There’s Still Time For SaaS Clients To Ask For And SaaS Vendors To Offer A Recession Clause In SaaS Contracts
Cloud software has become more common, whether in the form of multi-tenant software-as-a-service (SaaS) or single-instance hosted software. Companies in many cases have signed on to multi-year contracts with these cloud software vendors, yet the prices in those contracts are often based on usage metrics such as number of users, number of customers, or number of transactions that have, at best, loose relationships with company revenues and, at worst, negative relationships. As a result, many CIOs are likely to find that the cloud portion of their tech budgets has costs that are fixed or rising at a time in 2020 when those same CIOs will be facing pressure to cut their tech budgets due to recession.
For over a year, Forrester has urged clients to ask their SaaS vendors — and, indeed, any vendor where they pay subscription fees — for a recession clause in their contract (see the Forrester report, “Ten Ways To Prepare For The Next Recession“). The recession clause would state that the vendor agrees to cut its subscription fees for a client whose revenues drop in a fiscal year, in return for the client extending that contract by a year or two. When I have presented this idea to vendors that I cover, they almost universally have said that they would take that deal in a heartbeat. The value to them of having an extra year or two of client revenues would exceed the revenues they might lose in one year under such a contract.
Until the coronavirus hit, this was largely a theoretical discussion. Most companies and most vendors viewed a recession as a future, low-probability event. Now, it is a reality, so vendors that might have liked the idea of a recession clause in the past may not be so keen when their clients could be facing revenue declines of 10%, 20%, or, in the case of airlines and oil and gas companies, over 30%. But that doesn’t mean that clients should not ask for this clause now, nor does it mean the vendors should not be prepared to offer it.
So here is what I propose CIOs should do: Start with your largest SaaS vendor or the one with whom you have the best relationship, and make the following proposal to them:
- If our company’s revenues decline by more than X% in a given fiscal or calendar year, the SaaS vendor will agree to cut its subscription fee by 2X% for that period of time. X would be subject to negotiation. You could propose, say, a revenue decline of 2%; the vendor might counter that the clause would not come into effect until revenues dropped by at least 5%. The multiple of 2 would also be subject to negotiation. You could propose 2X; the vendor might counter with 1X and you could end up at 1.5X.
- In return for this change in price, you would agree to extend the SaaS contract by one year. The vendor might counter with a request for a two-year extension. It would be up to you to determine how long you would feel comfortable extending the contract. If you really like the product and the vendor, a two-year extension might be acceptable. If you have doubts, a one-year extension would be best.
- If this works with one vendor, you can then take this model to other vendors and use the precedent of having an agreement with one SaaS vendor to get others to follow suit.
There are some additional considerations:
- If you are a private company, you should be prepared to share audited financials with the vendor to prove the decline in revenues took place.
- If you want savings sooner rather than later, you could structure the terms of the discount to apply on a quarterly basis.
- You should decide if you want the discount to be paid as a rebate from the subscription fees paid in the effective year or as a credit against the fees for the coming year.
- For vendors, there are complex accounting rules that would need to be worked out. My understanding is that under public company accounting rules, this type of clause could force vendors to limit the amount of revenue they could recognize. It would require manual modeling and factoring of the probability of a client or an industry seeing a decrease in revenue. But this could a better alternative than having to make ad hoc renegotiations of individual contracts.