Software Sales: The Argument for Fixed Pricing (Ownership) or Monthly Subscription (Rental)

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This is a guest post by Nicole Laurier of Fisher Technology – the North American distributor of Business Process Management software for Sage ERP, Microsoft Dynamics, and SAP.
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Over the past few weeks, there has been a lot of debate on various discussion boards about what Sage Software’s plans will be when they announce their new pricing model and how it will affect their Value Added Resellers (VAR’s) and the Businesses that purchase their software.

Traditionally software has been purchased and implemented on-premise (i.e. at a customer’s place of work) where it is often maintained by an internal IT person, with a VAR offering additional support.  But with the advent of Software as a Service (SAAS), many businesses have been taking their traditional on-premise technology to the ‘cloud.’

The cloud is not a soft wooly place high in the sky – it’s where applications are run and managed on a server at a hosting company. Businesses using the ‘cloud’ don’t need to worry about internal IT staff since the hosting company typically maintains the IT infrastructure for them.  All the business needs is a fast and reliable internet connection.

These fundamental changes are forcing a shift in how software is being sold by all major vendors.  It’s not just Sage, but also Microsoft and SAP as well as many smaller software vendors.  In the past, software Vendors have sold a full license up front which, for the business owner, meant a large initial expenditure and an ongoing yearly maintenance fee (which many businesses chose NOT to continue renewing in subsequent years).

So how will these changes affect software sales, the customers, the VAR’s and the software vendor?

The Customers

From a customer perspective, a monthly subscription appears to be a good thing. And many businesses like this way of purchasing. First, they do not have to fund a large initial outlay for new software. They can just pay a monthly subscription for the applications they need. Plus, their monthly costs are predictable and they would always be on the latest edition of the software as the subscription usually includes upgrades.

However the downside is that over a 2 or 3 year period, the business could end up spending more money than if they had purchased the software outright. But many businesses are not worried about that aspect as they might buy a new system after a couple of years anyway as the original application may not suit their changing requirements.

The VAR

The main issue for the VAR channel with a cloud-based subscription model is their revenue stream. When they sell a software license, they earn a % from the software vendor. If the customers are paying a monthly subscription for the license rather than a one of large fee, VAR’s revenue from License sales will be drastically cut. And they would have to greatly increase the amount of customers they have on subscriptions in the short term to make up the revenue shortfall.

For smaller VAR’s who don’t have the resources to quickly increase their customer base, this could be a huge challenge. All VAR’s would need to change their business model to incorporate more service revenue or even perhaps align themselves to a niche so that they can differentiate themselves from the pack.

There is a big unknown and fear amongst the channel of how many VAR’s could survive these changes to a subscription-based pricing model. Not only could channels that have been built over many years be decimated, but all the wealth of experience from employees in these channels could be lost to the detriment of business customers and the software vendor themselves.

The Software Vendor

As is the case for the VAR, changing to a subscription only pricing model could have a huge economic impact for the Software Vendor. It can take at least 2- 3 years to get the same revenue from subscription-based licensing as they can from the traditional license model.

Additionally if it takes the vendor too long to make up revenues, it can cause serious cash flow issues for the company. Without their usual revenue stream, they would be unable to pay their staff and, in particular, their developers. Without good developers, their product and the product roadmap could seriously suffer.

They would also have to reduce the margins they offer to their VAR channels. Above, I mentioned some of the potential ramifications with that scenario. But for the vendor, they also risk losing their channel which they’ve have spent years building and cultivating.

An advantage for vendors, however, could be that they are dealing directly with their customer which offers better control of the sales cycle. In addition, they won’t have to share as much revenue with VAR’s. But with subscription only pricing, the vendor would need many more customers to keep their revenues at the same levels.  If the economy remains weak, this could pose some big challenges – especially if all the software vendors take the same route.

In Summary

I don’t have a crystal ball.  But I do believe that with our fast changing world, there will be a move towards subscription pricing. Any vendor that does not find a way to adopt this model could be as badly hurt as the short term loses they make in adapting to this pricing.

Perhaps the answer for customers, VARs, and software vendors would be to have some type of hybrid of both outright purchase and subscription options. In that way, businesses will have a choice of buying in the way they want. Software vendors won’t have revenues drastically cut and be able to retain their VARs.  And VAR’s will be able to offer the same level of skilled consultancy without being squeezed so hard they can’t survive.

Do you agree with my conclusions? Where do you think the future of Software pricing is going and do you think there will be winners and losers?

Comments

  1. says

    @Wayne, I agree with your comments that VAR’s will have to change their business models and be more service orientated. In fact I just posted another blog about that very topic: The March Towards Subscription Pricing Part 2 http://hub.am/ufqMdL.

    @Gary – there is definitely a way to go till these pricing model changes play out, and I think you are totally correct in saying ‘the subscription pricing model tends not to be all inclusive’.

    I also firmly believe that the customers will vote with their feet and if they don’t see value they will not buy or use services offered. That is not a new concept for business, its the way it has always been.

  2. says

    I think to a large extent most VARS have moved away from product based businesses to a service oriented offering. Those that haven’t will likely find themselves caught short. Especially vulnerable are VARS who have steadfastly remained on the old “our customers will pay us by the hour for our services” model.

    I believe for software companies there’s probably a financing market that can monetize many of these subscriptions. For example – a 12 month contract to use an ERP system can in turn be sold to a third party (at a discount) for a larger sum of money up front.

    However for VARS I see no other path except to pursue services — ESPECIALLy local services which are VERY VERY difficult for software publishers to compete against.

    The customer value chain will look like this:

    A Customers = Local customer where the VAR provides regular on-site services in a niche

    B Customers = Local customers where the VAR visits on-site semi-regularly for general services (non-niche)

    C Customers = Non-local customers where the VAR cannot visit but provides niche services

    D Customers = Non-local customers where the VAR cannot visit and provides only general services

    F Customers = Non-local customers who want to pay hourly in 10 minute increments at the lowest billing rate offered by the VAR. There are a surprising number of VARS who chase these customers tirelessly.

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