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Drafting IT contracts with foresight

Lessons lie buried in IT history for improving IT contracts, especially software contracts.

The key for discovering the lessons is to look for patterns of change. We argue a three stage pattern emerges from IT history. The pattern repeats over and over in IT history in the last six decades. Awareness of the pattern helps to improve contract strategy and draft more effective IT contracts.

A pattern in three stages

Here is our observation on the three stage pattern of change in IT history. The evidence is discuss later in this article.

First, technology changes. Distinguishing significant change is time consuming, particularly due to hype and other factors which talk up insignificant developments.

Second, business models change and respond to technology change. Ripples of change arrive with significant new technology, technology that is accepted by markets, and technology which is commercialised. They cause people to change habits of work and leisure, change arrangements, launch initiatives, do new types of deals, and make money or add value in new ways.

Again, distinguishing significant change is not easy. For companies business models form part of their tools of trade, part of their trade secrets. They are not regular fodder for press releases. Lawyers have to hunt down the contracts and data on their context. They have to then pull them apart to unlock secrets and understand linkages. This feeds then into decisions as to what to include and exclude in particular contracts.

Third, IT contracts change and respond to technology and commercial changes. It is the role of executives, their lawyers and other advisers to keep a look out for significant change in contract types and provisions. We have done this for decades.

The contracts and their provisions change as the underlying technology and business models change. Those who look for and respond to the changes are exercising foresight, and helping to innovate for market creators. They are distinguished from followers and those who do back office legal work.

A pattern of tragedy and ecstasy

IT history illustrates the above pattern and provides examples of IT contracts which have had enormous commercial significance. There are stories of tragedy and ecstasy.

An IT contract which lacks foresight or is blind to the future can bring a business to ruin. In contrast a clever or thorough IT contract can build a company and even shape an entire industry. IT contracts have done this repeatedly for Microsoft:

  • In Microsoft's early 1980s software supply contract with IBM for the Disk Operating System (DOS) for IBM's new PC range.
  • In Microsoft's 1980s application development contract with Apple Computer, Inc. This gave Microsoft access to Apple's user interface for Microsoft's Excel application program interface. Excel for Mac, released in 1985, was a hit. In 1987 it was released for PCs along with Windows 2.0. Years later when Apple sued alleging infringement by Microsoft's Windows of the Apple interface, Microsoft cited permission granted in the Excel contract.
  • In Microsoft's 1985 Joint Development Agreement with IBM for Operating System/2 (OS/2). Microsoft had no restraint on it from building a competing operating system. It worked in parallel on its Windows program. OS/2 died after release of Windows 3.1.
  • In Microsoft's OEM (original equipment manufacturer) contracts. These have contained various restraint clauses restricting computer manufacturers which release Microsoft products pre-installed (such as Windows and Explorer) from adding or also distributing competing programs (eg Netscape Navigator).

1950s - 1990s: Custom programming and commissioned software contract

From the 1950s to the 1970s custom programming contracts and commissioned software contracts ruled. The custom software programmed for clients was usually too client-specific to lead to erosion of value due to duplication. Copying was not a practical problem for such 1950s US systems as the SABRE airline reservation system commissioned by American Airlines from IBM, or the SAGE nationwide defence network commissioned by the US government with Western Electric as the prime contractor.

Back then software development agreements and hardware support agreements were among the most common types of IT contracts. These types are of course still used today, though the proliferation of types of IT contracts makes them seem less common today.

In simple terms, from the 1950s to the 1990s software development contracts offered this basic deal from one or a combination of suppliers: "The customer pays for the manufacturer to make, bundle together, sell and service the supplied hardware and software."

This deal mimicked engineering and construction industry contracts. For example, the financial terms were typically either fixed price or based on time and materials. The customers were typically big government and big business. it_sei_framework

Throughout the course of the history of IT contracts, each element of the above basic deal has been reconfigured. For example, offerings have been bundled (eg in the 1950s onwards IBM bundled hardware, software and services) and then unbundled (eg IBM unbundled all those three elements following its unbundling announcement in December 1968) and then bundled back again to meet needs in new contexts. Others have followed this pattern of bundling and unbundling for their competitive advantage, eg Microsoft which bundled its applications programs from the early 1990s into the Office Suite, and Apple with its iPod and iTunes bundling.

A newish context today is the demand for continuous process improvement as a requirement sought from software contracts. This is illustrated for example by the Capability Maturity Model Integration (CMMI), a process improvement approach (right) for software developed by Carnegie Mellon University Software Engineering Institute. This type of thinking has implications for outsourcing contracts, e-business contracts and enterprise-level contracts.

By the late 1970s custom and commissioned software started to decline significantly. The new pattern was increased use of turnkey solution contracts and software products contracts. The most significant change was the increasing release of packaged programs and its impact on standardisation within IT.

1970s - Today: Rise and rise of licence agreements

From the late 1970s licence agreements (a type of contract) became more common. This was the era of the VisiCalc spreadsheet, the first to be described as a "killer app" (ie killer application). It was followed by dozens of imitators, including Supercalc, Lotus 1-2-3, dBase II, WordPerfect and Excel.

In terms of contract clauses, the licensing agreements used for these programs generally mimicked model contracts and financial terms in older information and entertainment industries, particular book and music publishing and record and film distribution.

As was the case in those industries, in the software industry developers received royalties (as opposed to upfront or installment payments) on product unit sale prices and product upgrades. For equivalent deals in book publishing and music recording the jargon was (again) royalties, recommended retail prices, and new editions or re-issues.

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Illustrating the new royalty approach, in 1979, in its first year in Seattle, Microsoft had sales of US$2.5 million, almost entirely from the BASIC translator software product and almost entirely in the form of product sale royalties. BASIC was a licensed software product.

Licences worked well for standardised products. Programs when launched displayed a licence notice or licence provisions and sometimes required an action to accept the licence before the program could be accessed. The computer software business flourished. For the concept of licensing a key copyright law change helped shaped developments worldwide and for decades after. In 1964 the United States Copyright Office began to provide for the registration of computer programs. In time a computer program came to be internationally treated as a "literary work" under copyright law. It is the same category as applies for novels and non-fiction writing.(1)

The computer software industry began to add copyright strings to its contract bow. Just as in the last decade or so it has been adding patent strings as well.

In the 1980s and into the mid-1990s, printed software licences popped out of shrink-wrap packages or boxes, hence they became known as shrink-wrap licences. They combined two widely recognised legal concepts - licensing a copyright work and entering into a contract. The solution was novel, especially since no negotiation took place or was intended to happen before the contract became legally binding.

In part benefiting from the combined copyright and contract model, by the late 1980s the future looked bright for Wang, Computer Associates, Fujitsu, Novel, NEC, and DEC.(2) However, in an industry where change is endemic, few survived against competition. The same was the case for the application program companies - Lotus, WordPerfect and Ashton-Tate.

The cause for technological and commercial changes is outside the scope of this article, we'll remain focused on changes relevant to IT contracts and their underlying business models and financial terms.

1990 - Today: Contract types proliferate it_lara_croft

In the 1990s licences continued to proliferate, and not just for software. Content licensing contracts arrived with multimedia on CD-ROMs (beginning in the second half of the 1980s), later optical discs such as DVDs, and software publishing generally. Computer games contracts now mimicked film and television, eg with licensing of virtual stars (Mario Bros, Sonic the Hedgehog, Lara Croft etc).

In the second half of the 1990s click-wrap licences emerged, ie online licence contracts which you had to click to accept before being given access to software, a database or other online content. A few US court decisions accepted shrink-wrap licences and this was followed by general acceptance of click-wrap licences.

A background legal problem remains that such licences in their nature are what American law neatly refers to as "contracts of adhesion". These are contracts adopted by an organisation as a standard and offered with no opportunity to negotiate terms and conditions. For example, contracts to lease office equipment, hire a car or buy a plane ticket are contracts of adhesion. In Australia only the law of Victoria currently has special treatment for such standard form contracts, and only then where consumers are involved. Given this ever-present legal problem care must be taken with contracts of adhesion such as click-wrap licences.

Significantly, and once again, changes to copyright law in the second half of the 1990s in the United States, subsequently introduced in numerous jurisdictions, for the first time gave a monopoly right to a copyright owner to "communicate the work to the public".(3) This was a legal fix for an imbroglio - the logic of copyright law verses the logic of digital media copying. The fix favoured copyright owners in the realm of digital media, especially online. This change to copyright law in Australia and elsewhere further strengthened and popularised the use of copyright licence contracts.

In the 1990s enterprise resource planning contracts, or ERP contracts, grew under the radar as the media raved about the "browser wars " between Microsoft Explorer and Netscape Navigator. In the main arena business snowballed for ERP vendors such as SAP, Baan, Oracle, and PeopleSoft. The contract provisions which required focus here included costs and procedure for software installation. For example, SAP's R/3, cost five to ten times as much to install as the software itself.(4)

By 2000, the ERP market worldwide was valued much higher than for two other big IT markets - "professional software services" or "packaged mass-market software".(5)

For governments and the private sector the increasing mission-critical status of information systems contributed to the move to greater use of IT outsourcing contracts. They are offered by companies such as Accenture, Capgemini and Electronic Data Systems (EDS). They dragged IT contracts deeper into organisational business functions, processes and systems. They also increased the level of data crossing international geographic and time zones.

Recommendation for contemporary challenges in IT contract drafting

A comparable leap in thinking continues as a challenge for drafters of e-business IT contracts (which include business-to-consumer and business-to-business arrangements) as they innovate to accommodate the proliferation of Internet-linked mobile devices and services.

Drafting a mobile phone contract involves keeping in mind the architecture of IT contracts which linked together provide the solution - a set of voice and data services. These may include contracts with network operators, platform providers, content and application developers, content aggregators and developers, and marketing and media agencies.

Also challenging today are arrangements involving open source contracts (eg with operating systems from Redhat Linux, the Sugar CRM customer relationship management system, the Apache web serving software or the Mozilla Firefox web browser). They use of copyright and contract law principles is novel. The same applies to Creative Commons contracts.it_contract_firefox-eula

The ubiquity of the Internet means that with online services contracts users and licensees are now also often treated as subscribers and account holderes. This is the case with services such as Skype, eBay and Facebook. It mimics utility and and telecommunications contracts.

Along with e-commerce, the last decade has seen escalation in:

  • website advertising contracts,
  • ad server contracts, and
  • affiliate or referral contracts.

All contain general terms of trade for online linked business processes, transaction processing and various enquiries across the data cloud that is the Internet. The consequence is that today's online services contracts can be as sophisticated in their provisions as many other types of IT contracts.

The lesson thread through IT history for contract drafting is that short-sighted contract drafters achieve shorter-term results. Depending on the situation, engaging a lawyer after business considerations have been fully settled may be a bad decision. It is usually best to engage an experienced IT lawyer earlier in the cycle.

This is the case whether a business is a start-up, a developing or mature business, or a business needing a turn-around strategy.

For strategic and longer-term results executives and lawyers must collaboratively bond, work together at the earliest stages in venture idea generation, and share visions of where the market is heading technologically, financially, in terms of business models and legally. This means lawyers should often be engaged at the idea generation or strategic planning stage.

The development team should together test visions of the future, adjust and improve the viability and effectiveness of proposals, build in fall-back positions, business models, and financial terms.

With collaboration the business development team can formulate positions responding to the three stage pattern of change relevant to their required IT contract to be drafted. As we've seen the pattern is constant while the details vary greatly.


Reference

Martin Campbell-Kelly, From Airline Reservations to Sonic the Hedgehog A History of the Software Industry (Cambridge, Massachusetts: The MIT Press, 2003). Campbell-Kelly is a historian at the University of Warwick. At page 22 he states: "This book is perhaps the first attempt at writing a full-length history of the software industry broader than the study of an individual firm."

Footnotes

(1) Section 10 of the Australian Copyright Act 1968 (Cth) states the definition: " 'Computer program' means a set of statements or instructions to be used either directly or indirectly in a computer in order to bring about a certain result."

(2) Campbell-Kelly, p174.

(3) See also the Australian Copyright Act 1968 (Cth) section 31(1)(a)(iv).

(4) Campbell-Kelly, p191.

(5) Detlev J. Hock et al, Secrets of Software Success: Management Insights from 100 Software Firms around the World (Boston: Harvard Business School Press, 2000), see graphic on p. 27.


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