Back to insights

Why Your Software Buyer and Sponsor Might Prefer a Multi-Year Contract

Nate Lentz
October 18, 2021

The normal discussion with software sales teams is all around creating special incentives for these teams to sell multi-year contracts instead of settling for annually renewable contracts.  Multi-year deals are viewed as harder to sell and less likely to close and sales teams are looking for as fast and as certain a win as possible.  Many companies feel they need to discount future years to win years two and three.  In evaluating whether those special incentives or discounts are necessary, however, sometimes it helps to flip around the process and “sit in the seat” of your buyer and project sponsor.  Why would they want a three-year deal versus a deal where they have the choice to renew annually?

Many enterprise software buying decisions take time and often involve a team of people identifying a need and researching a solution.  A business case is created and a project is launched.  Someone owns the project, leads the buying decision, and makes the recommendation to the sponsor or to several senior decision makers.  Procurement and legal are engaged and the process comes to conclusion with a contract and a purchase order.  The project is ready to launch.

The advantage for the buyer of a single year contract is simple.  If the vendor’s product did not live up to the promised capabilities or if the support did not meet agreed SLAs, then the software contract can be cancelled and thus the risk of a bad decision is reduced.  The disadvantage is that part of the purchase process needs to be redone each year and the spending needs to be re-approved annually.

The advantage of the multi-year contract is a potential solution for your buyer to avoid the challenges of how large businesses operate.

  • Projects start slowly, staffing takes time, aligning calendars for a kick-off can take 45 days. One year is often insufficient time to demonstrate real value in a multi-year project.  Milestones may have been hit but it is hard to answer the “show me the ROI” question.  At renewal time for a one-year contract, the sponsor or project owner may be stretching to demonstrate value delivered to date.  The multi-year contract gives the project time to be a success.
  • Project owners want their projects to be successful and want to be given the time to make them work and to deliver value. Knowing the sponsor’s or the senior leadership’s priorities may change gives the project owner an incentive to lock in the contract to the timeline to prove success and deliver value.  The multi-year contract reduces the potential for disruption to the project due to the vicissitudes of the organization.
  • The renewal process can be time consuming and political and can involve additional organizations including procurement and senior signoffs. This process can be a challenge and a distraction and is never a guaranteed success.  The multi-year contract lets the internal customer project team focus on project success, not politics.
  • If you sign a multi-year contract and the software doesn’t deliver on the promise, you can still cancel since your legal team will have build such cancellation clauses for cause into the contract – especially if it is multi-year.

For the software provider, multi-year contract value is pretty clear.  Lower churn and longer life-time value, more predictable year-over-year revenue, less sales team and account management distraction associated with annual renewals, and likely a higher valuation multiple on revenue.  But the thing to remember is that a multi-year deal can truly be good for both the software provider and for their customer.

That’s win-win!