How software application pricing models are likely to change

With every technology platform innovation there comes a change in the pricing model. The software market today is at the height of such change, which last occurred in the early 1990s with the advent of client/server technology. At that time, software pricing went from being tier (hardware)-based to user-based.

Unfortunately today’s changes are not so binary.

Over the next five years, buyers will need to consider myriad ways of acquiring software, including open source, licensed software, leased software, and hosted applications.

Each of these models uses different characteristics to define how they are licensed—e.g., processor, named user, bandwidth consumed, employees, order records, and others. Buyers must be extra diligent in learning the long- and short-term risks of each model.

The change in pricing models is facilitated by two trends: huge discounting on standard long-term license fees, and the ability of vendors to download software (or services) over the Web.

Over the past five years, vendors have become more than willing to drop standard software prices by 50 percent or more as they realize the most profitable portion of their business is long-term maintenance payments, with gross margins exceeding 90 percent in some instances. In fact, most software companies that sell via a licensing model garner less than 30 percent of their total revenue from license fees.

The ability to download software and services via the Web also creates a new dynamic in how software can be deployed, making it more analogous to the type of services delivered by utilities companies or cable systems providers than traditional software. Thus the move to a subscription model for pricing is a rapidly occurring trend in the enterprise software space.

Against this backdrop are the four ways software companies are pricing their products for the market.

Open source : While giving away your products seems counterintuitive, a number of companies are exploring just how profitable it might be if you use it to change the way you go to market. Rather than have a large direct sales force that “pushes” product out to market, these companies rely on Web-based marketing and word of mouth to “pull” companies to them.

While these vendors may charge a subscription or license fee for “premium” products, their financial model is based on selling long-term service and update support for the downloaded “free” products. This model is widely accepted for more technical software offerings such as operating systems (Linux) and Web servers (Apache). There is growing acceptance in application spaces with companies such as SugarCRM and ERP vendor Compiere .

Licensed software : This category represents the dominant way buyers have been buying software for decades. Many buyers continue to prefer this method because they can own the software and capitalize it as they would any other asset. With ownership comes the ability to support and change it (in many cases) nearly any way desired. Companies also like the ability to predict the cost of software over time since it is an asset they have paid for.

Perhaps one of the largest shortcomings with this method is what is considered by many to be the forced march of upgrade paths, which can be expensive for the buyer to follow, yet often mandated by sellers.

Leased software : Leasing involves software that often is deployed at the customer site, but leased for a period of time. It was initiated years ago during the era of mainframe technology, and lives on via a few vendors—including SAS Institute . Unlike licensed software, it is not capitalized and must be acquired as an expense. A few specialty companies use this scheme for pricing their products, but it represents the minority of all pricing methods, particularly with the advent of Software-as-a-Service, or SaaS.

SaaS : This is the latest pricing scheme designed to deliver a service via the Web, and price by subscription. Like leasing, there is a subscription charge that is expensed, yet unlike leasing, all upgrades and changes to the software are done online in a hosted environment without the buyer being the wiser. This pricing method is seen as the future of application deployment. Stamford, Conn.-based Gartner and other industry analysts believe more than 25 percent of all software licensing will occur using SaaS within the next five years.

While SaaS is seen as the latest “savior” to the challenges many buyers face when acquiring software, it too has issues that must be considered. To date, the ability to integrate an array of SaaS and on-premise applications is in its infancy, as is knowing how far SaaS should be taken within corporations.

All these factors will make software procurement much more challenging, as no single model will dominate all spending, but rather a hybrid model of purchasing software via open-source, licensed, leased, and SaaS methods will be needed.

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