Getting to grips with your ESSO

Rethink IT, August, 2004

MARKET OVERVIEW

Recent activity levels suggest that we are well and truly into the summer period with little activity in the market. However, small to medium users should see this as a good opportunity to approach IBM with their requirements because the IBM resources needed to get the best deals are all more available in such quiet periods. In contrast, toward the end of quarters, halves or full years these resources are fully occupied on the larger accounts.

IBM normally attempts to bring the market back to life in the September period to coincide with the end of its third quarter and this year I expect this to be based around a number of software pricing announcements to in particular 'kick start' their larger users. These will all be around lower pricing for the largest users and lower cost addition of new applications to the mainframe platform.

AN ESSO MODEL

Last month I promised to provide a model for constructing an ESSO (enterprize services and software options) and also how to perform a risk analysis on the resultant contract. The model is produced below, first with the actual values calculated and then with the formulae visible so that you can construct your own model. Although very 'general' in nature this model has proved to be accurate to within 1-2% in predicting the final ESSO costs and can save a lot of time by outlining the likely level of commitment required before beginning a few months of effort to get the exact values.

It is based on a user with a current software inventory of 25m (the currency is irrelevant) with capacity growing at 25% per year. The model produces the following figures based upon the input detailed later.

To enable you to build your own model the detailed formulae are presented below

The figures that must be entered into the model are as follows:

The year one software inventory value which is to be agreed with IBM. Remember everything possible must be done to minimise this figure. For example the introduction of the T-Rex or z890 will lower the inventory cost by around 5% and moving to zOS with sub capacity pricing could give another 5% reduction.

The 'free growth' allowance which in this model has been used to provide an MLC discount rather than free growth which may not be needed. To use it as free growth you just need to add the figure calculated of 7.13 to the CAPS and to the annual cost over the three years. A figure of 10% 'free growth' is realistic for most users today but if the actual growth rate is below 20-25% perhaps a 5% figure is more realistic.

OTC from old contract which is the residual cost from any earlier ESSO or Passport Advantage contract that has been cancelled early to create this new contract. If this is a first ESSO and there is no Passport Advantage contact being included then there will be nothing to enter in this field.

OTC to growth ratio is the level of OTC commitment needed to obtain the free growth allowance calculated. A figure of 2.5 times the free growth allowance is realistic for most users today but the largest users may get away with something closer to 2 times.

S&S on current OTC commitments is the annual cost of S&S for OTC products (mainframe and passport advantage) already installed.

Growth rate is the users planned annual capacity growth.

Price increase/capacity increase is the 'rule of thumb' for the percentage of capacity increase by which the price increases. A figure of 40% is reasonable for most users but the range can be from 30-50%.

Price/performance is the percentage by which prices are expected to reduce over time due to new pricing initiatives such as higher clip levels, new models like PSLC/VWLC or hardware moves such as T-Rex and z890 which have 10% lower MSU values than previous generations for the same capacity. The faster you are growing the higher this percentage will be, up to as much as 10% per year, but for low growth users probably 0% is more realistic.

Finance cost is the annual rate of interest to be paid on the OTC commitment which will be financed over the full contract period.

All of the other figures, including the required CAPs, are calculated from your input and in this case the model gives a flat payment stream for three years. However, the payment stream can be almost anything you desire from low at the start to high at the end to the reverse with high initial payments followed by low payments towards the end--although clearly this can have some impact on finance charges. Indeed in my negotiations I concentrate almost entirely on negotiating the total cost of the contract as produced by this model and then negotiate the payment streams.

From a 'risk analysis' point of view the most common question is 'do we need to commit to this level of OTC's?' Well if you take the figure in this case of 17.82 to make this decision you are really looking at the wrong figure. What you have paid for new OTC's is closer to 10.69m which is the 17.82m less the free growth allowance/discount given. This is likely to represent a 70% plus discount on list as the pricing used by IBM within the ESSO is likely to be at most 50% of list and the free growth allowance represents a further 40% or so discount from this level.