2021 Budget Planning: Understanding Software Licensing Fees

December 8, 2020

Category: Digital Transformation Strategy

The end of the year often signals more than a focus on holiday sales, promotions, and shipping challenges. It’s many business’ fiscal year end, meaning one thing: budget planning.

As you consider your 2021 budget and priorities, digital transformation inevitably tops the list, thanks to the COVID-19 pandemic and the resulting global recession. And thus, the 2020/21 IT budgeting cycle will likely have even more eyes on it this year. 

Business leaders like you are being tasked with reevaluating projects and plans, prioritizing new ways to get business done virtually, and getting creative with budgets according to this year’s results.

When it comes to eCommerce technology, there’s quite a bit to consider when it comes to budget planning: different investment types defined by different types of platforms; your ability to structure an ROI plan; and common KPIs for measuring potential eCommerce value lift are just a few. 

Let’s explore a good place to start, and important things to understand in establishing your 2021 eCommerce budget.

Establishing Strong KPIs for Growth is an Important First Step

Your commerce strategy is ultimately going to drive your business’ investment decision. So establishing metrics, goals, and strong KPIs are an important first step in defining your budget.

Simply put, KPIs are metrics that drive the “why” and the “what” in your commerce strategy. They are the metrics you track that best align and inform your key business goals. If metrics are a way of measuring things, “KPIs are the method of monitoring the most important aspects of your business in a way that helps you determine what actions to take” (OBERLO).

Common KPIs in eCommerce include (but definitely aren’t limited to): 

  • Increased customer acquisition through an online commerce experience and a strong SEO and content strategy
  • Improved customer retention by adding differentiating features or capabilities to the experience you brand to your buyers, beyond just having an online catalog
  • Reduced operational costs through automating back office integrations and providing buyers and suppliers with self service
  • Increased revenue by providing an expanded catalog offering online to buyers with personalization
  • Channel expansion by integrating into other marketplaces and social platforms to drive access to your catalog and business

Gathering stakeholders across all departments who may have a hand in commerce will help establish alignment and get a handle on your goals for your commerce investment today, as well as for your market expansion down the line.

Next, Make Sure You Understand eCommerce Platform Investment Options

Traditional Vendor Lock-In Can Can Lead to “Budget Lock-In”

Historically, only one type of eCommerce platform existed. These traditional monolithic platform-centric or suite-based platforms generally come with well-defined price tags for core capabilities and you know exactly what you are getting “out of the box.” These are the types of investments your CFOs are used to, where you know exactly what you’ll get and what is owed by when.

But this type of investment leads to “budget lock-in.” Your company inevitably needs assurances of costs over time so you have confidence in projecting and executing your business strategy over the next one, three or five years and beyond. This in turns leads you to lock yourself into a large enterprise multi-million dollar contract. 

Not only that but the decision making process is generally elongated to get this over the line (because of the long term commitment) and is exacerbated by multiple decision-makers and stakeholders along the way. 

Many companies end up spending six months to a year drafting RFPs and evaluating vendors before they can even pull the trigger. 

The speed of innovation and pace of change at your business can be constrained by approaching the problem at a macro level and making large sweeping changes and gambles.

Today, Cloud-native Saas Software Is Changing The Way Enterprise IT Budgets Are Managed

Platforms like Four51 OrderCloud™ build with modern MACH architecture are allowing enterprises to move away from the previous trends of leaning on capital expenditures on your technology investments over multiple years.

When it comes to MACH architecture, there are several different levers, or licensing structures, that can be pulled to affect pricing and, therefore, budgeting.

2 Key Software Licensing Structures to Understand:

1. Annual or Flat License Fees: License based on Capabilities

2. Variable License Fees: License based on KPIs and/or ROI

1. Annual or Flat License Fees

What is it?

Annual or flat license fees are based on a complete set of features or capabilities offered on the software platform.

What are the benefits?

For businesses seeking software that will accomodate many stakeholders at once with differing needs, annual or flat license fees are often favored.

Generally you:

  • Want to buy value based on features and capabilities, and not based on transactions
  • Don’t want variable expenses in your budget as a condition of your cost center area
  • Can’t find a good way to budget based on potential improvements in ROI value 

When technology is purchased with an annual license fee, the dollars spent against the budget are often measured as internal value – be it a reduction in operational costs, or a covering of gaps in capabilities that would otherwise need to be acquired and paid for, as examples.

What is the downside?

You often end up buying more than what you need. Features, capabilities, and customizations are worked into your fee structure that you aren’t sure you’ll need, but you want to make sure you have the ability to assess if you do need them.

Contract considerations?

You can think of the annual or flat license model like going to a restaurant and ordering a big, extravagant, multi-course meal. Since you’ve never been, you’re unsure of the quantities or the quality. At the end of the meal, the restaurant isn’t going to reimburse you for the sides or courses you didn’t eat. So you have to decide if you’re up to the risk.

When signing a contract built with annual or flat license fees, there are several things to consider. 

  • Be aware of the fact that many large software platforms that license this way push the enterprise into buying a ton of features to accommodate many stakeholders in your organization, but the majority of the features are never fully utilized.
  • Once the deal is set, there’s often no incentive to the vendor if you actually utilize the software or not. Essentially you’ve paid them for the service, so your adoption of it “isn’t their problem.
  • Sometimes vendors will put in an overage threshold where you will be allowed to go over the original contract utilization up until some date without penalty, before re-negotiating.
  • Understand the license start date and if it is relative to use. In other words, will you start paying before you use it? Note: in all cases, the software party should have a commitment to support onboarding, training, engaging their resources at the start of the project which triggers their licensing formally.

A quick recommendation:

A good practice, if you buy this way, is to work with stakeholders across your enterprise to map each feature or capability to people, departments, or existing responsibilities. This way, your RFP and purchasing process doesn’t turn into a “wishlist” exercise of monolithic expense.

2. Variable License Fees

What is it?

Variable license fees are based on the KPIs explained earlier, and/or your return on investment (ROI). You often pay based on a price per usage (commerce, number of orders, or some other specific growth goal).

What are the benefits?

Variable license fees offer a more ideal way of looking at licensing which builds alignment to your business objectives and incentivises your use of the platform on the part of the vendor. 

For businesses looking for low cost of entry, variable license fees are often more ideal. Generally variable license fees present the opportunity, from a budgeting standpoint, to onboard with “your own procurement card vs. going through capitalization requests.” You can often start with a smaller investment, and grow your license as your usage grows.

If, looking ahead, you think your business may want to shift your investment or adopt other technology without a massive asset/investment on your books that needs to be paid off, this may be a better option.·  

What is the downside?

Risks of a variable licensing model are primarily focused around changing how your company looks at software licensing forecasts – this is different than many finance teams are used to.

Contract considerations?

With variable licensing models, there’s lots of different ways to structure the license. Be sure and work with the vendor to plot your possible growth and decide on the best way to structure the license – based on revenue versus based on order volume, for example. If you sell cars online, it may make more sense to opt for a volume-based variable licensing model versus a percentage of revenue.

You’ll also want to make sure you get:

  • Clarity from the vendor on initial onboarding costs or support the licensing
  • The opportunity to conduct your budget/expense forecast yourself, instead of having the vendor do it up front for you with hefty license expenses.
  • Understand the alignment, or partnership, between your organization and the software vendor, so you have a good idea of their incentive to drive your KPIs — such as migrating more orders online, customer onboards, cart value or size, etc.

Hybrid Licensing Models: An alternative

Some eCommerce platform vendors offer more of a hybrid licensing model that includes both an annual or flat licensing fee, as well as variable licensing. The proposed base annual licensing fee, which usually includes support and maintenance, stays steady and offers that reassurance many teams need of staying within your base budget. It offers something you can plan and forecast accurately as a baseline.

The variable side of the license usually offers a cap, where if you surpass specific volume, achieve specific growth goals, or meet a certain level of usage requirements, your price per unit usually decreases. This assures you the vendor is incentivized and motivated by delivering a strong ROI and continuing to offer you the support and updates needed to meet your growth goals.

Four51 has spent 20 years helping complex enterprises build the business case for commerce investment. Whether you need help establishing business-wide KPIs, understanding investment options and licensing fee structures, or building an ROI model, we can help.

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