Business & Technology Nexus

Dave Stephens on technology and business trends

Exploring Enterprise Software Pricing Models

with 4 comments

I’ve posted quite a few times on SaaS before. Some posts have been positive, while others have been more challenging.

But there’s one truth I think we can all agree on – that the pricing model of SaaS is fundamentally different and very challenging for traditional vendors to match.

Software license pricing is a very interesting area – as the business models themselves end up acting as a strong motivating force for very different styles of software development. But before we get into the psychology of pricing, let’s walk through the 3 basic approaches:

1. Bits-in-a-box Version-specific Perpetual License

Consumer software is sold this way, almost exclusively. Companies build a product, like Textmate 1.5 or Microsoft Word 2004 for the Mac, and sell you the right to use that software till the end of time. More and more, companies will use the internet to provide you minor updates for free, but these updates have more to do with controlling the firm’s support costs than anything else.

When a new version comes out you might receive a discounted price for an “upgrade” to the new version. But you may just cruise along on the old version if that proves good enough for your use. It’s up to the company to entice you to upgrade, presumably by building an impressive set of capabilities you determine you just can’t live without.

Support for consumer software products has been, for the most part, assumed. In the first place, if you are selling a product to hundreds of thousands of people for $20, you better not offer something that leads to them all wanting to call you to figure out some thorny technical problem. So, over time, people have gotten use to buying without the expectation of implicit support. And “bundled support” with the perpetual license, has become more and more paltry.

2. Introducing the Annual Support Contract

Software vendors have yet to offer the same quality and reliability in business software as they do for consumer software. And employees of the company buying the software, quick to protect their interests and standing, require significantly more assurances around a software buying decision. Enter the annual support contract. With it, software companies offer an array of telephone and web-based support, sometimes even including on-site presence.

At Oracle, this contract included a curious clause – as long as a customer stayed current on their support contract, both minor and major revisions of the software would be available “free of charge.”

In this way the customer pays for the current version via their perpetual license purchase, then for ongoing development with a portion of their annual support payment.

I assert that the Oracle model, while very fair to current customers, reduces the incentive to upsell its current customers on new versions of the software, and thereby decreases pressure to make more than incremental progress. Instead, it places an emphasis on new customer acquisition & on competent support thereafter.

3. Subscription – you know, like the Wall Street Journal

SaaS has been called “revolutionary” because it removes the burden of systems management from customers – instead relying on centralized, assumedly more expert resources to manage maintenance and updates efficiently. And we’re all used to SaaS – we use it via Google Maps, via Yahoo! Mail, and other B2C web services.

But in the enterprise space, SaaS tends to come along with something just as radical – the “end of the perpetual license.”

I’ve gotten in trouble in the past at describing SaaS as a “software rental service” – but the analogy holds here. But instead of thinking of software as “like a house” (which tends to appreciate over time), think of it instead as “like a car” (which tends to depreciate over time). So why not rent?

Knowing your software vendor’s preferred licensing model can give you insight into their likely future behavior. In the enterprise, there’s a definite shift away from a high up-front fee for an enterprise license fee, especially for big businesses concerned with the high degree of shelfware (software bought but rarely used i.e. sitting on the shelf).

The last point here, predictably, is that while SaaS made it popular, subscription licensing can work for on-premise software too. And for many businesses, subscriptions may just be a better way to go.

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Written by Dave Stephens

12/13/06 2:32 PM at 2:32 pm

Posted in IT, Procurement

4 Responses

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  1. Hi Dave,

    Nice breakdown. However, I either don’t fully understand or don’t agree with the assessment of SaaS as a depreciating asset. My opinion would be the opposite, as I feel that you run a larger risk of having dormant software with a perpetual license (that only has the carrot of upgrades) than with a shorter term SaaS license. Our software has had major upgrades every year since 2002 and the functionality is easily 5x-10x greater now than it was for some of our first wave of clients. Even though their cost has not changed, the software does much more (ie, appreciating).

    SaaS vendors are required to do this for survival and you can see the success of it with the extremely high percentage of contract extensions throughout the eSourcing industry.

    I guess your results all depends what neighborhood you live in. ;)

    David Bush

    12/18/06 5:49 AM at 5:49 am

  2. Ya, I could have written that piece better, because the point was more positive towards SaaS and the subscription model than you’ve deduced.

    The issue is if you pay $1MM upfront for some enterprise software, independent of support & without the right to automatically get upgrades, there’s no doubt the value of that software declines over time.

    Going with a subscription model, on-premise or on-demand, changes that. It treats the software as an expense (just like rent). Which makes a lot of sense compared to the prior case. Whether the intrinsic value of the software goes up or down over time is vendor-specific and up to debate.

    Good to hear from you David! Congratulations on your recent release – I’ll try to post on it before the end of time :)

    Dave Stephens

    12/18/06 3:03 PM at 3:03 pm

  3. As all of you agree, subscription model is the way to go for SaaS model especially with respect to entreprise solutions.

    Subscription model as such is very diverse. As debated over here, can be appreciate its value(by upgrading the software, without any down-time) or depreciate(Not upgradation happening).Even while depreciating, as SaaS employer can gain revenue by means of the quantity of users without shelling out a single penny(Provided the deployment model in SaaS is highly scalable). The argument hold true as all research publications estimate a major market share for SaaS in couple of year down the line.

    However, there are lot of other ways which we can make use of this subscription. It can be either through subscription based on transactions, based on the number of DDL statements, or even based on the number of users.

    Vinod Oommen Ninan

    02/17/07 9:59 AM at 9:59 am

  4. Could i call you about advice on how to price our enterprise software?

    Jay Kiley

    02/19/07 9:02 PM at 9:02 pm


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