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For a number of years there has been a push by the software vendors towards a “subscription” pricing model for software licensing as opposed to the historically dominant “perpetual” license. Subscription types range from limited term licenses paid on a rental basis with monthly or annual payments, to a utility or usage-based pricing model where payments are made based upon actual usage. There are powerful motivations for vendors to adopt subscription pricing models:

• More predictable revenue streams. Subscriptions produce more annuity type income as compared to perpetual licenses. While utility pricing might seem to have neither the benefits of perpetual licensing, i.e. large upfront payments, nor a guaranteed revenue stream, many usage-based contracts sill commit the buyer to use the software vendor’s offering for a period of time. Add to that the fact that switching costs are usually high for business software the enterprise does not switch on a whim. While revenue fluctuates more than with rental and other types of subscriptions, it is more predictable than perpetual license revenue, e.g. a poor economy might dry up sales but usage of business systems continues even if it is at a lower level.

• Higher revenue over time. With a limited term license for example, the enterprise will either have to renew to continue use, or, switch to another supplier. Switching incurs the risk of business process disruption and typically training and data base conversion costs. So, there is a high probability of renewal.

However, after a number of years of seeing increases in the number of software vendors offering subscription pricing models, there has been a decline of 8% in 2006 relative to 2005. In 2006, 32% of software vendors offered subscriptions falling from a high of 40% in 2005 and below the 2004 level of 33%. In 2005, vendors surveyed predicted that software subscriptions would be offered by 60% of their industry in just two years (by 2007). Now, they believe that in two years the level will be at 49% (in 2008).

Why the drop off? The Cistek Group offers the following reasons based upon client experience:

• Enterprises are pushing back. While they continue to want flexible pricing models from software vendors, and they like the lower upfront investment of subscription pricing, they have come to realize that they are paying more, even in present value terms, for software that they used to pay for once and use indefinitely.
• Software Vendors, particularly those that are publicly held, are being penalized for essentially deferring revenue. The increased predictability of subscription pricing comes at the loss of the large upfront payments. This is exacerbated if the vendor includes the deployment costs in the subscription rather than as a separate billable item. Some progressive financial analysts have taken the conversion cost of moving to subscription pricing into account but the stockholders tend to panic if they do not see revenue growth.
• Some subscriptions have not been priced properly, resulting in a poor return on the deal for the vendor. Turnkey vendors have large upfront costs which may not be accounted for in the pricing. Also, the time-value-of money has not always been taken into account. For example there have been cases where the vendor used the same pricing metric to calculate both the price of a perpetual license and the subscription price, e.g. price per transaction. If the vendor used the same price per transaction for the subscription as perpetual, then they are in effect financing the deal free for he buyer.

The drive for predictable revenue will lead to more software vendors offering subscription pricing. Enterprises will continue to evaluate these models based on both long and short term financial benefits. In the long term the issue isn’t perpetual vs. subscription but software vendors complying with enterprises demands for more flexibility and more pricing models from which to choose.