Don’t be Afraid of Subscription License Models

Subscription license models still seem to cause a fair amount of anxiety among customers looking into the possibility of offering such a model for their traditional software. While there are some minor variances in the interpretation of a subscription license model, it is typically defined as an annual or multi-year software license that combines the right-to-use the software with the rights to obtain software updates and service. At the end of the term, all rights associated with the use of the software and the acquisition of updates ceases.

It’s interesting to see some of the same conversations occur repeatedly as more companies look to offer such a license model. There is typically a fear that their company is going to take a “revenue hit” if they move to a subscription license model. What they are referring to is the change in accounting process for company revenue associated with the subscription license model. Revenue associated with perpetual licenses is recognized on the P/L statement when the order for software is booked, whereas the revenue for a subscription license is recognized over the term of the license, typically 1, 2, or 3 years. However, companies do like the annuity revenue-stream associated with a subscription license, usually providing more overall revenue for the company in the long run.

I am usually posed the inevitable question – “why should we move to a subscription license model if we’re going to lose revenue or take a revenue hit”. Most are shocked when I tell them NOT to move to a subscription license model if it’s going to negatively impact the business.

However, I tell independent software vendors that the adoption of subscription license models typically occurs differently than they may think:

• Use the subscription license model as a way to generate new business, and not simply as a different way to license software differently for a potential long term benefit. Software vendors, who have used the subscription license model, did so as a way to grow their business. It’s often possible to penetrate customers who have a limited capacity to pay for the software license all at one time, or, where the customer wanted to pay for the software using an expense budget, and not a capital budget, as in the case where software was being expensed to a project. Also, subscription license models are a great way to penetrate large accounts and fortress against competitors where you can offer a wider breadth of your offering for a fixed annual budget. The subscription license model is a way to grow your footprint in accounts where finance and access issues tend to be the business drivers (as opposed to accounts where access to different products or product functions are the issue).
• Subscription license models are typically not introduced to market in a way to replace all perpetual licenses. Typically, they are introduced as a way to extend the product line and offer customers a choice. The “revenue dip” that is theoretically associated with converting all new sales from perpetual licenses to subscription licenses (with revenue recognized up-front) usually doesn’t occur. Subscription licenses are typically offered as alternative method to buy software license, and not the only method. A few years ago at SoftSummit, an annual conference for the software industry, I asked a variety of customers in a conference session what happened to their revenue when they offered subscription licenses. None of them saw the revenue dip, and furthermore, about 60% said their revenue grew. However, I tell companies who are selling product to market for the first time and don’t have legacy products that offering only subscription licenses (or time-based licenses) may be the best way to go!
• Subscription license models are a great way to “test the waters” for other time-based license models. Sometimes independent software vendors find that customers suggest that they might want license terms less than a year to accommodate seasonal or project “bursts”. This can lead to other time or usage-based licenses.
• Pricing subscription licenses, like pricing anything can be a complex process. But at its core is a simple 3-5 year payback analysis. Customers are typically willing to pay a yearly subscription fee that equates to a 3-5 year payback, often the lifecycle timeframe of most assets.

So, unlike Grandma in the Story of Little Red Riding Hood, there is no big bad wolf hiding in subscription license models. But, think first about how to better reach new markets and customers, and determine if the value propositions of the Subscription License model can be an answer.