Multi-Year Contracts Only Work for Whom?
The Threat of Long-Term Contracts
We have all experienced the nightmare of being locked into an unreasonably long contract. Customers are now more sensitive about being locked in and are rapidly becoming aware that when providers fail to deliver on the promised value and they try to leave, life suddenly becomes very interesting.
Why Were Multi-Year Contracts a Thing?
There are a few reasons.
Let’s take hosting as an example. Before the cloud, procuring hardware was a long and expensive process. Long-term capital investments had to be made for dedicated IT hardware; hence, multi-year commitments were required.
It suited retailers keen to capitalize costs that showed in the profit and loss statement (P&L) as “depreciation and amortization” without impacting on the EBITDA. But what looks good in a P&L may not be the right choice for the business.
Due to high setup costs, vendors may incur reduced margins for the first year, hence the need to have guaranteed revenue with good margins for the following years.
Lastly, multi-year contracts opened up the opportunity to push for upfront payments.
Old Practices in the 'New World'
Cloud, SaaS and the subscription economies have caused three fundamental paradigm shifts:
- Move from CapEx (capital expense) to OpEx (operating expense)
- Move from fixed costs to pay-as-you-go (PAYG) approach for pricing
- Replaced multi-year contracts with monthly rolling contracts or at a click notice
You only pay for the service you consume, and once you stop using it, there are no additional costs or termination fees. No long-term contracts or complex licensing. It’s all about choice.
The ramifications and benefits go far deeper. Cloud is not in question anymore; it is the obvious choice.
So, why are there still retailers out there complaining about being locked into a multi-year contract that they now regret?
Old commercial practices haven’t adapted to the “new world.”
Why are there retailers complaining about being locked in a multi-year contract that they now regret? Old commercial practices haven’t adapted to the ‘new world.’
Dangerous Assumptions
Assumptions made by merchants when signing a multi-year contract are:
- It will save money over a long period of time.
- The solution fits current and future needs.
- The solution works as promised.
- Brand X use that service, so it must be good.
Nowadays, even the most established businesses are constantly being disrupted, and making decisions based on future predictions is riskier than ever. Having the tools and capability to quickly adapt to changes, accelerating the pace of innovation, and creating and delivering more value is paramount.
This level of agility needs to be reflected at technical, organizational and also contractual level. Multi-year contracts don’t bode well with an increasingly competitive landscape.
The lack of flexibility in a fast-changing market can stifle growth and innovation. Having options is far more valuable than a 10% discount gained by committing to a long-term contract.
The Implications of Multi-Year Contracts
The Dreadful Scenario
It's not uncommon to come across merchants who are extremely frustrated because they are on a solution that doesn’t work nearly as well as promised; worst of all, they are locked in for another one, two or often even three years. Unfortunately, this scenario is more common than many people think, and it’s every bit as dreadful as you can imagine.
As the owner of Akoova, I’ve helped several merchants disentangle themselves from their existing hosting contract. It’s an unbelievably stressful journey for all involved. In some cases, clients were suffering so badly that they were on the brink of going out of business. One owner (let’s call him Mike) of a fast-growing brand said: “In the second week of November 2019, things were looking pretty dire. Provider Y was slowly killing our business, and they appeared to just sit there watching and waiting for it to happen.”
They were slowly killing our business, and they appeared to just sit there watching and waiting for it to happen.
Mind the Social Proof
It is easy to get excited about a solution just because Brand X is using it.
But don’t take anything for granted; at times, those public references have no substance, and it is up to you to unveil the true story behind them.
For instance, Mike also told me: “I reached out to a few companies who were using Provider Y. To my surprise, one of them started a call saying they previously experienced a FULL WEEK OF DOWNTIME. I was shaking. ..” Mike’s decision to sign a three-year contract with Provider Y was originally influenced by Brand X using Provider Y.
I’ve seen brands on the stage of conferences, gloriously talking about their amazing experiences with their solution provider. On one occasion, one of these brands had recently received a hefty compensation for damage over a long period of time. The truth can often be well hidden.
So, how is it possible to mitigate the risk that is sugar-coated by a load of marketing spin? One simple way is to talk to experts, peers, and existing and previous clients. Engage in a one-to-one conversation, as they’ll be more willing to tell the truth. Do your research. It is worth the time; don’t just accept what you are told by a salesperson.
Opportunity Cost
Problems can have a direct impact on business’s revenue, which can be bad enough to dwarf any perceived cost saving. But the most frustrating aspect is how ongoing problems hold back business growth.
The biggest cost of all is the opportunity cost.
The cost of holding back that big campaign for fear that the site could fall apart.
The cost of postponing the new checkout, which would improve conversion rate.
The cost of not being able to open in a new market.
The cost of holding back because the business is firefighting.
And the list goes on…
Watch Out for Misalignments
How can a vendor’s business and pricing models affect a relationship?
For instance, the core business model of traditional hosting providers was, and for many still is, based on hardware markup, commonly referred to as “tin shifting.” Even if they introduced more value-added services, for many the fundamental business model hasn’t changed.
What happens when an e-commerce site has capacity and scalability issues? The hosting provider will recommend throwing hardware at the issue; after all, they make more money by selling more/bigger servers. Throwing hardware at a problem may be necessary in the short term to buy the time to fix a problem, but it is seldom a long-term solution.
Conversely, an all-inclusive fixed-price solution may be reluctant to scale up to sustain growth; it would eat their margins without extra charges or a commercial renegotiation.
What retailers may not always be aware of is that a three-year contract provides the opportunity to get a 60% discount off the on-demand price from AWS. The question is, who benefits from this discount?
Anyway, hardware does not solve problems; people engaged in problem solving do. If all you can do is to raise a ticket, that’s not conducive to having intelligent conversations necessary to solve problems.
A Better Approach
Every business should re-evaluate their options and have the courage to embrace better alternatives. However, new solutions bring known and unknown risks. No matter how good or bad a solution is, a salesperson's job is, ultimately, to sell the dream. When embracing a new mission-critical solution, criteria such as risk mitigation, optionality and flexibility should take priority over lazy discounting.
Brands and retailers that value optionality avoid multi-year contracts. They know that getting stuck in a long-term partnership with the wrong provider is harmful to the business. A trial is not a substitute for de-risking because critical problems are discovered once the service is used under production workload.
A better way of mitigating the risk of a new partnership or solution is to start the engagement with a short-term rolling contract (e.g., monthly). That puts the onus on the provider to do their best to keep the spark alive in the relationship with clients and actually be there to solve problems. This should be table stakes with any modern cloud provider. If clients are not loved, they will soon find out.
It is also important to make sure the partnership is future-proof and the relationship has the strength to survive the inevitable ups and downs. For instance, in e-commerce, hosting capacity planning must satisfy both growth for the years ahead and seasonal peaks
Long-term growth demands the evolution of the baseline infrastructure throughout the years.
Seasonal peaks are brief and at times unpredictable. They demand a reconfiguration of the baseline infrastructure within a short period of time, measured in hours, if not minutes (e.g., split Redis, vertically and horizontally scale the database). Without this level of flexibility and scalability, the larger the difference between peaks and troughs, the larger the cost during off-peak periods due to unused overcapacity.
A better way of mitigating the risk of a new partnership or solution is to start the engagement with a short-term rolling contract.
Selco Flexed from Coronavirus Closure to a Startling Reopening
Selco Builders Warehouse, a leading national builders’ merchant, decided to close the doors of its 68 branches and all its delivery services in the wake of the coronavirus lockdown on March 23. After six weeks of total closure, Selco reopened 42 branches to support the delivery of online orders — through Click & Collect and Click & Deliver — only. This approach worked successfully and generated an unprecedented spike of online orders throughout the month of May and beyond.
Selco benefited from their digital investment in technologies such as progressive web apps (PWA) and Magento Cloud infrastructure, in partnership with JH and Akoova.
During those six weeks of closure, Akoova scaled down its K-Hosting platform. Because Akoova passes through the AWS fees at cost, Selco was able to keep the cost of AWS and K-Hosting to a minimum.
Conversely, at the beginning of May, we scaled the site back up for the reopening of the online orders. The first few hours were very successful. The planned scaling combined with auto-scaling meant that Selco had a successful post lockdown reopening by easily adapting to a new level of demand.
