New SaaS vendors are on the rise while established ones are expanding their offerings trying to lock you in for a longer period of time. There are benefits and downsides when it comes to signing multi-year SaaS contracts that can either make or break your business.
Buying SaaS? Think twice about multi-year contracts
Cash is king for fast growing tech-forward companies. So when buying SaaS, companies often opt for multi-year contracts. It’s the logical choice, right? Vendors offer 10% to 30% discounts and companies can avoid annual price hikes and the hassle of renewal negotiations.
In theory this is good for everyone – customers save money and vendors have a steady stream of income. Of course, this assumes that you are fully utilizing your SaaS and that your growth projections are accurate.
However, as we’ve seen with dozens of clients running hundreds of SaaS applications, these are rarely safe assumptions. Based on 2019 The State of Business SaaS Spend, enterprises are wasting up to 30% of their SaaS spend.
Evaluating SaaS vendors and how worthwhile a multi-year contract would be, requires a clear view of license use. You can only make actual savings if you optimize your licenses properly.
Match the contract duration to the SaaS vendor’s product development phase. Early-stage vendors will prefer to go for monthly contracts to maximize experiential data while established vendors will shift to annual and multi-year contracts for stronger cash collections and sales goals.
What is a multi-year SaaS contract?
A multi-year SaaS contract is a contract for a SaaS vendor that lasts for more than twelve months. Multi-year contracts might make provisions that continued performance of the contract into the second and any following years of that contract will be dependent on the allocation of funds.
Before signing off on multi-year SaaS contracts, consider some of the benefits and downsides of buying this way.
Multi-year SaaS contract benefits
1. Higher Discounts
Higher discounts are one of the most common positive reasons why enterprises sign multi-year contracts if they completely understand what they’re agreeing to. Enterprises can use it as a powerful negotiation tool since it is in SaaS vendors’ interest to secure fixed volumes and repeat business.
2. Protection from price increase and volatility
Markets go up and down, and SaaS Vendors grow using different pricing models and tactics when increasing prices. If prices go up in the future, the contract is potentially locked in at the price when the contract was enacted. For example, Salesforce’s Master Subscription Agreement tells us they add 7% price increase each year. Signing a multi-year contract will often guarantee you no pricing increases.
3. Saving time and resources
The typical 800-person U.S. company used 141 SaaS vendors across the organization, based on The State of Business SaaS Spend 2019. Procurement spends an outstanding amount of time to review and renegotiate existing SaaS contracts, plus new vendors with new SaaS products require additional time on research and onboarding.
Multi-year contracts offer procurement to focus on strategic initiatives rather than spending time on preparing and managing renewals that usually happen during december.
Multi-year SaaS contract downsides
1. No solution flexibility
Not having the financial flexibility to respond to marketplace changes or evaluate competing services is a liability.
Innovation is a daily reality in the world of enterprise technology. Companies often get locked in multi-year agreement with legacy software companies, only to later find more fitting solutions. Without the financial flexibility to respond to marketplace changes or evaluate competing services, you are at a serious disadvantage. Unfortunately companies attracted to the savings offered in multi-year deals assume several risks with this approach. These include productivity, collaboration, integration, service model, speed, security and other risks if they can’t adopt better SaaS solutions.
2. Multi-year contract legalese
It’s important that you understand what you agree to in a multi-year deal.
Even if your licenses are discounted, confusing contract terms for a multi-year deal could mean paying too much. In some cases, the savings made become less important than the annual flexibility you lose. SaaS pricing is notoriously opaque and SaaS companies are expected to make revenue from new customers a strategic priority.
One study shows that 80% of the top 250 most successful SaaS companies in the world don’t list pricing. The reason for this? It is easier for salespeople to show value for services. They can pitch multi-year options or repackage discounts as one-time, initiation costs or ongoing service fees.
Of course, most SaaS companies do not engage in nefarious pricing tactics. We are also not demanding upfront pricing across the board. However, be cautious because it’s important to understand what’s you are agreeing to. If you can find great value in annual contracts, rather than multi-year deals, you should be kept in the know.
3. Innovation disincentive
When you’re locked into a fixed license amount, there’s not much that SaaS vendors can do to sell you more.
If a company has the bulk of its revenue tied up in multi-year contracts, its innovation urgency is low. These companies may think: why push for new updates when we have customers for a guaranteed 3+ years? Customers with multi-year contracts may notice they are not receiving the same level of attention. When you’re locked into a fixed license amount, there’s not much that SaaS vendors can do to sell you more.
While there’s no ill intent here, it has become common practice. Since their company business model and personal comp plans depend on adding new business, that’s where their attention will be. While this isn’t true of every vendor, it’s easy to see how vendor and customer incentives become quickly misaligned. This is especially the case for businesses that are dependent on this type of contracting model.
Multi-year SaaS contract vs per license (user)?
While counter-intuitive, companies should consider choosing to pay more on a per license basis. If they also actively manage their SaaS use, this would be a better long term approach.
Consider the simple example below:
This compares two companies. The first opts for a multi-year contract to lock in license pricing and the second chooses an annual fee. Both companies try to forecast license need, although it is far more difficult to look three years into the future.
In this example, the company pays more for every license. However, improved monitoring means they buy what they actually use. In our eyes, this is key to maximizing the ROI of a SaaS subscription.
With Cleanshelf, companies can take advantage of insights from Cleanshelf Service Reviews to audit the value of each application. They can also leverage our market insights to discover what other, similarly-sized companies are paying for common SaaS tools.
Ultimately, multi-year contracts may be the right solution but only commit after thoroughly reviewing your SaaS use. You need to be completely clear on what you are actually agreeing to. Once you understand the pros and cons of a multi-year SaaS contracts, then it’s time to negotiate your existing contracts.