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Chapter 26 - Negotiating IT Contracts

26.3 Special negotiation issues

26.3.2 Technology pricing negotiations

There are usually more costs involved in a technology acquisition than the initial sale price. The costs of support and ancillary technology far outweigh any sticker savings that may seem appealing on the original item purchase. Many suppliers are willing to reduce their initial sales prices to generate more revenue during the course of the contract.

  • Hardware. When negotiating an IT contract, remember that pricing for hardware, software, and services follow very different models. Hardware often is priced like a commodity unless the product is new or unique. Usually, supplier margins on hardware are small (one to 15 percent). 
  • Software. The margin for software is often large. Software is priced based on value to the customer and to recover the initial investment to develop the software, not the incremental cost to the supplier for each license, so license prices often can be negotiated down substantially. Maintenance and support are an ongoing cost of software ownership that can cumulatively exceed the cost of the license itself in a few years. Be sure to define what is to be provided for the cost of maintenance and support. If the supplier is requested to provide support with projected resolution time and specified availability windows (could be 24/7 or just during business hours), these are requests that may increase the agency’s costs. Annual fees are usually set as a percentage of the license fee. These should be based on the final, negotiated license fee, not the Supplier’s list price. Setting the maintenance and support fee at 15 to 20 percent is a good target; however, validate current market prices before establishing a target. The software supplier also may want to be able to increase the fees over the term of the contract. Any increases should be capped at an absolute percentage (3-5 percent is typical) or based on a standard inflation index. Often, agencies can negotiate a freeze on any increases for the first few years of the contract. Often, suppliers who are/will be strategic partners will negotiate more favorably for a long-term relationship.
  • Services. Services are usually based on labor rates and are marked up based on the demand for those skills (15-50 percent). 
  • Licensed Services. Application hosting services or software-as-a-service suppliers usually offer an annual subscription rate based on the number of application users. Always try to negotiate a pay as you go rate, so that you are only charged per number of actual users, if your user base is subject to fluctuation. Obtaining concurrent user licenses will also reduce these fees depending on your user base access needs.
  • Telecommunications. Because of common carrier regulations, it may be difficult to get major concessions when acquiring traditional telecommunications services. Often, concessions are won by agreeing to revenue commitments annually or over the term of the contract. It may be unavoidable to commit to a revenue commitment over the term of the contract to achieve rate savings, but revenue commitments should be entered into with caution. Have a firm understanding of your telecommunications spend. You need to know how much is actually spent before you can responsibly commit. If the supplier proposes a commitment based on an agency’s current spending, ask for documentation of the basis for that proposal, including how much of your current spend is represented by the commitment. Aim for commitments no greater than 75 percent of the agency’s historical spend to ensure flexibility and competitive leverage in the future. If a purchasing agency is using supplier data to evaluate a commitment, include contract language whereby the supplier acknowledges that the agency is relying on their data and agrees to reduce the commitment if their data is later found to be inaccurate. Provide for business downturns. If demand for services is reduced through cutbacks in agency operations, the contract should allow for such an adjustment.

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