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The Coming Software Pricing Revolution

A revolution awaits in software pricing as services and composite apps change the game.

How enterprise software companies charge for their products is a great mystery, buried in concepts such as "value-based pricing," per-seat and per-CPU charges and revenue-based price increases. This status quo has been accepted, usually without question. But not for much longer.

The winds of change are a blowin', fueled by the aftermath of Oracle's hostile takeover of PeopleSoft, ironically enough. Oracle has been a market leader in pricing transparency, and it deserves a lot of credit for shining a light on a great deal of industry secrecy. Recent moves, however — aimed squarely at Oracle — by companies such as Conexus, TomorrowNow and TomorrowNow's new owner, SAP, have highlighted some essential problems in the world of software economics — problems that may end up being solved in ways no vendor, or customer, ever anticipated. These problems, coupled with the complexities that service-oriented architectures bring to software pricing, guarantee that a major pricing revolution is in the works.

Enterprise software economics are unique. Most successful vendors earn one-third of their revenue from license revenues, one-third from maintenance fees and one-third from services income. License revenue is, of course, the driver and leading indicator: If you can't sell new licenses, maintenance and services income will go down. The other big driver is existing customers: Most successful enterprise software companies get more than 60 percent of their revenues from their installed bases.

A quick look at revenue will tell you how a vendor is doing. Companies with most of their revenue coming from maintenance aren't very innovative or can't sell new licenses to their customers. Companies with most of their revenue coming from services aren't selling enough products to sustain growth. And companies that can't pull most of these revenues from their installed bases have high sales costs that make them uncompetitive in the market.

That's why TomorrowNow and Conexus are so disruptive: They're both betting that certain customers — TomorrowNow is going after PeopleSoft clients while Conexus is trying to grab J.D. Edwards clientele — won't want to buy new licenses, get new services or otherwise be part of the golden triangle of software revenues. Customers don't want upgrades with new bells and whistles that are supposed to make it worth paying 22 percent of the license cost every year in maintenance. They'd rather pay less (in some cases, 50 percent less) to keep their software running and in regulatory compliance — or so TomorrowNow and Conexus contend.

Because the installed base is the place to go for revenue growth, pulling existing customers out of the financial equation is tantamount to economic subversion. An alternative model based on minimizing these sacred maintenance revenues begs an important question: What else is up for grabs?

The whole notion of a software license — and with it maintenance and service — will be under attack as soon as service-oriented architectures and composite applications start dominating the market. Say you're a vendor that has just split CRM applications into dozens of individual Web services: What do you sell to the customer? One-off services? A collection of services tied to a unifying business process? Can you still sell a monolithic application called CRM? How do you charge? Is it a license, a subscription or a service? Do you price it by business process? Number of users? Business value? Can you charge maintenance on a service that isn't necessarily running inside the customers' firewall?

In the end, there are only questions, not answers. But if we look at how companies such as TomorrowNow and Conexus are doing business, it's obvious they'll take revenues away from the conventional software business model and subvert the dominant licensing paradigm. If the trend continues, and the changes that service-oriented architectures promise come to fruition, the current economic model driving the industry will disappear. Which begs the final question: Without the big three revenue sources — license, maintenance and services — will innovation as we know it disappear, too?

Joshua Greenbaum is a principal at Enterprise Applications Consulting. Write to him at josh@eaconsult.com.

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