Traditional Software Licensing Comes To An End 

Cloud computing, on-demand solutions, subscription fees… software licensing is undergoing significant changes. Enforced by the current economic crises with tight IT budgets, companies don’t have the money to pay upfront licenses and are reluctant to take financial risks over many years when purchasing software. A key factor of the current growth of cloud computing is its financial benefits: no capital expenditures, no upfront financial risk, no depreciation and nothing on the balance sheet! But pay-by-use licensing models are not necessarily limited to cloud deployment models and can be applied to more traditional implementations as well.

Traditional software licensing with upfront payments has served vendors well over the last 40 years. However, over time vendors had to face significant disadvantages as well. The pressure to successfully close quarter by quarter and the fiscal year has led to a common practice by customers to push decisions until year end for a special deal. Discounts up to 80% became not uncommon in the software business. Another problem is the revenue volatility in difficult economic times. In 2009 many software companies had to face a decline in new license revenues of 10 to 25%. Without the constant stream of maintenance revenues many software companies would be facing severe financial problems today.

Because of these challenges, software companies introduced longer term subscription fees as an alternative to traditional licensing. Most such models like SAP’s global enterprise agreements for key customers, relief the client from the upfront payment, stretching the cost typically over three to five years. However, customers are still taking the overall risk and have very limited choices to cancel the deal before it expires. Real on-demand licensing models that meet the growing market changes however, require payments only while services are consumed and can be cancelled any time. The feasibility of such cancellation depending on disruptive consequences and reliable alternatives is a different story though.

In order to stay competitive, vendors need to offer flexible on-demand-like license models for all their offerings. The transition from upfront licensing to flexible pricing however needs to be managed carefully. AspenTech for example reported in December this year a YoY decline of 78% in Q1 FY2010 software revenues because of their first quarter with a new subscription based licensing.

The software market is going through a new cycle of innovation, on the technology as well as the commercial licensing and pricing side. Software vendors need to successfully manage both in order stay competitive for the opportunities in the coming decade.

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