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CHIPS Articles: Best Practices for Negotiating Cloud-Based Software Contracts

Best Practices for Negotiating Cloud-Based Software Contracts
Smart buying with DoD ESI saves money — eliminates headaches later
By Floyd Groce and Tom Crawford - July-September 2013
As cloud computing grows in popularity, organizations are being challenged to think about how this capability might change the way they purchase software. Ultimately, they need to decide whether it’s better to stick with the traditional model of buying a perpetual license and have software physically reside on-site, or opting to “rent” software as in the software as a service (SaaS) delivery model with software centrally hosted by a cloud service.

Before making that decision, organizations need to understand cloud-based software and the associated contracts for purchasing cloud services. The Department of Defense Enterprise Software Initiative (DoD ESI) team has a great deal of experience in the field and is ready to help organizations develop that understanding, offering best practices and tools for use in negotiating cloud-based software contracts.

So, what is cloud computing? Broadly speaking, cloud computing is the scalable provisioning of information technology as a service using the Internet. In a cloud environment, software is hosted by either a software provider or an off-premises third party hosting provider. The user rents the right to use the software from the provider; accessing it via the Internet.

Choosing cloud delivery over a traditional arrangement can result in several benefits. One of the most significant is the potential for cost savings. By accessing software in the cloud, the user avoids the cost of building and maintaining an infrastructure to run software. Also, since renting the right to use SaaS is often less expensive in the short term than buying a perpetual software license, the initial investment is less. Taken together, these factors should reduce an organization’s software costs.

Therefore, the total cost of ownership (TCO) could be reduced depending on the discounted up-front costs, lower operational costs (by not having to implement and maintain software in-house), and other benefits realized by choosing a cloud delivery model. However, it’s important for an organization to examine its specific computing needs and to perform a cost-benefit analysis to determine if the cloud model will result in cost avoidance or cost reduction. Analyzing the cost-benefit for an individual transaction might yield a different result than one which looks at the effects of several transactions on the overall IT environment.

Cloud delivery offers non-financial benefits as well, such as speed and flexibility. A software service delivered from the cloud can be rapidly scaled up or down in response to demand. Software deployment and expansion to additional users can be accomplished faster and at less expense than with traditional methods. Many SaaS providers also offer self-service provisioning for adding functionality and new users.

There are contractual differences between traditional delivery and the cloud model and the arrangement that works best for the organization is clearly a central consideration in deciding which to choose. Under either delivery model, most contractual terms and conditions will be the same. However, there are four key exceptions: grant of a software license and payment terms, service level agreements and data ownership and security.

Grant of a Software License
With cloud delivery, software usage rights are subscription-based, in other words, the user rents the right to use the software as a service for a specific time period. Subscriptions are granted normally monthly or annually, and software can only be accessed if a subscription is current. In the traditional model, the right to use software is purchased in perpetuity, essentially, the purchaser may use the software forever. A lump sum is paid up front, usually with a recurring annual maintenance fee. Under a traditional arrangement, the provider may also support customization, which is normally not available in the cloud model.

Payment Terms
Payment terms differ greatly between cloud and traditional software delivery. The most pronounced difference is that under a traditional model, the purchaser may be able to withhold a portion of the software license fees until after the go-live date or acceptance of the software. Alternatively, cloud-based solutions sometimes bundle hosting, software licensing/use rights and maintenance fees into a single monthly or annual fee. The user is required to start paying for the service as soon as the provider is authorized to make it available, whether or not the user is ready to employ it in production.

Service Level Agreements
Although service level agreements (SLAs) are usually included in perpetual license maintenance and support agreements, they are crucial in a SaaS contract because the user is completely dependent on the provider to ensure system availability and functionality. Strict guidelines detailing how provider performance will be measured and reasonable penalties for underperformance are musts.

Data Ownership/Security
Since under the SaaS model, a customer is unlikely to have physical control of its data, the license must specifically state that a customer retains constant ownership of its data. Additionally, a SaaS license should include comprehensive security requirements to ensure the provider takes all possible precautions to safeguard user data.

If the decision is made to use a cloud SaaS model, contract negotiation and management and vendor management begin. The user organization will not be focused on technical management of a software application, but rather on managing a SaaS vendor relationship. The best way to do this is to get a solid contract in place. The white paper, “Best Practices for Negotiating Cloud-Based Software Contracts” helps readers understand key cloud terms, identifies the risks that need to be addressed in a SaaS contract, and provides detailed explanations of the associated negotiating points.

Cloud computing is here to stay. Deciding whether a cloud-based or a traditional service model is best for your organization requires an understanding of the advantages and disadvantages of both. Once the decision is made, a good contract will help guarantee a successful relationship between you and your vendor.

Floyd Groce is a member of the DON CIO Efficiencies and Analysis Directorate, Efficiencies Branch.
Tom Crawford provides contractual support to the DoD ESI.

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