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Software // Enterprise Applications
03:02 PM
John Foley
John Foley
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Power Shift

Users gain flexibility and influence with new software pricing models

It's a phenomenon Christopher Lochhead, Mercury Interactive's chief marketing officer, calls "lie until they buy," a stress-filled process familiar to many CIOs. The bare-knuckles approach has left such a bad taste that fewer than 30% of companies surveyed by IDC believe software-vendor licensing practices are fair. "We believe the traditional enterprise-software model is dying," Lochhead says. "The reason is simple--it doesn't work for customers, and, it turns out, it doesn't work for vendors either."

The concept of subscription licenses isn't entirely new. "The ideas have been stewing," says IDC's Mizoras Konary. What's different now is that the hype around ASPs--early proponents of the subscription model--has died down, while more traditional software companies are offering subscription licenses and, in many cases, hosted services that give customers the option of letting the vendor manage the software for them, also on a subscription basis. Subscription licenses represent a growing percentage of overall revenue, ranging from 25% to 45% of new software deals, depending on the companies and software categories involved, according to the Merrill Lynch report to be released this week.

Bella Pictures LLC, a startup that describes itself as the first national wedding-photography company, supports its business using nothing but subscription-type applications: accounting, human-resources, photo-processing, and Salesforce.com Inc.'s customer-relationship-management apps. "Subscription software is a great idea," president and co-founder Tom Kramer says. "We didn't even consider the do-it-yourself, in-house, client-server solution because we knew it would be out of our price range or underpowered for what we needed."

chartFour years ago, all of Mercury Interactive's money came in the old way, through perpetual licenses and associated maintenance fees. The company introduced subscription licenses in 2000 when it launched a hosted application service, and, since then, subscriptions have comprised a growing share of its revenue. Last quarter, subscription licenses accounted for 51% of Mercury Interactive's new product orders, marking the first time they surpassed perpetual-license fees. "It started off as kind of an interesting experiment," Lochhead says. "Customers adopted it." The company is scheduled to release first-quarter financial results this week.

Software buyers started experimenting with the subscription model during the economic slowdown of recent years, as their companies looked for ways to take on projects without multimillion-dollar capital outlays. They found it adds a new dimension to negotiation dynamics. "It gives [buyers] a carrot and a stick with the vendor in negotiation," says Maynard of Merrill Lynch. "They can better link performance to that negotiation process." Adds Southern's Trupiano: "Vendors really have to stay on top of their game because after two years you can decide not to subscribe again." The average length of one of Mercury Interactive's subscription contracts is two years.

The new types of license options come in many forms, ranging from Salesforce's hosted applications, available only via subscription, to Computer Associates' try-before-you-buy approach, in which customers are encouraged to sign subscription licenses the first time they use a product with the option of securing a long-term perpetual license later. Mercury Interactive offers its older products, such as its WinRunner testing software, under perpetual licenses, while subscription licenses are its preferred way of doing business for all new products. Closely related to subscription licenses are pay-as-you-use models, where costs rise or fall based on usage.

The University of Florida uses products from between 50 and 100 software companies, but its subscription license with Mercury Interactive is the first deal of its kind at the school. "I wish there were more," Conlon says.

Autodesk Inc. designed its fast-growing subscription model to add value for about the same cost as a version upgrade to the company's graphic-design software. For a $420-per-user annual fee, customers of Autodesk's flagship AutoCAD 2005 application get online support, electronic tutorials, and access to regular software updates. For nonsubscribers, the cost of an application upgrade alone is $495 per user. Upgrade once a year, and the subscription option is cheaper.

The definitions can get fuzzy. Some analysts consider Microsoft's Software Assurance program, under which regular product upgrades are offered at an annual premium, a subscription offering, but others put Software Assurance in the maintenance category. For vendors, the difference may be less than it seems because subscription revenue and maintenance revenue often end up in the same financial bucket--deferred revenue.

Merrill Lynch's On-Demand Index should help investors and others make better sense of the financial fine points. In addition to factoring in the license revenue reported on a company's income statement and changes in earnings per share (Maynard calls both "rear-view indicators"), the index tallies changes in a company's deferred revenue and cash flow and reflects how much business comes from software delivered in hosted or outsourced environments. "We're trying to capture the dynamic flow of revenue here," Maynard says.

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