The rise of subscription software licensing

Recently, Apple announced a new subscription service whereby customers can pay a monthly recurring fee to get an annual phone (hardware) upgrade.

Similarly, all Autodesk software will only be available on a subscription basis beginning August 1, 2016. These announcements yet again signal that the dominance of perpetual licensing in the market place is on decline.

Indeed, according to new research from Flexera Software, today 26 percent of producers say that all of their revenues come from perpetual licenses. Within two years this will decrease by more than half to 14 percent. 61 percent say half or more of their revenues comes from perpetual licenses today. Within two years this will decrease to 54 percent.

There are several reasons for the shift away from perpetual licensing. Organizations increasingly want to align the cost of their investment in software assets with the benefit received -- and a perpetual license model does not make this easy. Perpetual software license require higher upfront costs -- before the software has proven its value to the organization.

As the subscription model gains prevalence, application developers and producers need a clear definition and comparison of software monetization models. They must also understand the business case for adopting or adding news models. Finally, they must realize the operational considerations and impacts. In fact, software producers can implement a variety of licensing models encapsulating different strategies for monetizing their software. There are hundreds of different types of software licensing models. Some examples include:

• Subscription Licensing: A subscription license enables buyers to rent their software over a contract period, rather than purchasing the license outright. Offerings, such as Salesforce.com, are examples of hosted or Software as a Service (SaaS)-based software to which one can subscribe. One can also purchase on-premises software using a subscription model. Subscription licenses also typically include the entitlement to new software releases and basic technical support over the period of the subscription.
• Usage-Based Licensing: Usage-based licenses enable organizations to "pay as you go" based upon some measure of consumption. That metric could be based on the number of accesses to the software, speed or disk capacity, or the amount of data transferred, to name a few. Like subscription models, usage based models allow enterprises to closely align cost to use.
• Capacity/Infrastructure: Software vendors frequently also charge for software based on the enterprise’s capacity or infrastructure. For instance, a license may be tied to the size of the server on which the software resides (i.e. the number of cores, processors or sockets) or the type of machine. This data is then converted to points, which have costs associated with them. This model helps make software more affordable to smaller companies, or those running smaller infrastructures -- with costs rising as an organization scales.

According to Flexera Software’s research, the subscription licensing model is rapidly on the rise. Today only 14 percent of producers say that half or more of their revenues comes from subscription (SaaS-based) licenses. Within two years this will increase by half, to 21 percent.

The Allure of Subscription Licensing

There are many benefits for producers who offer subscription licensing -- provided they can navigate the negatives. On the plus side, subscription software often delivers revenue growth and predictable and recurring revenue streams, which in turn results in stronger company valuations. Assuming the software delivers important value, customers will continue to subscribe to the solution in the long run, resulting in more predictable revenues lasting far into the future.

In addition, subscription models tend to require lower up-front costs which can be appealing to enterprises who prefer to tie software costs to actual usage and value over time, rather than paying the full cost immediately before the software has proven itself. Thus customers that might not have otherwise purchased a perpetual license, may spend money on a subscription. A more flexible, pay-over-time approach can appeal to enterprises with a big appetite for software but a limited budget for perpetual licenses. The subscription license model allows a wide and deeper penetration of your software for a given annual budget.

Furthermore, with lower up-front costs and the built-in ability of customers to discontinue the subscription once the term expires -- there is less risk for customers to acquire a piece of software. This can reduce pressure on producers to discount their software.

These benefits are available to any producer able to successfully manage the transition from a predominantly perpetual license business model, or, add subscription license models to the license portfolio. But managing this transition can be tricky. Incorporating subscriptions into the mix requires business process changes.

This can be a cumbersome and inefficient process if the software producer develops its own software licensing and entitlement management systems in house because there tends to be a lot of overhead in maintaining and modifying homegrown licensing systems. Implementing commercially available software monetization solutions would drastically ease the transition and enable flexibility and nimbleness for producers needing to implement any new licensing model -- subscription or otherwise.

Finally, producers have to think about their revenue models. Revenue is recognized over the term of the subscription license. Bookings are immediate and a revenue backlog builds over time. This means initial revenue certainty will be unclear early on until renewal rates and sales pipeline stabilizes after the transition to subscription licensing.

The shift from perpetual to subscription licensing is inevitable, a sign of the evolving preferences of enterprise customers. Adding a subscription software licensing model can offer producers tremendous value in terms of new revenue and market expansion opportunities – as long as producers are able to manage the transition from a software monetization perspective.

Cris Wendt, principal consultant at Flexera Software.

Published under license from ITProPortal.com, a Net Communities Ltd Publication. All rights reserved.

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