Subscription license models are still a hot topic in the software industry, especially with their more widespread use with SaaS software. The subscription license model typically involves providing the combination of software licensing (or “right to use” the software) along with all electronic software delivery and updates during a period of time, typically on an annual basis.
Why Subscription Licensing Matters for Software Vendors
The benefit to the software publisher is the promise of a strong annuity-based revenue stream. This is because the revenue for a subscription license model is recognized on a company’s income statement over the period of the term. In the traditional perpetual license model, the revenue is typically recognized at the time of booking, leading to the proverbial revenue “hockey stick” at the end of the quarter when most deals are booked.
Most CFOs see the subscription software license model as a good way to manage revenue streams in a more predictable way, and create an overall higher revenue stream over the course of time when the subscription license is renewed. Typically, the cross-over point is in 4-5 years, at which time the subscription license model provides more total revenue.
Certainly, the apparent downside can be the initial revenue drop to the P&L if the company sells a subscription license instead of a perpetual license. For a perpetual license (say $100) and maintenance (say $20) that is sold at the end of the quarter, $100 is recognized immediately, the maintenance revenue is deferred over the course of the agreement.
When a subscription license is sold at the end of the quarter, $0 at that time if an annual subscription license is sold. The $35 – $40 for the subscription license fee (a typical number if the perpetual license were priced at $100) is then recognized over the next year. Hopefully, the customer continues to renew the license, and over time, a stronger revenue stream is built. However, if the sales rep is compensated on bookings or even revenue, then there is little incentive to sell the subscription license.
Additionally, the CFO doesn’t want to take the revenue “hit” as the revenue stream is converted to the more predictable subscription revenue stream. If the only option is to sell a single subscription license instead of a single perpetual license, then the benefit is marginal, and the sales rep may not be incentivized to sell the subscription. This can lead to low adoption.
However, the secret is to increase deal size with the subscription license, so that the initial bookings remain the same, even though the revenue recognition occurs over a time period. This creates the proper incentive for sales and helps to increase your market penetration.
Strategies to Drive Adoption and Increase Deal Size
The way to do this is to find situations where the demand for your software licenses is higher than the customer can afford in a single purchase. This allows the customer to acquire more software license rights in a single purchase, and satisfy the needs of more users. This tends to work quite well in many desktop application markets where teams of employees need to work on tasks, and when the tasks may change over time, requiring the purchase of new software.
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In these cases, you can equip more users with your software. This can also work well in some enterprise software markets, where you want to achieve rapid penetration across an entire organization, and the subscription license model makes this adoption easier. In these cases, the customer may buy more software over time for more users, because it’s more affordable for their budget.
Software licensing solutions may work well where customers generally prefer to purchase the perpetual license, but have an occasional need for periods of high workloads, and the subscription license can meet this need.
So, if your choice is only perpetual vs. subscription, the option may be to remain with the perpetual license, as your business is probably built for selling that way. But, the subscription license model works best when it helps you to capture more business and opportunities.
How have you made subscription software licensing models work for you?
Common Questions
What is a subscription license model?
It’s a licensing approach where customers pay for the right to use software over a set period, typically annually, and receive updates and support during that term. This model is common in SaaS and helps vendors build predictable revenue streams.
How does subscription licensing impact revenue recognition?
Unlike perpetual licenses, which recognize revenue upfront, subscription revenue is recognized over the term of the agreement. This creates steadier income but can cause an initial dip when transitioning from perpetual to subscription models.
Why do some companies struggle to adopt subscription models?
Sales teams may lack incentives if bookings appear smaller, and CFOs may resist short-term revenue drops. Without strategies to increase deal size or demonstrate long-term gains, adoption can remain low.
How can vendors make subscription models successful?
Focus on scenarios where customers need more licenses than they can afford upfront. Subscription pricing enables broader adoption, faster market penetration, and long-term revenue growth when paired with the right sales incentives.
