Businesses Turn To Software Subscriptions

Companies that buy business software are less likely to tolerate heavy up-front costs and feature-laden upgrades, and software vendors are offering more pay-as-you-go arrangements to try to accommodate them, according to a panel of IT executives and a Wall Street analyst speaking at InformationWeek's Fall 2004 Conference in Rancho Mirage, Calif.

IT departments will still buy perpetual licenses that offer lifetime ownership of software code for complex computer systems that they'll need for a long time. But they want less-burdensome contracts for many desktop apps or departmental systems, the panelists said. "We're not sitting on the edge of our seats at United Pipe waiting for the next release out of Redmond," said Michael Green, CIO at United Pipe & Supply, which sells pipes for irrigation systems and golf courses.

"The traditional enterprise-software business model is flawed and broken," said Jason Maynard, a software analyst at Merrill Lynch. Customers don't want to pay tens of millions of dollars up front and annual maintenance fees during the years it takes to get systems installed and working properly, nor house legions of consultants in their office space during that time. "You guys aren't buying that anymore," he said.

In many cases, there's more demand for subscription license agreements in which customers pay monthly or annual fees to use vendors' code. Merrill Lynch has developed an On-Demand Index that values software companies in part on the growth in deferred revenue that results when they move toward subscription licensing. If a vendor's subscription-license renewal rate drops, Maynard said, "we will punish them."

With IT spending down dramatically compared with just a few years ago, IT buyers said they have more clout. "We go into every software negotiation believing we have leverage," said Mike Conlon, an IT director at the University of Florida, which has signed large deals with PeopleSoft Inc. and Mercury Interactive Corp. Daniel Sheehan, CIO at direct mailer Advo Inc., said he was able to get a good deal with Oracle by signing it near the end of Oracle's fiscal year. Software vendors often rely on signing licensing deals that contain big up-front payments to meet investors' quarterly sales and profit expectations.

But Maynard said the days of "hit-and-run" software deals are numbered. And software companies in markets with competitors that have built their businesses around selling software for regular subscription payments are losing business, he said. Case in point: Siebel Systems Inc., which has lost market share to Salesforce.com Inc., which sells customer-relationship management as a service.

United Pipe is evaluating a new CRM system, and the project is an opportunity to evaluate software from Salesforce, CIO Green said. The company wants to "prove the concept before [we] have to spring for the big bucks," he said. "I'm going about this very cautiously." Subscription licensing can also make software projects more saleable to a company's board of directors, he said, since it has some of the same effects on cash flow as financing a purchase.

Another benefit of a subscription license is that it can make a company's buying decisions more uniform. At the University of Florida, some 5,000 buyers often make "contradictory" decisions among departments, Conlon said. For example, some desktop PCs can't be upgraded to the latest version of Microsoft software because a buyer hasn't purchased Microsoft's Software Assurance maintenance contract. Conlon said the university hopes subscription licensing can help solve that problem.