Originally appeared in MSI Magazine
November 1, 1999

Finding Value in All the Right Places

There’s nothing certain except death and enterprise system migrations. For many of us, that truism rang all too true. Sure, the new systems were supposed to help rationalize processes, improve visibility, and offer the chance to finally get supply chains under control. All too often, however, the perception of benefits was overwhelmed by the trauma of reengineering.

If the migration succeeded, the next question is whether it was actually worthwhile. However, quantifying value beyond anecdotal evidence has been a challenge since the dawning of MRP nearly a quarter century ago.

Initially, the problem was that we were all measuring the wrong things. Classical accounting measured ROI in productivity or labor savings. The sudden upsurge in ERP migrations during the last half of the 1990s proved, not necessarily that manufacturers finally figured out a way to calculate the numbers, but that there were more strategic issues at stake such as fixing supply chains or replacing non-Y2K compliant systems.

But that still didn’t answer the question how much these investments were actually worth. Most manufacturers migrated because they had to.

Ironically, changes in licensing of software or the role of software providers may finally provide the long-awaited answers. The changes are coming courtesy of the Internet, which is forcing software providers to reevaluate how they make their money, and driving enterprises to examine the true potential of always being on-line with their business partners and customers.

As you might recall, client/server technology replaced the processor-based software pricing of mainframes with user-based models. The rationale was that MIPS, the yardstick used in the mainframe world, was irrelevant when most software functionality was executing on desktop machines.

We recently studied how the Internet was affecting software licensing, and found yet another major shift in vendor practices. Although user-based pricing was still being applied for Intranet applications, once you venture beyond the firewall, that model breaks down because it is virtually impossible to control or identify who’s using the system. In some cases, processor-based pricing is making a comeback, and with it, arguments over fairness. Some software vendors simply charge a flat fee per processor, while others, such as Oracle, base it on the clock speed of the machine—an approach which Gartner Group figures estimate results in 30% higher charges for Pentium users.

However, these arguments miss the point of what software, or the business changes that it enables, are really worth. Some vendors, such as i2, have broached the idea of value pricing, where the user pays less up front in return for giving the software vendor a share of the proceeds—which could either be in the form of operational savings or new revenue streams. Although nice in theory, value pricing rests on shaky assumptions over criteria and fears from customers that the result could turn into a permanent tax on their business.

However, the emergence of Internet-based Application Service Providers (ASPs), and their close relative, On-Line Trading Communities, are giving software vendors yet another chance to rethink the whole value proposition.

Obviously, this is not necessarily occurring as an exercise of altruism. It’s no secret that application vendors, whose revenues took a severe hit from Y2K activity, are looking for alternatives to one-shot licensing deals. According to Microsoft’s Steve Ballmer, within the next decade, most software will be sold as constantly-updated subscriptions. Or, maybe it might take the form of a transaction fee or sales commission. That’s what builders of on-line trading communities, such as Ariba and CommerceOne, are proposing.

The results are fees that are theoretically more tied to business activity, rather than some arbitrary contract fee hammered out after protracted negotiations. For vendors, that translates to an annuity-like revenue stream. For customers, it’s a way of factoring in the cost of doing business, although it comes at the risk of being perceived as another tax or another way for vendors to raise their pricing structures quietly.

Nonetheless, the transition will require software vendors to morph into service providers. That will require a huge change of mindset. For users, who’ve been pressured by vendors to reengineer their business processes to fit the new software systems, the turning of the tables should provide hidden satisfaction. Who said the Internet didn’t change everything?