider will often split out their budget and license fees per business unit.
This is the biggest trick in the book and the largest companies in the world forget to do this step.
It creates massive chaos because you can’t get everyone on the same page. This situation forces the client to align internally at multiple times throughout the year in the interest of representing the entire company. Clients typically lose 10 - 20% when they are in a non-coterminous environment. .
If you you are subject to an non-coterminous environment, then the ERP provider is in the driver’s seat. They will divide and conquer you. This is called a split requirement and they will negotiate with each department individually.
In other words, the ERP software provider negotiates at a business unit level versus an enterprise level. At enterprise level, you have volume and leverage to get better terms which typically drives an additional 10-20% in value.
Whether you’re negotiating an initial contract or a renewal, make sure you develop and maintain a total cost of ownership view.
First, make sure you understand how your business will be growing over the next 10 years.
Then, dissect the contract so that you better understand the unit cost and connection fees.
In the contract, layout all potential possibilities early as opposed to being forced to react to them as they come along. The more prepared you are, the better you’ll be able to handle surprises, pivots, and conflicts.
Make sure that in the contract, each of the specific points outlined above are detailed with zero ambiguity. Hit all these points as a minimum.
The truth of the situation is that the sales representatives at these ERP providers know you aren’t negotiating an ERP contract everyday. While we’re not saying that every ERP sales representative leverages this face in a malicious manner, it’s important to understand how to protect your company.
As you can see, there is a lot to take into consideration when negotiating contracts with ERP providers. Keeping these points in mind will help you to protect yourself and your company. If you need help implementing any of the above, we have the experience and know-how to protect you from being held ransom now and 10 years down the line. Reach out to us, we’re here to help you with negotiating contracts with your ERP provider.
Curious to understand if there are savings opportunities in your ERP contract? Contact me at Dan@TheNegotiator.guru for an initial free consultation.
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