On Your Assets?

The Executive Vice-president of procurement in Amsterdam for the major international finance company put it bluntly. "Whenever an employee comes to me and says he's saved $10 million," he told Michael Swanson, president of US-based software asset optimization firm ISAM (Information Systems Asset Management), "I interpret that to mean he wasn't doing a good job before, if he had that much waste out there."

And after analyzing hundreds of data centres of all shapes and sizes and across all industries, Swanson can only agree.

"The best companies don't save the most money," says Swanson. "In the same sense that your best athlete — say Ian Thorpe — doesn't break the record by 10 seconds; he breaks it by maybe 100th of a second. When you get really good, you're not saving a lot of money."

The figures seem to tell the story clearly: with top performing companies spending less than half of what their peers do on software costs, the average data centre would effectively have to negotiate to get all of its ISV software for "free" to match them.

However, armed with a raft of fresh data, Swanson insists there is not a company in the world that cannot achieve best-in-class status by imitating those high achievers. Just be sure to ignore all the myths about just how good those best-in-class companies are, and how they got there. "There's nothing hard about lowering software costs — in fact, every company, big or small, and in whatever industry, can achieve superior results by following the example of best-in-class companies," Swanson says.

"So, how do some companies typically spend less than half of what others spend on software costs? They work on managing product inventory and usage, obtaining the best available software pricing — and they don't buy into the myths of Software Asset Management (SAM)," he wrote in a paper for ISAM. To reach this conclusion, ISAM examined data centres of all shapes and sizes across every industry against eight commonly held myths and found no statistical data to substantiate even one of them.

The constant evolution of mainframe hardware technology, software licensing and vendor consolidation have left many companies scrambling to meet growing business demands on a shrinking budget. Many organizations have turned to IT asset management and, more narrowly, software asset management, as the answer, Swanson says. But vendors offering solutions to perceived SAM problems have left companies no better off; they are not spending less on software, and the chasm between vendors and customers is as big as ever, he says.

The only way to start salvaging the situation is first to confront the myths, then defy them, according to Swanson.

MYTH 1 :

Low software costs depend on data centre size.

Reality: Traditional thinking, which says the bigger your data centre the less money you spend, fails to differentiate between the money you pay and the cost to the business, Swanson says. While larger data centres often have enough muscle and reputation to secure steep price cuts, it isn't discounts that make a company best-in-class.

Look at it from the point of view of buying a plane ticket and getting a discount. A discount off a coach ticket is very different from a business class discount. A discount on a seven-day purchase will differ significantly from the discount on a three-week purchase. A discount on a ticket to return the same day will be very different from the discount on a ticket that includes a three-day stay. And that doesn't even start to consider the factors influencing variations in the list price.

"You have to look at what kind of discount you're getting, because the discount is very artificial," Swanson says. "It's not always about price; it's about how much you have. People think if you have a big IT data centre you're going to get a better discount and therefore you're going to be performing better, and that's not always the case."

Big data centres often cannot manage hundreds of products running on dozens of large LPARs (logical partitions), struggle to get a handle on their product inventory usage and must rely on discounts to manage their software costs, Swanson says. Small data centres are frequently more efficient in managing their costs, and better at understanding their inventory, usage and product value.

"The average large data centre (one with over 5000 MIPs has over 300 products, compared to 92 products at data centres smaller than 500 MIPs, so it is not surprising that smaller data centres manage their software costs better," Swanson says. "The reality, however, is that there is a statistically insignificant relationship between large data centres and low software costs."

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MYTH 2 :

Low software costs depend on having good negotiators.

Reality: The data is compelling: "best-in-class" companies spend less than half of what an "average" data centre spends on software costs. In fact, they do so well on pricing that an average data centre would have to negotiate all of its ISV software for "free" to achieve the same cost structure. Many people assume that is because the best-in-class boys have been able to negotiate a better price than their peers running average data centres.

Not true, Swanson says. In fact, some of the best negotiators have the worst cost structures. They negotiate 50 to 90 percent discounts on artificially high cost scenarios. What a company may perceive to be a good negotiation, can, and often does, work against them.

"Many vendors want to build relationships and offer discounts based on relationships," Swanson says. "When a company's approach to a vendor is to try to get the biggest discount possible, a vendor will often stiffen in their position of discounting. They may even raise the base price offered to the customer and then offer a discount, only getting the customer back to a 'negotiated' list price.

"To be sure, a company will never benefit from creating a hostile negotiating environment. But in reality, although SAM managers may negotiate with great fervour, a well-managed data centre can pay full list price and still end up with a lower cost data centre."

So if the perception is that data centres manage software cost through good vendor negotiation, the reality is very different: a data centre's savings come primarily from factors outside of vendor negotiation. Price accounts for just 5 to 15 percent of potential savings, product placement for 25 to 35 percent more, but there is potential to save between 50 and 60 percent on product quality, Swanson's data shows.

"A focus on price is the basic role of corporate procurement, and organizations like Gartner Group and others say that focusing on price in negotiating discounts is the easiest thing to do and gives you the most political awareness; everyone applauds when you negotiate a 20 percent discount. The reality is your cost has more to do with what you have than how much you paid for it. Those are the issues that they need to be concerned about," Swanson says.

"What it comes down to is: how many software products do you have to run your data centre, and how are your software products licensed? That is more critical than the price you pay for your software products. We all need a database in our data centre, but I may have three different databases, and you have just one. So the issue is not how much did I pay for my database versus what you paid for yours, but that I have three databases and you have one database," he says.

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MYTH 3 :

Low software costs come from good vendor discounts.

Reality: A discount is relative to some cost structure based on a commonly accepted set of assumptions around hardware configuration, software configuration and pricing metrics. Alter the metrics and you dramatically alter the baseline cost the vendor uses to determine a discount.

In other words, just because a discount looks good on paper does not necessarily mean it is good, since discounts can be and sometimes are, above list price based on actual usage.

And the discount you get often depends on the region you are in. "A typical data centre will spend $5500 per MIP on its software costs. Negotiated discounts represent between 5 and 15 percent of the total savings opportunities," Swanson says.

"Product inventory is the single largest contributing factor to software costs. Over 35 percent of mainframe software products have replacements available. A best-in-class company might pay a greater amount for its software even though it typically utilizes 36 percent fewer products than an average data centre. The reality is that over 80 percent of savings opportunities are directly attributed to managing product inventory and configuration and have nothing to do with discounts," he says.

MYTH 4 :

Low software costs come from having a large number of enterprise licence agreements (ELAs) with best-in-class terms and conditions.

Reality: The theory goes that many enterprise licence agreements are built around best-in-class terms and conditions. Negotiate numerous multi-year deals with really good contract language, and you can expect to enjoy low software costs.

In practice, though, many such deals damage data centres by locking them into a commitment that may have been good for the business environment of the time but that is totally unsuited to any new business reality. "Businesses change so rapidly today that if you make a three-year commitment, your business is going to be so different in three years time than it is today that you will find yourself committed and locked into something that you shouldn't be," Swanson says.

When data centres were growing rapidly in the 1980s and 1990s there is no doubt ELAs helped, he says, but in slower growth years much of the cost is soaked up in unused inventory and capacity. ELAs often feature a "waste factor" of more than 50 percent to pay for unessential products and capacity.

"A common problem associated with ELAs negotiated prior to 2001 was that data centres were growing at 20 to 35 percent annually and thus wanted large capacity amounts imbedded in their ELAs," he says. "Since 2001, data centre growth has slowed dramatically, leaving many companies with excess capacity. The notion that best-in-class companies negotiate large ELAs as a cost protection was true during high growth years. As old ELAs were renewed, they were negotiated with similar product configurations."

Part of the problem is that companies do not allow enough time to review their inventory mix and configuration in order to understand the current value of their data centre's core products. Organizations thus sign long-term commitments based on a set of assumptions built on the current business environment, which often features many inefficiencies in the way the data centre is run. Commit to a long-term deal and you commit to the inefficiencies.

"ELAs are [also] padded with bundled-in products and discounts, in much the same way that a 20-course meal might be offered to someone on a diet. The reality is that best-in-class companies have the fewest ELAs and are smart in buying only what they need when they need it," Swanson says.

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MYTH 5 :

Low software costs come from using best-in-class processes.

Reality: Good processes are essential, but software vendors do not reduce your invoice because you have a good process.

"There are a lot of companies out there that say you need a good process in place to reduce your costs," Swanson says. "The reality is, you may have a good process, but that doesn't mean a vendor is going to give you a good discount. And a good process going down the wrong road still gets you to the wrong destination. Some of the companies most known for their processes actually have some of the worst costs, because they're more concerned about the process or the input than they are the output."

SAM processes support financial objectives that are seldom fully appreciated before the processes are implemented, he says. Business processes tend to be transactional in nature and help cut labour costs associated with change management, data collection, inventory management, invoicing and so on. That is why there is no correlation between managing software costs and processes.

"Companies known for their best-in-class business processes may excel with their processes, but they frequently fail to achieve the same results when applying them to SAM. Some of the lowest cost data centres lack any formal process in managing their software. Conversely, some of the best processes deliver savings, but fail to address core business problems in managing software costs. In fact, in a study conducted on a random sampling of over 100 companies, there was found to be no correlation between processes and costs," Swanson says.

MYTH 6 :

ELA discounts and "Terms and Conditions" are restricted by SOP 97-2, SOP 98-4 and SOP 98-9.

Reality: Particularly in the US, where vendors are subject to a myriad of accounting rules, vendors will sometimes try to claim those rules restrict their ability to negotiate price and contract terms. Don't be fooled. The American Institute of Certified Public Accountants (AICPA), Financial Accounting Standards Board (FASB), Generally Accepted Accounting Principles (GAAP) and the US Securities and Exchange Commission (SEC) do not tell vendors how to price software; they only govern how to recognize the revenue.

In fact there is nothing in the AICPA, FASB, GAAP or SEC that gives vendors any guidance on pricing software and no accounting rules restrict a vendor's ability to negotiate the price and terms of a contract. Moreover the rules certainly do not address discounting in any way, so any vendor using them as an excuse is being dishonest.

"Accounting rules do not tell you what kind of a discount to offer a customer. Accounting rules tell you how to allocate your revenue from a customer, but they don't tell you what to sell and ask," Swanson says. "What the accounting rules will say is that whatever product you sell to customer A, the price has to be consistent with that same product sold to somebody else and it has to be consistent with how you've always priced things."

On the other hand, licence agreement terms and conditions can certainly impact the vendor's timing of revenue recognition, and this is a real issue for the vendor (and its shareholders). "Vendors should not attempt to hide behind these rules in failing to grant a customer favourable terms and pricing. The reality is that the accounting rules govern revenue recognition and not business practice," Swanson says.

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MYTH 7 :

Using IBM's Workload Licence Charge (WLC) pricing will give you the lowest possible IBM software costs.

Reality: It seemed the answer to a prayer when IBM first announced WLC — and certainly many saw the notion of only having to pay for the capacity when the products were running as the mainframe industry's software saviour.

Not so, says Swanson, and he has the price books to prove it.

"IBM has gone out there saying: 'We can reduce your software costs by going to WLC'," he says. "My response is: If WLC can cut your costs by, let's say $100, but there are other things out there that can cut it by $200, did you create a savings by going to WLC? Well yes, relative to where you were, but no, in that there were other options that were out there.

"Although WLC is frequently a better option than most data centres currently have, it is rarely the best option that's out there in the sense that there are other things that they can do that are even better."

[Editor's note: Swanson's company ISAM (Information Systems Asset Management) provides services for optimizing mainframe software. One trademarked service is the IBM Pricing Audit, where "ISAM studies your IBM software and invoices to determine the most advantageous pricing metrics and product bundling options to minimize cost and maximize overall value".

MYTH 8 :

Best-in-class companies save the most money.

Reality: Many CIOs dream of following in the footsteps of the individual or company that boasts of the millions of dollars they have beaten out of the software vendors, thinking large savings equals best-in-class. The irony is that if those companies were truly best-in-class, there would not be large amounts of money to be saved, Swanson says.

"We don't view the most improved athlete as the best, yet we think of the most improved SAM manager (as measured by software savings) as the best. If you want to become a world class athlete, you don't emulate the most improved athlete, but rather set your sights on the best athlete. Once you reach elite status, it becomes more difficult to obtain that incremental improvement. The reality is that in benchmarking hundreds of companies, most best-in-class companies are rarely seen or heard of in SAM circles," Swanson says.

So when companies stand up and talk about all the money they have saved in the past year, Swanson takes that as a measure of how badly they were managing before. And, as he says, if any organization is that bad, why should anyone listen to them? "I want to hear stories from somebody who says: 'There's nothing left to save'," he says.

As Swanson points out, it is often the quiet SAM manager, unrecognized by management, who is doing the best job controlling software costs.

CREATE A ROAD MAP

The moral of the story is that while there might be a proper role for software asset management, traditional SAM methods are no panacea, Swanson says, and to dispel the eight myths is to prove it.

To achieve best-in-class status, SAM managers need to understand the software asset management landscape and the mainframe and distributed environments then create a road map.

"Until you know where you're going, any road will get you there," Swanson says. "And how do you know where you're going, if you don't know how good best-of-class is? What I say is first find out how good is good, and then find out why they're that much better than you, and in what areas they are better than you, and then create a road map to get there.

"In creating the road map, assess your situation. Benchmark, build a plan of attack, execute and then measure and repeat it. Just because you did well a year ago means nothing today. You can't sit on your laurels. You have to constantly be going back, and you have to take a phased approach on this. Don't try to do it all at one time. Look at what can be done in the immediate terms, medium and then long term, and then try to tackle them one step at a time.

"When I came up with the eight myths, some of them are specifically directed at various institutions out there that are promoting a specific idea to gain revenue and I think a plan of action helps."

You should ask yourself whether it is enough to simply reduce costs or run at the lowest possible cost. But having the technical knowledge isn't enough, Swanson says. And there, he says, is the rub: most people are simply not aware of the savings waiting to be realized.