Why On-Premises Business Software Vendors Should Give Their Products Away

Traditional on-premises business software vendors are facing challenges on multiple fronts:

  • Published financial results for the second calendar quarter of 2009 from 10 of the major vendors reported license revenue declines in the 20-40% range year-over-year.
  • Buyers continue to show increasing interest and preference for Software as a Service (SaaS) business software.  SaaS business software vendors reported an average of over 20% increase in new subscription revenue for the same year-over-year period.
  • On-premises vendors now derive 50% or more of their revenues from annual maintenance fees, but are facing increasing dissension from customers over increasing costs and perceived lack of value for the annual maintenance fees.
Licenses are the lifeblood of on-premises business software vendors – it’s what drives current revenues from services and long-term revenues from maintenance.  These vendors must sell more licenses by acquiring new customers and/or selling more products and/or user seats to existing customers.  While most on-premise vendors have announced plans for delivering SaaS solutions and some have already delivered some SaaS applications, their on-premises licensed products are still the core of their businesses and SaaS may not be the preferred delivery for many customers.

Some vendors are responding to the challenge by offering ‘buy one get another free’ type of deals to increase the number of licenses and users for which customers will require implementation services and pay annual maintenance fees.  IMO, this is a flawed marketing tactic as discussed in last week’s bog post.

On-premises business software vendors have to get more licenses to feed their continued existence as viable businesses.  A review of their business models reveals some interesting points:
  1. Based on results for the 12 months through second calendar quarter of 2009, License revenues now account for approximately 20-25% of total revenues.
  2. These vendors spend approximately 20-22% of total revenues on sales and marketing, of which over 90% is usually targeted at license sales.
  3. Taking cost of goods and other expenses into account, license sales are at best a break-even proposition.
  4. On-premises vendors are known to deeply discount product licenses to get a sale.  Discounts of 75% or more off list are more common than most are willing to admit.
  5. These vendors now derive 50% or more of their total revenues from annual maintenance fees with 80% or higher gross margins on this revenue source.
  6. Services account for approximately 25% of revenues with gross margins typically in the 25-30% range.
  7. License sales currently contribute little or nothing to profitability, but are the lifeblood that drives maintenance and services revenues and profitability.
Given all the abovementioned circumstances and other factors, why not give the product licenses away?  The end game is to get more customers and users using more products for which they pay implementation services and annual maintenance fees.  The business of selling licenses is tough and hardly profitable.  Why not change the game and focus on creating value for customers rather than selling them licenses.

A proactive move by on-premises business software vendors to give their product licenses away can produce several positive results:
  • Bolster current services revenues and longer term maintenance revenues.
  • Compete more effectively with SaaS vendors.  Negate a big selling point of SaaS vendors because there would be no initial license cost for on-premises products.
  • Change the relationship with customers from selling them stuff to creating value for their businesses.
  • Get rid of the licensing fee and discounting practices that customers view as a farce.
  • Realign a leaner sales organization focused on creating lifetime customer value.
  • Change the way customers view the annual maintenance fee to be more like an annual license fee that includes support, enhancements and maintenance.
I would go as far to argue that if these vendors don’t do this proactively now, they will have to do it reactively later anyway to survive.  They can do it on their terms now and make this a win-win situation for them and their customers.

Depending on your role from a vendor or customer perspective, what do you think about this situation and the recommendation?  Your comments are always welcome.
Copyright © 2009 The Marketing Mélange and Ingistics LLC. http://marketing.infocat.com

3 comments:

Melissa Paulik said...

Mike,

You suggest an interesting pricing strategy. Thinking about it, I asked myself what anchors the traditional on-premise software developers to their current model?

The financial reports you mentioned could be one piece of it. Traditionally, these companies have been judged on the ratio of license to services and maintenance. Too little license revenue could spell trouble. Of course, that may just be a matter of retraining the market.

Then, of course, there are those companies that sell products through a reseller channel. Some of them make their living (not usually the successful ones) off of license revenue. The vendors need these feet on the street to help them sell product, but I think you could tackle this issue by changing the way these VARs are paid. SaaS vendors are already trying to tackle this so I’d take a close look at how they are handling channel sales compensation.

Very interesting challenge to wrestle with, isn’t it?

All the best!

Melissa

Steve Christensen said...

Mike,

Great discussion. Certainly from an economics perspective I agree with your premise. I think if you look at the cost structure of these same companies you will find while they spend 20 - 22% on marketing, most of that is in headcount. They would dismantle the revenue supporting part of their business (the sales teams work as hard as anyone) and they still wouldn't deliver the value that you call for in your creating value for customers link. Their revenue on services pales in comparison to the revenue earned by the Systems Integrators of the world. The ecosystem is incestuous and the customer is left wanting. So free or not, the software's value fails to deliver 93% (CIO.com) of the time. Customers only think they get 68% of what they paid for on an enterprise project.

20 years ago, when the core architecture of these systems was built, the problem was caste. The market need they responded to was the need to consolidate operational control. Primarily from a financial perspective and some from a manufacturing/scheduling perspective. A lot of their customers had non-integrated applications that were adjacent to each other causing redundant data and duplicate effort. Complex, large scale applications that consolidated control was the seeming answer. For the last 10 years we have seen the impact these systems have had; good for the software companies and services companies, bad for the customer.

So, yes, free would be better. But it still leaves the value question on the table.

Steve

Mike Frichol said...

I received this comment via email from someone who wishes to remain anonymous:
I read with interest your blog today since I think the idea of giving the licenses away for free has tremendous merit, but I do have a fundamental question. Don’t all your arguments from the previous week (when offering CRM for free with ERP) also apply if you offer all the software for free? For example, “The vendor is debasing the product they’re giving away by openly declaring that it has no license value”.

My response:
Good observation and question. The difference IMO is that selling one product and giving another product away, debases the value of the product being given away – it’s a declarative position that a vendor is attaching zero value to a product in comparison to others. However, if all products have no initial license cost, it reflects a completely different business model of how value is delivered to customers and revenue is generated. Therefore, all products are delivered on the same basis in a new delivery/pricing model and none are debased relative to others.