Setting the Price of a Term Software License
As software-as-a-service (SaaS) based licensing becomes more popular, it’s essential that marketers know how to compare the value of different licensing models. In my previous post, we calculated as an example a perpetual license valued at $7,735. This post explains important considerations about a term license.
A term license is loaning the present value of the perpetual license to the customer for a period of time, such as three years; however, instead of making the payment at the end of the term, the customer makes the initial payment at the start of the first pay period. Microsoft Excel actually has a payment calculator that can figure this out; the PMT function calculates the payments on a loan for a period of time. In order to compare like to like, let’s use the present value of the perpetual license as the amount loaned. Using the PMT function and setting the parameters to interest to equal 10 percent, three periods, with a $7,335 principal and payment periods at the beginning of the term, the annual term license fee is $2,681 – or $8,044 over three years.
Sellers also need to calculate a risk premium that takes into account the fact that customers can cancel their license at the end of each year, so if you don’t charge them a little extra for the right to cancel, you’re giving away something of value. This should be related to the anticipated retention rate and retention cost. If you think the risk premium is 25 percent, the term license moves to an effective interest rate of 10 percent plus 25 percent, yielding an annual price of $3,204 – or $9,611 over three years. This could go even higher because the cost of gaining a new customer may be high, but on the other hand your competition might put pressure on your perception of risk – possibly necessitating adjustments. You might also reduce the risk by requiring a multi-year commitment when the license is sold.
This post, and my previous one, have hopefully given you some ideas about the factors that should be considered when comparing the prices of perpetual and term licenses. And, if you’re like me, a reason to pull that finance book off the shelf where it has just been gathering dust.