Rethink Your Software Licensing Monetization Strategy
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This whitepaper discusses how software companies can introduce subscription licensing models to generate recurring revenue streams. Some key points: - Perpetual licenses are still dominant but subscription models are growing as cloud/SaaS grows. Subscription licenses provide recurring revenue over time rather than an upfront lump sum. - Subscription models offer benefits like predictable recurring revenue, flexibility to meet different customer needs, and lower upfront costs that can open new markets. However, they require changes to business processes like pricing, product numbering, renewals, and revenue recognition. - When implementing a subscription model, companies should add it without replacing perpetual licenses. They also need to align compensation, pricing structures, and operations to support the subscription business
Rethink Your Software Licensing Monetization Strategy
- 1. WHITEPAPER Rethink Your Software Monetization Strategy: Subscription Licensing Models Enable Recurring Revenue and Customer Experience Advantages
- 2. Rethink Your Software Monetization Strategy 2 As cloud applications, based upon SaaS delivery models, continue to show significant growth, many application producers are taking a step back and asking: How can we achieve the desired business outcome of driving predictable recurring revenue streams given our mix of legacy and new cloud-based solution offerings? And an even bigger question: Is there a flexible software monetization model which can help us derive maximum business value from existing solutions and customers—while setting the stage for the next round of solution offerings? Perpetual licenses, the traditional software monetization model, continue to be a dominant model and have served the industry well. However, with the growth of SaaS and cloud, many producers are adding subscription licensing models into their existing go-to-market strategy to create predictable and recurring revenue streams. In fact, many industry analyst reports, as well as software licensing and pricing surveys, show that perpetual licensing revenue is on the decline and subscription licensing revenues are on the rise and will continue to increase as technology shifts to SaaS and the cloud. In some cases, entire software vertical markets such as Electronic Design Automation (EDA) standardized on the subscription license model in the early 2000s, after several years of limited releases to the low and high end of their markets. This white paper will offer insight on how application producers can introduce a subscription model into their software monetization strategy to maximize revenue generation and offer customers a compelling experience. Topics include: • Definition and comparison of software monetization models • The business case (and a myth) • Pros and cons • Operational considerations Rethink Your Software Monetization Strategy: Subscription Licensing Models Enable Recurring Revenue and Customer Experience Advantages Myth Debunked Do subscription licensing models cause revenue dips? No, a subscription license model is typically added to a portfolio of models to address new market needs, and doesn’t replace the perpetual revenue stream. Three important preparations: • Add, don’t flip to subscription license models • Align compensation with the desired outcome • Culturally prepare for a new revenue recognition process
- 3. Rethink Your Software Monetization Strategy 3 Definition and Comparison of Software Monetization Models Monetization models for software applications typically include the following, each one designed to meet a different customer need: • Perpetual: most common, pay once and unlimited use, revenue hits PL when the order is booked. Maintenance, which typically includes technical support and the right to software updates, is usually priced as a separate item. This is the classic license model behind most software. This model was largely based upon a paradigm of thinking of the software license as a physical good that is purchased once and used forever. But, if you conceptually think of software as a service (not to be confused with SaaS), you can become more creative in matching your “service” to the way it is purchased and consumed. As a result, some of the models below are becoming more popular. • Subscription: fast growing, highly flexible, and where revenue is recognized based on a regular schedule (monthly, quarterly or annually) to reflect the delivery of value over time (e.g. the stream of maintenance updates). The subscription license is usually based on an annual or bi-annual term such as 1, 2 or 3 years, and includes the right-to-use the software and support. If a subscription license is not renewed at the end of the term, then the customer loses the right to use the software and maintenance rights. • Rental (or Term): This is similar in concept to a subscription license in that the right to use is temporary. With these licenses, maintenance may or may not be included. These are typically designed for peak usage needs, such as a 1 month license. This allows for the delivery of a license to meet a short-term need (e.g. tax software during tax season), without discounting a subscription or perpetual license to meet the customer need. • Utility (pay-for-use, pay-for-burst, pay-for-overage): fees are based upon actual usage (i.e. water or utilities for a home, cell phone) and revenue is recognized periodically as consumed and paid. While this tends to be the least used of all of the models, it is gaining momentum in cloud and SaaS based applications. In fact, IDC predicts: “Usage-based software pricing models will be an option for 80% of applications by 2017.” While perpetual license models are still most common, many application producers have a hybrid mix of subscription, rental, usage and traditional license models to meet different market needs. Subscription Licensing Model Business Case Subscription software license models bring several benefits to software producers and intelligent device manufacturers, including revenue growth, predictable and recurring revenue streams, flexibility to meet customer needs and easier adaptability to pursue new markets or market segments where the large up-front cost of a perpetual license may not resonate with customers. Greater Monetization Opportunity At first glance, it might appear that a perpetual model offers a higher revenue stream because of more immediate revenue recognition. However, the long-term reality is different. After 3 to 5 years, the models hit a crossover point where subscription revenue exceeds perpetual results. It can be compared to the amortization of physical goods like computers. The pricing of a subscription license model is described in greater detail later in this white paper. Increased Flexibility to Meet Customer Needs and Pursue New Markets While revenue certainly plays a big role in a decision to add a subscription model, customer and market needs play an equally important role. Because of their flexibility, subscription models can be adapted to different customer and market needs. Examples include: • More flexible pay-over-time approach can appeal to large accounts with a big appetite for software but a limited budget for perpetual licenses. Large accounts may need a wide amount and variety of software to get their job done. The subscription license model allows a wide and deeper penetration of your software for a given annual budget. This may allow you to fortress your customers against “point tool” providers because your software is easier to buy. Figure 1: License Model Definitions Model Perpetual Subscription Rental (Term) Utility (Pay-per-use) Time Limit No 1, 2, 3 year 1 mo. - 3 yr Yes Maintenance Included in the License No (Separate Item) Yes No Yes Revenue Recognition Up Front Periodic Up Front Periodic Payment At Delivery Periodic At Delivery Periodic Arrears $250 $200 $150 $100 $50 Purchase Year 1 Year 2 Year 3 Year 4 Year 5 • Perpetual: $100 list price; $20 annual maintenance • Subscription: $40 annual fees Perpetual License Revenue Stream Subscription License Revenue Stream Subscription license priced to achieve 3-5 year “cross over” Figure 2: Subscription License Model Pricing
- 4. Rethink Your Software Monetization Strategy 4 • Lower cost of entry opens up opportunity with budget- sensitive or smaller accounts. Smaller customers (who may eventually grow into large customers) may find the cash-flow of a subscription model more affordable to their finances. • Subscriptions can be a preferred model for businesses driven by operating expenses, which is a popular option where the use of software may be expensed for the duration of a project, common with technical software. • Increased customer loyalty by offering license models more suited to the way that customers by and use software. Subscription models can be adapted for variable use patterns (engineering design automation firms that run experiments and testing at different phases throughout the project) and project-based spend. For solutions that change less (ERP or storage management) perpetual licenses still represent a good option. Summary of the Pros and Cons of the Subscription Licensing Model The revenue potential and new customer opportunities make subscription monetization models highly attractive. As a company considers adding the model, it’s important to weigh all the variables involved in offering a subscription model. By thinking through these variables, application producers can execute a plan that optimizes the benefits and minimizes challenges. Operational Considerations Adding a subscription model to your operations requires changing business processes. The following areas need to be assessed: How will you handle pricing? To set up a structure that will support different scenarios, key pricing issues and considerations should be reviewed. • If you already have a perpetual license model, the pricing for a subscription license should be such that there is a cut-over point in the 3-5 year timeframe. Before that cutover, the total fees for the perpetual license and maintenance are greater than the fees for the subscription license for the same period. If we refer back to Table 2, we can see that for a 4 year cutover, the price of a subscription license is about 40% the price of the associated perpetual license for the product. • Will there be consistent pricing across perpetual and subscription licenses across all products? For example, should the subscription version of a product be sold as a fixed percentage of the perpetual license (assuming one is already in the portfolio), or should there be adjustments based upon product usage patterns or other factors such as market position. • How will mid-term upgrades be handled? For example, in the table below if a customer has the Basic CAD package and is 6 months into an annual term, are your systems and processes capable of pricing the Upgrade Basic to Advanced product at $60K, to reflect the remaining portion of the license? And if so, will your reporting systems know the difference between a mid-term upgrade versus an upgrade that was simply discounted for some other reason (competitive pressure). High Medium Low Small Typical Large Revenue Deal Size Budget-sensitive Customers +Subscription Operating Expense Appeal Large Account Flexibility Perpetual Figure 3: Subscription License Model Business Opportunities Enterprise Customers Pros Cons Lower cost of entry Higher total cost of ownership (TCO) Wider solution access for a given spend Possible spend uncertainty for future needs Applied to operational expense budget Sales focused on engaged relationship vs. a new sale Remix or adjust based on usage needs Application Producers Pros Cons Predictable recurring revenue stream over time Business process changes, including ammendments or changes to the subscription agreement over its lifecycle Retain/gain customers since easier to do business Revenue deferral through recognition change Wider market appeal, more options Initial revenue certainty during the initial change, customers selections will be unlcear Less need to discount because offering can match customer needs
- 5. Rethink Your Software Monetization Strategy 5 • At some point, you will have to market-test your pricing assumptions and refine them to meet customer needs. A nice attribute of a subscription license is that you can periodically adjust the price to meet market conditions. What will the impact be on product numbering? It’s important to establish a part number structure to allow for your software with subscription licenses to be differentiated from those offered with a perpetual license for purposes of ordering, renewal and operational business processes. There are two different approaches that are typically used, depending upon the design of your Configure, Price and Quote (CPQ) systems and processes. These two typical approaches include: 1. The perpetual and subscription license model should be identified by a unique product code. This means if you were to add a subscription license model for all of your existing products, your product codes would double, leading potentially to “SKU proliferation”. Below is an example of this approach. This tends to be the most popular approach used by companies • Perpetual code: A123456P • Subscription code: A123456S 2. Use the same part numbers for identifying both license models, but add an “order time attribute” to the product code when ordering the product to identify a duration or begin and end-date of the subscription. This approach reduces SKU proliferation, but requires the use of a flexible configurator at the time of ordering and tracking of the part through the various systems requires retaining the order time attributes to distinguish between the two products for operational purposes (revenue recognition, sales tracking, etc.) • Perpetual code: A123-456 • Subscription code: A123-456 15April2015 14April2016 Other variants may exist based upon your systems and processes. Whatever the approach, plan ahead to determine what works best for your business systems and processes and determine if you need to make changes. When should the subscription period begin and end? This seemingly simple question has important implications to revenue/billing systems and the customer experience. If the subscription period begins when an order is processed in the software producers system, then a predictable billing cycle can begin. But, the customer may feel short-changed if they don’t activate their software for a few weeks. If the subscription period begins when the customer activates or downloads the software, then they get the benefit of the subscription for the entire period but the software producer has to have “internal system triggers” to know when the software has been activated or downloaded. In general, for direct sales, the period usually begins when the order for subscription software is processed. For subscription software sold and renewed through a channel, the subscription period usually begins at activation. What is involved in the renewal process? Establishing a reliable and accurate renewal process is critical to protecting and growing the recurring revenue stream. The renewal process can be complex and begins with identifying which customer licenses are about to expire and sending them notification in advance of a renewal. However, if a customer is using a lot of licenses, perhaps across multiple organizations or groups, you may want to look at their entire configuration and see if they prefer grouping renewals by location or internal organizations and re-aligning or “co-terming” different groups of licenses (see the next question for more considerations for a subscription co-term or co-termination). The renewal process can be a little more involved if there is a renewal event for a customer who purchased the subscription license from a channel partner. In this case, should the software producer initiate the renewal directly with the end-customer or should the channel partner initiate the renewal process? When a channel is used for selling subscription licenses, it’s typically advantageous for everyone if the software producer knows who the end-user is and initiates the subscription process, but uses the channel partner to present the renewal. Renewals can be structured as: • Event-driven—sent based on expiration date on one or more licenses • Evergreen—an automatic renewal with an option to opt-out There is also a very important consideration for this to work – accurate contact and renewal information must be captured and tracked. A detailed system of record may need to be in place that goes beyond what a typical CRM tracks. For example, a customer might want to renew licenses based upon various hardware where the software is used. This information might only be available from license activation and download systems. Product Annual Price Basic CAD $100,000 Advanced CAD $200,000 Upgrade Basic to Advanced $120,000
- 6. Rethink Your Software Monetization Strategy 6 How will co-termination work (alignment of all expiration and renewal dates for customer convenience)? It’s best to get ahead of this well-known challenge and define a specific approach for a new subscription licensing model. Customer convenience needs to be balanced with a fair and equitable solution that avoids manual processes. Example: • Customer buys a license on January 1, 2015 that expires January 1, 2016 • Customer buys another license on June 1, 2015 that will expire June 1, 2016 • Customer requests a single renewal event per year Options: • Price partial year maintenance for the second license when it is purchased (revenue decrease in current year) • Charge a full year for the second year license and adjust all expiration to a common date (operational overhead) • Or perhaps there are other options that follow company policy After you define the policy it should be documented like all other policies and consistently used with customers. How will revenue recognition change? A purchase of a perpetual license is accounted for as immediate revenue and bookings/revenue are done at the same time. With a subscription license, that changes. Revenue is recognized ratably over the term of the license by the financial billing system. Bookings are immediate and a revenue backlog builds over time. Your ERP and finance systems may need to be adjusted in two key ways: • The billing process may need adjustment to bill the customer at various intervals • Systems need to properly accrue revenue for the new model By planning for these changes in advance, revenue reports will remain accurate and it will help prepare key stakeholders for how revenue will change under a subscription model. What product changes need to be made? Software products often use license keys that define license rights – what can be accessed for use and how long that use is available. Products under a subscription licensing model need to recognize that the “right to use” in a license key may expire, which the product must identify in the license file and act accordingly if the end-user is trying to use the license beyond the expiration date. The product behavior that you want to occur needs to be designed for the subscription licensing model. The licensing code needs to know what to do if the rights identified by the license key has reached expiration, which can include: • Stop operating • Operate with limited functions • Continue to operate but with messages How the product behaves should be carefully considered. The customer must be made aware of an out-of-compliance situation, but you want to avoid disrupting the customer trying to perform work. This behavior should be defined by appropriate cross-functional team members, and codified in a standard way across all software in the portfolio. Do changes need to be made to license key generation? License keys with a begin date and expiration date, or a begin date and duration need to be generated. By using licensing technology, the license keys can be generated to adjust the subscription term to begin at the expiration of the previous license based upon the SKU or SKU + entitlement attribute. Another advantage of subscription licenses is that there is no need to create a “version” in the license key since clients are entitled to all updates. What key areas of the legal agreement should be reviewed? Legal agreements may need to be updated to recognize expiration events and the customer obligation should this occur. The agreement should clearly state that a customer has a limited right to use instead of a perpetual right to use the software. Does sales compensation need to be adjusted? Under a perpetual license model, sales compensation works through bookings, which usually aligns with revenue recognition. However, in a subscription license model, compensation is realized up front but revenue is realized over time. Timing of sales compensation will change since renewals occur over time. Because of this change, sales may be more attracted to perpetual licenses and encourage clients to select that option. So that the best option for the customer is presented, sales incentives need to be reviewed and updated to incent sales to present options in this way. It may mean a higher sales cost up front (percentage of revenue). In addition, some companies design their sales systems and processes to compensate sales on the initial bookings, and then use an internal renewals team to manage the renewals.
- 7. Rethink Your Software Monetization Strategy 7 What is the best approach to roll out to customers? For many companies, the most advantageous approach has been to position a subscription as a purchase choice of “lease or buy.” A more successful rollout will occur by finding customer opportunities where the value proposition naturally resonates. There’s no need to force a change and require a full-scale migration to a subscription model. In fact, this flexibility can be used as a competitive advantage. Preparation of customer-facing departments also plays an important role in the customer rollout. “Inside-out” training of sales, customer service, technical support and other key areas will ensure that your customers understand the benefits, options and the impact. It’s also important to proactively address a concern/myth that may emerge: offering a new model will cause customer shifts to the competition. It’s rare and here’s why. Customers invest deeply in enterprise solutions and often times integrate with other systems and establish key business processes and training. A subscription licensing model is normally considered a minor change in the overall scope of things and not worth switching to the competition. Over time and with increased acceptance, migrating exclusively to the subscription model can be considered (but don’t move too fast!). By building a solid plan addressing these questions and concerns, adding a subscription licensing model to your software monetization strategy will function smoothly and effectively in your organization. Rethink Your Software Monetization Strategy—It’s Time! If your company is asking “What’s the best software monetization strategy to drive predictable recurring revenue streams?” …a subscription licensing model offers powerful benefits. • Enterprise customers win with flexible options that meet their needs • Application producers win with a long-term revenue gain and new market opportunities As SaaS, cloud, and other technologies continue to explode, the time is now to rethink software monetization strategies and explore the recurring revenue and customer advantages afforded by a winning subscription software licensing model. How Can Flexera Software Help? With over 25 years of experience helping software vendors and intelligent device manufacturers adopt and implement business and revenue strategies for growing and transforming their businesses, Flexera Software is uniquely positioned to help guide and advise you in your adoption of new software licensing models. Our Global Consulting Services organization has helped many industries and hundreds of companies adopt new and innovative software monetization models (helping the EDA community transition to “EDA On Tap” usage and subscription models several years ago). Our experts can help you develop the right monetization strategy for your business, create best-in-class business processes and implement enabling technology to support your software monetization and revenue strategies. About Flexera Software Flexera Software helps application producers and enterprises increase application usage and the value they derive from their software. Our next-generation software licensing, compliance and installation solutions are essential to ensure continuous licensing compliance, optimized software investments and to future-proof businesses against the risks and costs of constantly changing technology. Over 80,000 customers turn to Flexera Software as a trusted and neutral source for the knowledge and expertise we have gained as the marketplace leader for over 25 years and for the automation and intelligence designed into our products. For more information, please go to: www.flexerasoftware.com
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