Don’t buy software from services-driven vendors
In Part 1, we looked at how to keep services from exploding out of control and blasting your project budget. In part 2, we look at why a software vendor who depends too much on services is a bad choice.
Software vendors have viewed traditional revenue sources through three lenses:
- Initial license fees
The ‘up front’ costs of acquiring the right to use the software. These fees are frequently viewed as an offset to sales and marketing (customer acquisition) costs.
- Recurring license fees
These are typically maintenance fees paid periodically to gain access to fixes, upgrades, hot line services, and the like. These fees support research and development, customer support, and administration functions.
- Services fees
These are the fees paid for consulting and training services provided by the vendor, and are typically billed by man-hour.
The Software-as-a-Service (SaaS) or cloud models have changed the perspective only a bit – SaaS revenue models have essentially zero Initial License fees, and charge higher recurring fees for the right to use the software.
In each case, software vendors seeking revenue growth will frequently look to the services group. Services revenues can quickly dwarf initial license fees – for many years, the services revenue associated with ERP implementation projects was more than 4X the initial license fees. More recently, implementations of big ERP systems have been cut back to a little more than 1X initial license fees due to improved experience and customer push-back. Unfortunately, I’ve heard some healthcare enterprise implementations driving services revenue at 7X initial license fees or more. Even SaaS companies frequently look to services fees for revenue growth.
So what’s wrong with driving lots of services revenue? After all, IBM used growth in Global Services to meet ever higher revenue targets for much of the last decade or so. And if you look at the hourly rates typically charged for services, they must make money, right?
A services business makes money based on two key metrics: rates and utilization. The higher they can keep their rates, the more money they’ll make. But utilization is the tougher metric to manage. Consultants cost the same whether they are billing or not. And vendors can’t just fire consultants during lean times and hire them back during growth years – consultants take time to educate and gain experience. But having them ‘on the bench’ is a sure way to kill profitability.
There’s a slippery slope here. Vendors will staff up services to meet peak demand in order to grow revenue. They’ll avoid quick-hit high-value projects that can help you achieve a high ROI in favor of long-term engagements that improve utilization. Then, when demand is down, they’ll have consultants spending a long time ‘on the bench.’ Then the vendor will try to sell services – probably services you don’t need – to avoid under-utilization. While management’s attention is on resolving the services problem, the software suffers.
As a buyer, you may have been tempted to look for a vendor that has lots of consultants available for your project. Or, after reading this, you may be tempted to look for a vendor that has lots of consultants that are heavily utilized. Don’t give in to either temptation. Both are examples of vendors that have started down the slippery slope of services dependency. You’d be better off selecting a software solution that minimizes (or eliminates) the consulting services you need.