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The Hidden Cost of Software
By Tim Chou

May 29, 2003

Do you know what is the real cost of your software?

Before you reach for a calculator, be forewarned that it’s a trick question. Even technology industry analysts and seasoned IT executives have difficulty putting a hard figure on the Total Cost of Ownership (TCO) of today’s enterprise application solutions. What makes the equation so tricky is the sheer number of variables that must be factored in — many of which cannot be lined up in a neat column and reconciled, such as issues of security, availability, performance, problem resolution and change management.

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“The best way to achieve greater accountability is for the software industry to create a model for assessing and measuring an organization’s success in managing software.”

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In computing the cost of software, companies tend to focus on the purchase price and initial implementation. Yet even when fully operational, software is never free. It must be supported, maintained and upgraded — often across geographies and in multiple languages, currencies and regulatory climates. In fact, industry analysts estimate that the cost of maintenance equals or exceeds the cost of software, and can be as high as twice or three times the purchase price over the life of the software.

There are hidden costs as well. Owing to the resources, time and cost involved in getting an enterprise application up and running (especially globally), many corporate IT groups are hesitant to make incremental improvements or upgrades. This inertia can cost the enterprise dearly in terms of productivity, customer service quality and market competitiveness.

Without a clear understanding of the full issues and costs, businesses still are making decisions that can govern software usage for years to come. Certainly, the options open to companies are more numerous than ever before. They can outsource all of their software needs, operate their own data facilities while leasing vendor-supported software services, or build and support their own proprietary enterprise solution. Moreover, as businesses migrate to the Web, organizations now can standardize globally on a single instance of software, or integrate multi-vendors solutions into their existing legacy system.

Yet with no common basis for comparison, how can a company weigh the pros and cons of all of these alternatives?

The confusion over software TCO works to everyone’s detriment: software manufacturers, systems integrators and consultants, value-added retailers (VARs) and customers. Before committing to an enterprise solution, companies should understand where their software dollars are going.

The best way to achieve greater accountability is for the software industry to create a model for assessing and measuring an organization’s success in managing software. There is a successful precedent for this: the Capability Maturity Model (CMM) developed by Carnegie Mellon University’s Software Engineering Institute in concert with a consortium of software manufacturers. The CMM model has become the software industry’s de facto standard for assessing and improving the maturity of processes guiding software development, testing and implementation.

In this article, we will examine some of the hidden costs of software and the need for an industry model to help quantify, analyze and trim maintenance costs. We’ll also examine how the outsourcing model offers the economy of scale to standardize and automate software processes and support specialization.

Software’s “Hidden” Costs
Understanding the cost of software means tracking all related expenditures across its life cycle: purchase/lease, implementation, training, support, maintenance and all subsequent upgrades. It is simpler said than done. Obfuscating the whole price issue, some systems integrators bundle the cost of the software in with their services, and quote one, all-inclusive price. For large organizations, these custom integration projects often run into millions of dollars; still, they have no idea how that lump sum is divided and expended.

How do the software costs break down?

In addressing total software related spending, JP Morgan Chase technology analyst Chuck Phillips cites a recent U.S. Department of Commerce study indicating that software license expenditures account for only 30 percent of the total. The lion’s share represents labor costs, with 37 percent of spending going toward internal IT staff support and 33 percent earmarked for external consultants related to software implementations. The numbers translate to a ratio of 1:2, software license to management/labor costs; and 1.1, license fee to implementation work.

IDC recently reported that “Many companies underestimate the cost of managing applications. When you consider the annual costs of administering the applications and the cost of managing issues around performance, changes and availability, it is most likely significantly greater than the application purchase price.”

When assessing “bang-for-buck,” consider that software performance is less a factor of purchase price than its successful integration into the business culture. Simply put: you can invest in a world-class enterprise application solution, yet if it is poorly implemented and managed, you’ll end up with under-performing, problem-riddled software.

Inertia vs. Innovation
When I meet with companies to discuss their software needs, they’ll typically volunteer a figure on their annual software costs. Presumably, that sum covers the whole nut, yet in reality, it is only the starting point. The real question is what are they getting for that amount.

To help frame the larger discussion, I ask corporate executives the following questions:

  • When did you do your last security audit?
  • Do you have a disaster recovery plan in place? If a major data center goes down, how quickly can you shift operations to an alternate location?
  • Is your software delivering on its full benefits?
  • Who handles major system upgrades and failures?
  • Does your information infrastructure and culture support continuous innovation and change?

There are lots of hidden costs to managing software. A chief technology officer of a G2000 company recently told me that he had three database administrators (DBAs) managing 130 instances of software on a 24/7 basis. I shuddered at the thought. No matter how qualified and knowledgeable those individuals might be, three IT professionals were not sufficient for the task.

This situation is not unusual as companies try to rein in IT costs and operate “lean.” Yet rather than reducing or eliminating maintenance costs, this form of economizing just shifts the expenditures around; in this case, literally out the door. While the internal staff can cope with everyday situations, their bandwidth is easily over-taxed. For heavy lifting, such as major systems upgrades and/or failures, a team of high-priced systems integrators and consultants are brought in.

The labor-intensive nature of managing software gives rise to another hidden cost: inertia. With custom legacy systems constructed like Rube Goldberg contraptions, changing one piece of software often requires reconfiguring the whole. No wonder IT groups are hesitant to risk upgrading or adding to the solution. Their motto might as well be: “If it’s not broke, don’t fix it!” But technology keeps reinventing itself and making quantum leaps forward in features and functionality. In a 24/7 global economy, can any company afford to lag behind?

Increasingly companies are turning to outsourcing as a way to trim costs, concentrate on their core business and improve services. Also fueling this worldwide trend are security issues, such as site redundancy, business continuity and rapid disaster recovery.

Continued on Page 2

Timothy Chou is president of Oracle Outsourcing. In this capacity he has led the strategic and tactical transformation of Oracle from an offline provider of enterprise business software to a provider of online enterprise-class business services through the Internet. Before joining Oracle, he was the chief operating officer at Reasoning Inc., an IT service provider. Prior to Reasoning he held numerous executive-level positions at Tandem Computers.

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