The world is changing and we have to be ready to adapt to the change quickly. As software vendor you have to face the change as well. The traditionally way of selling software licenses on is using a Perpetual licensing model where the customer pays for;
- The Software usage license up-front
- An annual maintenance based % of the original license fee
The maintenance fee in the perpetual model is intended to cover the cost of bug fixes enhancements and occasionally version upgrades. This model has been a good model when you deliver the software by sending a CD or other media with the latest version of your software to your customer. An alternative model is the Subscription based licensing model. In this model the customer pays for;
- A monthly software usage fee
This monthly fee replaces the upfront and maintenance licensing fee. Subscription based model generally include updates, patches and new versions of the software when they occur.
Be aware, that a subscription-licensing model is not a new phenomenon. The providers of newspaper and magazine have used the subscription based payment system for years.
Reason for the changing software delivery model
There are a couple of obvious reasons that the software delivery model are changing and changing rapidly. One reason is the world economic situation. As companies need to adapt to rapid change in their customers ability to pay for their goods, they need alternative and more flexible settlement systems for their payment of the software usage and maintenance. Another reason is the change in delivery of software. As software delivery is changing to cloud delivery solutions and in particularly when Software-as-a-Service (SaaS) model, becomes more frequent, alternative licensing models are needed.
The advantage of a subscription based model
There are advantages both for the software vendor and for the user of the software by moving from a perpetual model to a subscription-based model.
The software vendor has the advantage of;
- Shorter sales cycles due to customers can take the expense as OpEx instead of a CApEx.
- There are expected to be increased recurring revenue, which gives the vendor a less cyclical revenue stream.
- Customers continue to pay for usage so software maintenance is not a discussion point with the customer – it is included.
- Longer-term contracts with the customers (more than 3 years) secure difficulties for competitors to enter the account.
- With a long-term relationship with your customer you have the ability to upsell more services and products to your customer and increase revenue.
The software customer has the advantage of;
- Software use has limited commitment and no CApEx investment, which makes the decision easier for the customer to take – you do not need the many approvals, as it is limited commitment.
- Licensing matches users as their requirements fluctuate.
- Eliminate of unused software “Shelf ware”.
- OpEx expense model conserves cash and matches expense periods.
Moving from a perpetual to a subscription based licensing model have some impact both on a short and long-term financial basis for the software vendor.
The impact for the software vendor is;
- Pricing
- Booking of revenue
Pricing
There are a couple of hurdles getting the right subscription price. Common ways to calculate the subscription price is by taking the perpetual license and maintenance price and divide it by 36 month on a per user basis to get a monthly user subscription fee. For software vendors who want to keep their customers for more than 3 years the subscription model will generate more revenue than a perpetual model.
Booking of revenue
With the perpetual license model you tie the revenue of the license to the quarter or month the actual license is sold and then you build the maintenance agreement on top. This model does not build monthly recurring revenue. The subscription license model on the other hand will secure monthly recurring revenue. But as a company you must be ready on a short term (the 1 year) to reduce the recognized revenue. In year 2 and forward you will increase revenue and monthly recurring revenue, and with this model often secure revenue- forecasting stability after the 1 year.
Summary
Looking at our fast changing world the software licenses must adapt to what is needed from our customers. Further the licenses structure must be tailored to the customer’s reality. A subscription based license model is the number one match as the model is;
- More flexible
- As customer you have to use OpEx expense model conserves cash and matches expense periods.
- Elimination of unused software
- Easier to order as the software has limited commitment
From a customer and a vendor perspective the subscription based license model is more attractable than a perpetual based license model. The subscription model is easy to understand for the customer as the price cover both maintenance and use of latest version of the software. The vendor get a better recurring business as the relationship with the customer is based on longer terms and makes it more difficult for competitors to take over your customer.