Let's say you're in the market for a new car. You find the model you think is right, but, as soon as you sit down with the salesman to hammer out a deal, he tells you he can't quote you a specific figure because the price is based on a complicated formula that includes various factors such as the size or your garage and the number of passengers and amount of cargo the vehicle will carry per month. Also, he informs you, you'll be expected to pay an annual "maintenance" fee equal to 20% of the purchase price to cover new features that you may or may not use.
Would you:
A) Say, "That sounds reasonable," and get out your checkbook.
B) Ask to speak to the manager.
C) Laugh in his face and head for a different dealership.
It's safe to say that most consumers would jump on option C rather than submit to a complicated pricing scheme that leaves them exposed to ongoing and unpredictable costs. Most consumer goods companies understand this and do everything possible to make it easier for customers to buy their products.
Unfortunately, the same cannot be said for providers of enterprise software products. Historically, vendors of ERP, MRP, supply chain, and other enterprise software applications have subjected manufacturing customers to complex licensing and purchasing schemes that have made it difficult for customers to predict and control exactly how much a software product would cost.
As a result, frustrated technology managers and users have struggled to interpret software licensing terms and conditions and to explain them to enterprise and line-of-business executives who are increasingly making the final calls on enterprise software purchases.
"Lots of times, companies need to hire somebody like me just to understand pricing and licensing terms," says Joe Gulino, ERP practice director at consulting firm Green Beacon Solutions LLC, which focuses mainly on deployment of Microsoft AX applications at manufacturing companies. "Until recently," he says, "licensing was a complicated matrix based on the number of users, modules, and resources a company needed. It drove customers crazy."
But there's good news for technology users and managers. Spurred on by a number of factors -- not the least of which is the rapid rise of software-as-a-service (SaaS) deployment and licensing models -- many vendors are overcoming their fear of leaving money on the table and are beginning to plan and roll out new licensing schemes, such as subscription and per-user pricing, that promise to take much of the unnecessary cost, complexity, and confusion out of buying enterprise software.
It can't come soon enough for many manufacturers. "The way software companies price their products today leads to too many cost surprises," says Chris Hirt, until recently CEO of Swoboda Inc., the U.S. subsidiary of the German maker of electrical assemblies for automobile and other manufacturers. "And the complexity makes it very difficult to explain the value of software to senior managers," adds Hirt, who in February replaced the company's manufacturing software -- Fourth Shift from SoftBrands Inc., which had been purchased on a traditional perpetual license basis -- with applications from Plexus Systems Inc. that are delivered as on-demand services and purchased on a per-user, per-month basis.
"I strongly believe this is the wave of the future, especially for smaller companies," Hirt says.
According to SoftBrands officials, Swoboda's decision to switch from Fourth Shift to an on-demand offering does not represent a widespread trend. "We don't see any exodus yet," says Dick Schultz, SoftBrands' vice president of product management. "A lot of customers still aren't comfortable with the loss of control involved in the on-demand model."
But it is a growing trend, Schultz concedes. He says SoftBrands expects to see a slowly growing interest in on-demand, subscription-based ERP offerings. "It's something that's growing and that we're watching," he says. Although SoftBrands does offer hosting services to Fourth Shift customers, moving to an on-demand, subscription-based version would require rearchitecting of the product, Schultz says.
Even large, traditional vendors of enterprise software are beginning to catch on. Recently, SAP AG quietly assembled a team to comprehensively examine how the ERP market leader could both rationalize and simplify software pricing and licensing models. While the exercise was prompted by SAP's plan to offer on-demand versions of its products -- beginning with CRM -- the review isn't limited to the company's SaaS offerings, says Pascal Brosset, head of SAP's market strategies and leader of the team.
"For some reason, people confuse deployment models and licensing models, and they assume that subscription pricing is just for a hosted model, and up-front licenses are for on-premise deployments," Brosset says. "But we are looking at decoupling those things."
Specifically, Brosset says, SAP plans to offer customers a matrix of different deployment and financing options on its software products. The range, he says, would include per-user, subscription-style pricing for software that is deployed on premise.
Complexity Rising
So how did enterprise software licensing models get so complex in the first place? In the early days of enterprise software -- the pre-Internet 1980s -- applications such as enterprise resource planning were evaluated and selected mainly by technologists in IT organizations and often deployed on mainframe computers. As a result, enterprise licensing models were technology-driven and linked to mainframe purchasing conventions. Customers were expected to pay up front for enterprise applications by buying what is known as a perpetual license. (Customers could also spread payments out by purchasing a term license.) Often, the price of a given piece of enterprise software was determined by how it was deployed. More or larger processors used to run the application meant a higher price tag.
Over time, enterprise applications became more complicated, adding modules for functions such as supply chain management and CRM as well as industry-specific modules. That added to licensing complexity as customers were often forced to pick from a long list of options. On top of that, some vendors added more pricing parameters such as site licenses, user-based licenses, and concurrent licensing options. The result was rising complexity, with customers often expected to predict up front how much of a given module they would need over time and pay in advance. Many ended up with unused licenses.
To make matters worse, many enterprise software vendors in recent years have been slowly raising the fees they charge for software maintenance. These fees, which cover most product upgrades, bug fixes, and other support, now range from an annual cost of 18% of the initial license charge for supply chain management applications to 23% for sourcing and procurement applications, according to a study last year by AMR Research.
In the midst of this rising tide of cost and complexity, SaaS -- which generally includes maintenance costs as part of a monthly fee -- has begun to look more and more attractive to some manufacturing companies. A recent study by research firm IDC predicted that spending on SaaS products will grow by 21% annually between now and 2009.
The simplicity of hosted SaaS deployments is certainly one big reason for the rise in popularity of the model. Manufacturers opting for SaaS can deploy enterprise applications without the delays and expense involved in setting up and operating data centers.
But equally attractive, manufacturers say, is the simpler licensing model that comes with most SaaS offerings. In most cases, SaaS customers pay a modest set-up fee plus a per-user, per-month charge. For example, NetSuite Inc., which offers an SaaS suite that includes financial, salesforce automation, light manufacturing, and other functions, charges a $500 set-up fee plus $99 per user, per month for its core set of applications. Maintenance charges are included. NetSuite also requires a one-year contract.
This type of subscription-based licensing simplicity has attracted the attention of many manufacturing organizations. Only 9% of organizations today say they take advantage of SaaS software with usage-based licensing, but 23% call it their preferred licensing model, according to a recent AMR Research survey. While few experts expect SaaS to represent much more than 25% of the enterprise software market over the next few years, the model's rising popularity is beginning to change the way manufacturers think about how best to buy and deploy software.
"What we're seeing is quite a lot of interest from buyers in the model, even though most don't have much experience with it," says Jim Shepherd, a senior vice president at AMR. "This has got major vendors such as Microsoft, SAP, and Oracle flirting with the model and thinking about how to reconcile traditional licensing models with on-demand models."
One manufacturer that is more than just interested in SaaS is Southwest Windpower Inc., a $100 million, Flagstaff, AZ, maker of wind-powered generators for residential use. The company earlier this year switched from Sage Software Inc.'s Accpac on-premise financial and inventory management system to NetSuite's SaaS product rather than go through a major Accpac upgrade. While the opportunity to downsize the company's data center was a big selling point in moving to an SaaS product, so was the simpler licensing model, says Susan Casebeer, Southwest Windpower's CFO.
The per-user, subscription-based SaaS licensing option, Casebeer says, allowed the company to gain more visibility and certainty around software pricing. "As we add employees, we can just add more seats at a fixed, per-user price. No surprises," reports Casebeer, who says she signed a three-year contract with NetSuite in order to lock in pricing. Sage officials declined to comment on Southwest Windpower's switch from AccPac.
The per-user, subscription-based pricing also made it easier for Southwest Windpower executives to understand and approve the investment in the NetSuite applications, Casebeer says. Rather than making the case for the NetSuite deployment as a large, up-front capital investment, she says, the company was able to fund the deployment as a regular operating expense. That opened up more capital for priorities such as research and development, she notes.
"In the future, we will continue to acquire software in this manner," says Casebeer, whose company still licenses applications such as computer-aided design in the traditional perpetual license fashion. "It has changed our decision-making process."
But it's not just SaaS that is forcing enterprise software vendors to consider new, simpler licensing models. One trend that favors simpler, subscription-based licensing, experts say, is manufacturers' increasing willingness to deploy standard, off-the-shelf application configurations rather than engaging in long, expensive customization efforts.
"Our industry is finally reaching a level of maturity where people no longer believe that ERP needs to be customized to death," says SAP's Brosset. "Customers are seeing it can be implemented more simply, and that opens the door for buying things in different ways."
Specifically, he says, if customization is no longer a high priority, there's less reason to acquire software under a perpetual license and more reason to consider subscribing to it either as a service or as part of an outsourced business process. As a result, in addition to beginning to offer selected CRM functionality under an SaaS model -- complete with per-user, subscription-based pricing -- SAP is beginning to roll out what it calls business process outsourcing offerings that bundle hosted applications with outsourced business process expertise that customers can pay for on a subscription basis. Currently, SAP offers payroll BPO services with partner Automatic Data Processing Inc. (ADP). Next, Brosset says, SAP will roll out an e-procurement BPO offering.
Seeds of Change
Also pushing vendors toward simpler, subscription-style licensing models are underlying changes in enterprise software architecture. Vendors across the board are replacing monolithic enterprise software architectures with foundations based on service-oriented architectures. As they do, experts say, it is no longer necessary for customers to buy a collection of modules up front in order to end up with an integrated suite. Instead, they can buy pieces of application functionality as services and deploy them as needed. This, says AMR's Shepherd, means that manufacturers increasingly will have the option of buying enterprise application functionality incrementally on a subscription basis.
Supply chain application vendor i2 Technologies Inc., an early advocate of service-oriented architectures, has begun offering subscription pricing to its larger customers under what the company calls its Supply Chain Leaders Program. Under the program, larger customers commit to using a wide range of i2 products over a long period in exchange for deferred, subscription-based pricing and a voice in product direction. Large i2 customers including Dell and Nokia have signed up for the program.
"As it becomes more popular for companies to hire companies like i2 to provide managed services, we're going to see more subscription-style licenses both for hosted and on-premise software," predicts John Cummings, i2's chief marketing officer.
Another trend pushing enterprise software vendors to move to simpler, customer-friendly licensing schemes is the entry of new market competitors. Microsoft, a vendor with extensive experience selling to consumers as well as businesses, has entered the enterprise applications market, bringing with it a low-cost mentality and simpler licensing terms.
Earlier this year, for example, the company revamped the complex perpetual licensing program for its Dynamics family of enterprise applications, replacing it with a program the company calls Business Ready Licensing. Rather than requiring customers to select from a long list of product modules and deployment options in order to determine pricing, Microsoft, under Business Ready Licensing, allows customers to select from three basic configuration levels of each of its enterprise suites. Each configuration is priced on a per-user basis for a perpetual license. So, for example, customers selecting the Business Essentials configuration of Microsoft's suites -- which includes basic financial, AR, AP, fixed assets, and supply chain functionality -- pay $2,250 per user. Customers opting for the Advanced Management Edition -- which adds features such as advanced analytics and project management -- pay $3,980 per user.
Microsoft also allows reseller partners to offer its CRM application as an on-demand, subscription-based product under its Solution Provider License Agreement (SPLA). And the company currently has a pilot program under way to extend that program to Microsoft's Dynamics AX ERP product.
"Microsoft is relatively new to the [enterprise applications] sector, but our business model has always been based on high-volume, mass market, channel-driven distribution and low cost of ownership," says James Utzschneider, general manager for marketing for the Dynamics product line. "We are simply taking a page from our playbook and applying it to the ERP business."
Partners say they expect Microsoft eventually to offer a subscription licensing option for its on-premise ERP products. And even competitors say they expect Microsoft's simplified enterprise software licensing model to force other vendors to respond.
"Microsoft seems to be on the right track, and they will influence licensing and pricing in this market," says Mike Frichol, vice president for product marketing at Infor and a former Microsoft executive. "Customers are looking for transparency."
Like SAP, Infor is currently conducting a major review of its licensing practices, Frichol says, with the intent of not only simplifying but also rationalizing licensing options across its wide range of recently acquired enterprise software product lines.
Blended Pricing
As options such as SaaS gradually make their way into the market, manufacturers are beginning to push vendors to find ways to make on-premise and SaaS offerings easily co-exist from a licensing point of view. Coatings, glass, and chemicals manufacturer PPG Industries, for example, currently licenses Ariba's spend management analytics software on a traditional perpetual license basis and is about to implement the company's procure-to-pay collection of procurement transaction management applications on an on-demand, subscription-licensed basis. Eventually, says Jim Polak, director of general purchasing at PPG, the company would like to have all of its Ariba applications running on the same on-demand platform and licensed under the same subscription model.
"If they were all on the same platform and same licensing model, it would make life easier for PPG and Ariba," Polak says.
In response, Ariba is beginning to offer what it calls blended pricing, which allows customers using both SaaS and on-premise Ariba products to license all of them on a subscription basis.
Supply chain visibility software vendor Kinaxis Inc. is taking a similar approach. Earlier this year, the company shifted its products from on premise to SaaS. As part of the transition to the new model, the company late last year began giving existing customers the option to shift traditional on-premise licenses to a subscription model. The offer has proven popular among Kinaxis's customers, particularly in North America, where 95% of the company's business is now subscription-based, according to marketing vice president Randy Littleson.
"ERP eats up so much of most companies' capital budgets that they have a hard time getting approval for another big, up-front license expense," Littleson says. "The subscription model makes it so much easier for them to get approval."
Despite the forces driving enterprise software vendors to move to simpler licensing models, don't expect the transition to subscription and user-based models to happen overnight. For one thing, not all manufacturers are or should be interested in trading in perpetual licenses for subscriptions. Companies expecting to substantially modify their enterprise applications and to run them for a long time -- five years or more -- may very well come out ahead by continuing to purchase their applications under traditional perpetual licenses, says Amy Konary, director of software pricing and licensing at IDC.
Most SaaS subscription licensing models today, Konary says, are calculated to deliver savings over a three-year period. After that, as monthly subscription fees continue to add up, subscription pricing begins to cost more than buying the software up front, Konary says.
"We don't see perpetual licenses going away," Konary says. "Subscriptions may reach 25% of all enterprise licenses."
On top of that, vendors -- particularly large, publicly owned enterprise software suppliers -- will find it very difficult to quickly make the transition to new licensing models such as subscription pricing. Most, analysts note, have built their business models around winning large deals that generate large amounts of revenue up front. Switching to a model such as subscription pricing, while it can create more stable, predictable revenue flows in the long term, would also certainly produce short-term revenue shortfalls for vendors and unhappiness among their investors. i2, for example, has blamed disappointing revenues in recent quarters in part on a transition in its business toward more incremental buying and more deferred revenues.
Officials at SAP, however, say they don't expect the transition to new licensing models to be particularly painful. "We expect that between 5 and 10% of our revenue will come from on demand in the next two to three years," says SAP's Brosset. "Right now indications are that many customers are interested in these models, but, when push comes to shove, they will buy in the classical fashion. We don't see the transition happening fast."
Whether the transition to new, simpler enterprise software licensing models comes fast or slow, there's little doubt that it's coming. And manufacturers should be the beneficiaries of what amounts to a long-overdue sea change.
"The balance of power has shifted from vendors to customers," says IDC's Konary. "The market has matured, and customers have become more savvy. And vendors are being forced to listen and change the way they do business."