Software giants are developing new financing techniques in an attempt to provide smaller companies with access to their high-end systems.
With enterprise application software costing anywhere from 500,000 to 2 million to implement, financing IT is a bit like taking out a mortgage. It is a major financial commitment for any company, but at least when you buy a home you have some idea how much it is going to cost you before you take the plunge.
With software and IT, the total cost of implementation, including ongoing operating costs and maintenance, is not that transparent from the outset. According to PricewaterhouseCoopers (PwC), 75% of the inhibitors to companies investing in enterprise application software are linked to financial concernswhether it is the prohibitive costs of implementation and integration, reduced profits, unwillingness to increase IT budgets, or that age-old bugbear, the difficulty faced by companies when trying to calculate the return on investment (ROI).
Despite their inhibitions, companies of all sizes are under increasing pressure to invest more in IT and automation. The strain is particularly acute for small to medium-size companies (SMEs) that do not have the financial wherewithal of their larger competitors but view IT as a strategic component in terms of remaining competitive. The need for more companies to invest in software and their increasing inability to finance these purchases has raised questions about traditional software financing approaches. The emergence of subscription-based software models similar to that provided by Salesforce.com has put pressure on traditional software vendors to come up with more innovative approaches.
According to Werner Trattnig, a director at PwC, the advent of software subscription models, or pay-as-you-use financing, accelerates ROI by reducing upfront project and infrastructure costs. The software industry needs to respond to this new customer demand, he says. Unlike traditional software financing, where a company pays a substantial sum upfront, subscription or pay-as-you-use models allow companies to spread the cost of software implementation over a period of years (generally three to five years), based on a pricing plan that is tailored to their individual needs and circumstances.
Most of the major software houses provide some form of financial assistance to companies wanting to implement their software in the form of software leasing solutions. Leasing solutions can also take account of soft costs (training, annual maintenance and service agreement contracts), which are less transparent when software is purchased upfront. Although software licensing has been around since the 1980s, prevailing economic, market and regulatory conditions have led to renewed interest.
Last October one of the worlds largest enterprise application software companies, Germanys SAP, announced the launch of SAP Financing, a pay-as-you-use software financing scheme developed jointly with Siemens Financial Services (SFS). SAP Financing was initially rolled out to 13 countries, including the UK and Germany as well as emerging markets. The service will be extended to another 28 countries by mid-June. Most software leasing solutions are short term, explains Joachim Diers, SAP product manager at SFS. The smaller the companies, the shorter the timeline becomes. But SAP Financing can provide unsecured financing for up to seven years. We also offer the solution across all of SAPs sales channels. SAP Financing, which SFS developed specifically for the German software giant, provides four different forms of debt financinghire purchase, loan, finance lease and operating lease.
Fishing In a Bigger Pond
The emergence of fast-growing emerging economies such as China was certainly a factor in SAPs decision to offer software financing. The offering of financing in emerging markets is new and of biggest importance for the growth of SAP, says Hans Juergen Uhink, SAPs senior vice president of new business development. The company was also eager to make the costs of implementing its ERP application software less prohibitive for SMEs and believed the only way it could do that was by providing some form of financial assistance to help these companies get on the first rung of the ladder.
We wanted to accelerate growth in the mid-tier market segment and overcome the obstacle of financing, says Uhink. We are convinced that there is the need for financing ERP projects especially among mid-tier companies. Although SAP Financing is largely targeted at new customers, Uhink says existing customers or larger corporates could also use it to fund ongoing SAP software upgrades and IT projects. Within two months of launching, SAP Financing had already attracted significant deals from companies in both mature and emerging markets, with deals ranging in size from 15,000 at the lower end of the scale to tens of millions at the higher end, which is expected to increase significantly within the first year.
Uhink says pay-as-you-use software financing provides companies with predictable monthly payments, covering all project-related costs, including software and hardware costs, external service costs (software customization, implementation, training) and internal service costs (costs incurred by the company in implementing and maintaining the software). There are no hidden surcharges or unexpected surprises, he says, adding that this allows companies to more accurately predict and budget for IT costs over a period of several years.
Unlike purchasing software upfront, Uhink says payments under its financing program only commence once the installation has been deemed productive. SAP Financing also includes an online investment calculator so that mid-market companies can measure the total costs of ownership, including monthly repayments, before implementing an SAP solution. PwC estimates that the cumulated annual net cost savings are higher for pay-as-you-use than for traditional software purchasing solutions up to the fifth year. One of the drawbacks, however, of the pay-per-use model is that the company does not own the software outright.
SAP initially thought about providing the software financing itself but was advised by PwC that, if it did so, US GAAP accounting regulations would not allow software sales to be accounted for immediately until payments were due. The business model developed by SAP with advice from PwC assigns the financial risk to an independent third party [SFS] and the performance risk to SAP, Trattnig of PwC explains. This solution enables SAP to recognize revenues immediately.
But why not just leave software financing to the banks? Traditionally, companies may have sought bank financing to fund major IT and software projects. However, the credit cycle is contracting, and banks are less inclined to extend credit to non-investment-grade SMEs. Offering unsecured loans for periods of up to seven years in countries, including emerging markets, without additional collateral is unlikely to appeal to the banks, especially those having to comply with Basel II regulations. So SAP turned to SFS. SFS has 10 billion in assets under management and a financial network spanning 30 countries.
As Diers of SFS explains, using a global credit risk portfolio approach, it is able to spread the credit risk it assumes on behalf of SAP across its global portfolio of customers, which means that a strong credit profile among UK customers allows it to meet the needs of companies in more challenging economies such as Russia, for example. Thanks to our activities in the Project and Export Finance [PEF] division, we have good contacts to local sales financiers in a multitude of countries, Diers explains. This is why we were able to offer SAP financings even in markets such as Russia, India, Australia, Mexico and Brazil, countries where we do not have a balance sheet that would allow us to handle our own financing transactions.