Do software vendors really know what their users are doing?

TORONTO – Canadian software companies should be conducting audits on their clients at least once every two or three years to get their money out of the 90 per cent who don’t live up to their licence agreements, a group of lawyers and consultants said Tuesday.

Speaking as part of a licensing “roadshow” put on by PricewaterhouseCoopers (PwC) and Toronto law firm McCarthy Tetrault, George Takach said our amiable national culture may be part of the problem. He told the story of a software company client whose chief executive attended a user group meeting and asked how many attendees had already obtained what amounted to an illegal beta version of his next release. About half the hands in the room went up, Takach said, but the client didn’t seem to realize the severity of the situation.

“You have to be a little less Canadian when you approach some of these issues,” said Takach, a McCarthy Tetrault partner who represented Research In Motion during its intellectual property dispute with NTP. “There’s money being left on the table, and there’s no reason Canadians shouldn’t be scooping up some of it.”

Just last week, Takach said another client had received a letter from a U.S. software firm that manages more than 50,000 active patents and which said his client must be infringing on some of them. The letter demanded an upfront licence fee of US$500,000, followed by regular payments of US$300,000 over the next five years to avoid litigation.

“This was without mentioning any (specific) infringement whatsoever,” said Takach, adding that the RIM case was a wake-up call for Canadian firms who haven’t sorted through their licence and patent portfolio.

Though admittedly a pitch for the two firms’ legal and consulting services, PwC’s licensing management practice national leader Michael Dobner said the roadshow will prove being proactive about checking up on licence and royalty fees pays for itself in the long run. While enterprise customers have struggled to effectively manage the licence agreements they sign with software companies, Dobner said the software companies have troubles of their own.

“Royalties are calculated on spreadsheets that are unconnected to the financial reporting system,” he said. “If you enter a new territory or sales area, the manual updates that need to happen may not occur, and that’s when you get revenue leakage.”

Dobner said most customers are only at a medium risk of underreporting what they should be paying in licence fees. In many cases, sending a letter requesting an audit will lead clients to come forward voluntarily to correct any discrepancies. “Right there you’ve recovered your (legal and consulting) fees,” he said.

McCarthy Tetrault partner Charles Morgan said the company did an analysis in June based on about 800 cases it has dealt with over the last few years, which showed that about 90 per cent of royalty examinations identified misreported earnings that were due a software company. A big issue is the lack of clear language in many software contracts, particularly differences of interpretation around terms like named, authorized or concurrent users. These nuances directly link to the revenue steam of a vendor, Morgan said.

“In general, there aren’t enough examples that illustrate the components of the agreement,” he said. “You’re dealing a lot in ambiguities.”

Takach said many vendors have not updated their licensing agreements since they were offering object-oriented executable code on CD-ROMs. Software as a service over the Internet means those contracts have to change, he said.

“These companies are now handing over tools and source code and what their customers are dealing with is much more of a development environment,” he said.

Piracy is also a big problem, but Takach noted that efforts by groups like the Canadian Alliance Against Software Theft to publicly shame illegal users could backfire.

“You have to think about what kind of message you’re sending out to your user group,” he said. “Approaching the customer base is a very delicate subject.

PwC and McCarthy Tetrault said licensing revenue leakage is most acute in software companies with net sales of between $100 million and $750 million.

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