Commercial Issues in "as a Service" Offerings
What does "aaS" mean and what is the appeal? A broad range of technology suppliers are aggressively marketing their "as a Service" ("aaS") offerings. At its simplest, an aaS offering is a bundled product that is provided at stated standard service levels, under a unit-rate based pricing structure appropriate for the specific items concerned. A common example is "Oracle as a Service" (database processing using the Oracle software). The appeal to customers is the opportunity to pay only for what they need of such offerings while avoiding the capital intensive requirements associated with data centers, up front license fees and the like. The specific contract terms vary depending upon the nature of the service and the supplier's market position and view of the risks associated with the offering; terms increasingly permit broad volume elasticity, require short (if any) minimum term, and provide strict limits to the supplier's liability.
A brief history. Until the early 1980s, companies typically handled their own technology needs using purchased or leased equipment and licensed systems software, bespoke (and often self-developed) applications in their own data centers. Eventually, IT heavyweights began to offer to outsource the management of customers' technology environments, evolving to a long-term (typically 5-10 years) outsourcing model involving carefully defined bespoke services (with tailored service levels and pricing) that included substantial early termination fees and other contract terms that effectively locked the customer in to both the vendor and technology solution. More recently, increasingly sophisticated customers have demanded lower price and more flexible service and contract paradigms, resulting in the evolution of these aaS offerings.
Striking the commercial balance. Any viable aaS offering is a play between standardization, on one hand, and flexibility and lower price, on the other. By creating a highly standardized product, the supplier can rapidly create, eliminate and resize virtual environments as customers' needs change without incurring significant stranded costs. This interplay gives rise to a very different negotiations context – one that can eliminate several drivers of cost and delay but nonetheless requires careful consideration by customers of the following key commercial issues:
- Purchasing the "right" services. Although the flexibility and pricing benefits associated with aaS offerings are always desirable from a customer perspective, the aaS paradigm is not appropriate in all contexts. For example, for products that differentiate a company from its competitors it is not advisable to engage in the level of standardization required to procure them on an aaS basis. Accordingly, in some circumstances the optimal outcome may be to use an aaS offering as a "building block", but also to layer in additional vendor and/or customer services or management to provide the optimal fit for the customer business needs.
- Leveling the playing field. While the flexibility inherent in a true aaS offering may reduce the need for some protections commonly included in long-term outsourcing contracts, customers should not omit these protections before confirming that the vendor's offering actually includes the right degree of ongoing competitive tension. Examples of protections of this nature include allocation of decision rights, provisions relating to supplier personnel (including key supplier personnel), benchmarking, co-operation with third parties, and the like. In this regard, "the devil is in the detail"; a vendor's actual offer may be determinable only after at least the initial exchange of draft contract documentation. If there are not viable competitive offerings available in the marketplace, or if there are contractual limits on the right of the customer to "vote with its feet", then certain of the provisions typically used in a long-term contact remain justifiably negotiable as a tool to level the playing field after the contract is signed.
- Avoiding technical lock-in. Although at first blush it might seem that avoiding technical lock-in (to a particular vendor) should be an easy outcome to achieve in an aaS offering, in our experience this is not always the case in practice. For example, suppliers often require the use of proprietary supplier tools (on the customer's systems) in order to access the offering. If this is the case, the customer should carefully examine whether the use of those tools would alter its environment (or its data) in such a way that it would be unable to switch vendors or take the relevant product in-house without a long or costly reverse transformation. This issue is exacerbated when the customer is required to make costly changes to its own systems that interface with the aaS offering. We note that the need to make some changes to interfacing customer systems may be unavoidable. In any case, customers should: (a) investigate the adaptive changes that will be required; (b) ensure that the business case includes the relevant costs and that the project plan reflects the relevant time and effort required to accomplish them; and (c) if the customer will be technically locked to a particular vendor as a result of those changes, that its evaluation and down-selection procedures explicitly identify the degree of technical lock-in and account for it in the customer's decision process.
- Performance and management issues. Long-term outsourcing contracts typically included highly-negotiated bespoke service levels or other performance requirements and required the supplier to provide a comprehensive set of management reports tailored to the circumstance. In aaS offerings, the supplier may provide several discretely priced options (e.g., "gold, silver or bronze" service levels) and corresponding management reports, but there will typically be little, if any, ability to negotiate highly tailored offerings. Accordingly, if a supplier's aaS offering itself cannot satisfy a customer's initial requirements, that customer should consider whether the offering is appropriate and, if so, whether it is necessary to purchase additional management or other services from the supplier in order for the offering to be effective.
- Pricing. Pricing for aaS offerings can be highly problematic. First, in most cases, it must accurately reflect the supplier's use of multiple factors of production, often leveraged across many customers. For instance, in a typical software as a service (or SaaS) offering, the supplier must account for data center facility costs, equipment costs, licensing costs, data storage costs and network costs. Moreover, the supplier's right to receive fees should be tied to the accomplishment of the customer's business objectives. For example, a SaaS offering for the human resources space could be priced on a per employee basis. The challenge in this still developing area is to establish pricing regimes that: (a) reflect both the supplier's cost of doing business and the customer's desire for simple metrics based on their needs; and (b) incentivize desired behaviours on the supplier and customer sides. The suppliers willing and able to address these challenges will have a large advantage as aaS offerings develop in the marketplace.
- Knowledge issues. There are two issues related to ongoing knowledge in the aaS context. First, it is often not realistic to expect a supplier technical team to build and retain specific knowledge about the customer over a long term. Given that most offerings are based on a model that achieves lower pricing through leveraging of personnel (and other resources), requiring attention from named highly-qualified technical experts (for example, under a "key supplier personnel" clause) is generally not commercially feasible. Many of our clients have found this issue to be manageable by requiring disciplined use of knowledge management systems. A second issue, more problematic, relates to ensuring that the customer's team retains an adequate knowledge base about the services themselves. While suppliers often view the manner in which it performs the particular aaS offering as highly proprietary, it is nonetheless key for the customer to: (a) negotiate appropriate knowledge-sharing provisions; (b) arrange itself organizationally such that key information and knowledge flows as required; and (c) ensure that its own teams have – and actually use – appropriate knowledge management tools. Without these steps, the customer may find itself locked in to the supplier in practice even if it has total flexibility from a purely contractual, and a purely technical, perspective.
Conclusion. Customers are generally rightly excited by the benefits associated with the rapidly evolving world of aaS offerings. In coming to understand and embrace the contract paradigm under which suppliers can profitably provide such services, sophisticated customers have accepted that some customer protections common to long-term outsourcing arrangements may not be warranted in this context. Nonetheless, customers should be wary of a number of potential pitfalls and contract carefully to ensure that they actually realize the substantial commercial benefits available under the developing aaS paradigm.
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© 2012 White & Case LLP