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