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Wed, 02/29/2012

Software Advances Drive Changes to Vendor Pricing Models

By Scott Kersnar

With mortgage technology rapidly advancing, the pricing structures that software vendors employ are also evolving. Vendors must be wary of pricing themselves out of business as they strive for a win-win relationship that keeps costs low for users.

Spurred by a soft economy, the industry has seen expensive custom technology projects give way to easily implemented, hosted solutions, primarily via software as a service. The days of 20% annual maintenance fees on million-dollar systems are disappearing as lenders have come to realize they can get routine software updates from the cloud at much lower costs.

In the near term, “increasing tension between vendors’ insatiable demands for revenue and buyers’ pressing need to cut non-value-adding maintenance expense, coupled with technology
changes such as cloud and mobility” are forcing vendors to change longstanding policies, according to a Forrester Research white paper, “Software Pricing and Licensing Trends,” by principal analyst Duncan Jones.

The April 2011 report documents a widespread overhaul of traditional software licensing and pricing models across all industries in light of the rapid evolution of software as a service and other cloud-based technologies.

The research adds that a weak economy makes corporate users push back, as chief information officers find ways to make do with less.

Today, corporations have plenty of “real alternatives to their incumbent vendors,” Jones wrote, stating flatly that “cloud and mobility kill deployment-based licensing.”

It’s a concept that’s been growing for some time. A 2007 PricewaterhouseCoopers report on software pricing trends, written by senior research fellow Alan Morrison, director Terril Retter and InfoWorld executive editor Galen Gruman, predicted that by 2016, few large software vendors would remain, with lots of niche-oriented small developers— such as best-of-breed mortgage technology specialists—filling the void.

Service-oriented architectures will be the norm for both vendors and users, the report said. PWC envisions large enterprises using SOAs “to give them full control over the value they leverage from their software.”

Meanwhile, said PWC, software vendors will use SOA “to deliver their software as a utility computing service— hosting multiple applications and integrating them in real time for customers and other vendors.”

“We’re moving almost completely to SaaS,” said Kevin Marconi, chief operating officer of United Fidelity Funding. “We even got rid of Outlook on the desktop. SaaS is the way to go.”

As a major part of that shift Kansas City, Mo.-based wholesale mortgage lender UFF is in the process of implementing the SaaS version of the MortgageFlex loan origination system.

There is no doubt that commoditization via SaaS has drastically lowered software costs for small and midsize mortgage lenders. However, it’s difficult to get hard numbers on pricing models and trends because most of the industry’s software vendors and service providers are privately held entrepreneurial players.

Jeff Lebowitz, president of Bend, Ore.-based Mortech LLC, said his firm’s research continues to show that lender preferences on pricing models are “highly segmented.” Larger lenders continue to prefer fixed costs, he said, while the demand for variable, transaction- based costs is largely confined to the industry’s smaller players.

“Where you have smaller vendors saying they are winning volume from large lenders,” said Lebowitz, “they’re probably talking about overflow.” He added that the top-tier lenders—the ones doing the lion’s share of production— remain wedded to their legacy mortgage systems and lean toward using private cloud technology.

Nevertheless, top-tier lenders do partner frequently with best-of-breed providers— in default technology, for example.

What vendors have to demonstrate to prospective users of all sizes, said the PWC study, is tangible value in terms of efficiency and flexibility. PWC said software vendors “must begin thinking of their applications as flexible platforms that allow customers to choose among software components and pricing models.”

To make the thinner SaaS revenue stream work, the PWC report recommended vendors focus on service and support “as key differentiators.” Marconi and other mortgage professionals agreed with that view, citing exemplary service as a crucial element for any SaaS-based providers seeking staying power in the industry.

But the flexibility of transactionbased pricing is still what’s driving many technology decisions in the mortgage industry. “I don’t know many people doing subscription; almost all prefer transaction-based,” said Scott Stoddard, CEO of Foothill Ranch, Calif.- based default-technology provider Quandis. “I think the only place where licensing will exist pretty soon is in core systems, which are relatively static. And eventually we will go away from that. Everyone is going to the cloud.”

“Using a transaction-based pricing model such as Quandis, we only have to pay for the files that we run through their platform,” said Virgil Watson, chief operating officer of Sherborn, Mass.–based real estate data and analytics firm Collateral Intelligence. “As a result, we are able to take advantage of variable pricing versus a fixed cost, which enables us to better manage large variances in volume.”

“Transaction-based pricing is the new way to go,” said Julie Vazquez, director of automation at Paramount Residential Mortgage Group. She cited the Corona, Calif.-based retail and wholesale lender’s document provider DocMagic and LOS provider Avista as particular examples.

In fact, she said, all the lenders that have survived the recent bad years did that by partnering with vendors “who have allowed us to pay per transaction.”

“We have used the closed-loan model since we started,” said Mark Phlieger, CEO of Charleston, S.C.-based Avista Solutions.

“We think it creates a winwin for the customer and the vendor because it aligns our interests. We both get paid when the loan closes. And as we add more people to our cloudbased platform, we get economies of scale that save our lenders money.”

“Everyone has been pressured to reduce pricing to help lenders increase profitability,” said Dominic Iannitti, president and CEO of Carson, Calif.- based Document Systems Inc., which offers the DocMagic platform. “Lenders are looking for certainty in actual pricing, a single price for the whole menu, a single fee per closed loan.”

Vazquez said DocMagic offers that. “And I love the flexibility DocMagic has given us. Not only do they charge only per closed loan,” she said, “they offer a variety of supporting services. The dollars we save with them on the back end are considerable.”

“Their legal department is outstanding. When we go into a new market our legal department doesn’t have to spend days or weeks researching regulations because we know DocMagic is a compliant doc provider for every locality,” she added. “I can shave off X number of dollars per every closing.”

Global DMS is another vendor that has prospered with per-transaction pricing, charging users a flat dollar per order.

“The per-transaction model has been extremely profitable for us,” said Vladimir Bien-Aime, president of Lansdale, Pa.-based Global DMS. “We have experienced 275% growth in the last three years. We make money when our customers make money. That’s why people are gravitating to a model like ours.”

But this revolution didn’t happen overnight—Global DMS launched in 1999 as a SaaS-only provider.

“How we monetized our solutions at first was a monthly subscription model with discounts for annual subscription, where you pay for all the features whether you use them or not,” Bien- Aime said. “We found that many were paying more than they should. We moved to a 100% transaction model.”

Like Quandis, Global DMS did not succeed by giving away the farm. “We as a company are always price sensitive,” said Bien-Aime. “At the end of the day, how much does it cost us, how do we pay our expenses? We are never going to be the low-ball player that competes on price only.”

What the company does instead, he said, is make sure its product delivers provable operational value and return on investment. “Our moving away from the [appraisal management company] model would not have been possible without Global DMS,” said UFF’s Marconi. “They are one of the best vendors we partner with.”

Some older vendors that originally launched with the client-server model have since adopted the SaaS model, but still offer per-seat as well as pertransaction pricing. For example, Jacksonville, Fla.-based MortgageFlex Systems offers four pricing models: hosted, licensed on premises, by number of users and by closed loans.

“When their volumes are low, or going up and down, people love you for the per-transaction payment basis,” said CEO Lester Dominick. “There’s a crossover point where the per-seat license makes more sense. If you’re not growing or don’t have confidence in where your mmarket is trending, paying per-transaction makes more sense. As people know their business is growing, there is more interest in user licensing.”

Iannitti said large lenders are good at estimating their annual loan volumes in advance and negotiating upfront pricing for services. “Here’s what we did last year, and here’s what we’re going to have this year. We will prepay a year’s worth of production.”

Often, Iannitti said, “big lenders pay upfront, let’s say, for a hundred thousand closed loans, with an additional fee for volumes over that.”

When all is said and done for mortgage lenders of all sizes, there is no questions that cloud computing is having a huge impact on software pricing. “Mortgage technology pricing has become permanently commoditized,” said Iannitti. “When you’re literally selling ones and zeroes it’s difficult to nickel and dime clients into paying more.”

Craig Doriot, marketing director for Appleton, Wis.-based LoanSifter, agreed. “Larger players want an allin price that they don’t want to think about every month. Most are looking for something consistent.”

Sales Compensation
When large, upfront licensing fees disappear, sales strategies have to change radically. Selling SaaS-based systems takes more than persuasive talent.

“We’ve been offering a hosted version for almost 10 years,” said MortgageFlex’s Dominick. “We found we had to pay to attract the sales talent we needed. The sales force has to be proactive and skilled in terms of service. You train the new users during the sales process. You do team-based sales because you can’t expect salespeople to be expert in all areas. In the old days a sales cycle took a few weeks. That doesn’t happen anymore.”

Compensation is more drawn out as well, he said. “Compensation is based on the value of the contract over the period of the term. Salesmen get paid when we get paid.”

Doriot said sales compensation at Loansifter “has gotten very sophisticated” as the company has acquired larger mortgage industry clients.

“There are many demos involving multiple team members communicating internally, doing needs analysis on the workflow, how pieces are going to work with one another, helping them work through their challenges,” Doriot said. “As the implementation moves toward completion and inking of contracts, the salespeople make a smooth transition to the account managers. The compensation moves from a set salary during the ramp-up period of their careers, with commissions supplanting salary as they do more sales.”

“With enterprise sales the price is substantially lower per seat,” he continued. “You reach a cutoff point that gets somewhat commoditized but we become more predictable internally.”

Developing SaaS
Just as housing prices could not rise forever, software pricing cannot remain in perpetual decline.

Given the low prevailing upfront implementation fees and low-cost monthly maintenance fees with SaaS, funding for research and development is a real issue. Development has to take place on a continual basis with multitenant systems—and to a lesser extent with single-instance hosted models— but is supported by drastically lower pass-through revenues.

Stoddard believes that the multitenant SaaS market will continue to grow because “software is never done and the rules are always changing,” at a time when small to midsized players “don’t have the money to spend on developing applications.”

But vendors like Quandis must continually upgrade their systems, he said—and must price accordingly. He said Quandis is able to keep its transactions priced on a cost-plus basis “where we don’t have a single app we’re not working on, profitably. If you can’t make money in default technology today, you never will,” he said.

Having recently completed a total .NET rewrite of its system puts MortgageFlex in a good position to deal with the challenges of the current market, said Dominick.

“Charging per-transaction works best from a competitive standpoint because we’ve already made that investment. If our competitors still have to make a rewrite, how do you pay for that when you charge on an upfront licensing basis and have to find money for a rewrite of your system?” Dominick said. “What you want to do is build up a reserve to pay for your next big R&D expenditure.”

One way that vendors reduce their own R&D costs is to have customers pay. The PWC report discusses customer-supported R&D, which typically leverages the commercial open source model in a SaaS environment.

For the mortgage industry, this means lender customers pay time and materials for the vendor to develop new features that are automatically delivered to the vendor’s other customers as well. That kind of cooperative brainstorming between vendors and their customers, converting R&D wish lists into working software applications, has long been a high priority at user conferences. Mark Phlieger said a “bread-and-butter capability” at Avista has long been showing users that its programming teams are able to code, test and release new apps faster than lenders can accomplish in-house.

Integration Reduces Costs
In today’s uncertain market, lenders cannot predict which vendor integrations they will need next. A hidden factor in determining whether lenders are getting what they’re paying for is having the right integrations—and making sure their vendors do, too.

“When they’re doing their due diligence,” said Marconi, “lenders should ask vendors, ‘How many vendors do you integrate with now?’ If they say three, then basically that means they only have three friends. You want a technology partner that collaborates with lots of partners.”

Marconi singled out Global DMS as a vendor that integrates with a number of other solutions. “They do it right, and they’re willing to make friends with anyone. For us small- to mediumsized lenders, that is incalculable, to do it for a dollar per transaction,” he said. “In the technology business no one can be everything to everyone. If you can’t integrate easily with other vendors, you’re going to become obsolete.”

Integration may not be a direct component of pricing, but it must enter into any assessment of the total cost of doing business. The most useful tech partners are not always the cheapest; at some critical junctures, lenders really do get what they pay for, whether they realize it or not.

As Published By Mortgage Technology, March 2011