Weighing Subscription Licensing Versus Perpetual Licensing

By Geoffrey James

According to the most recent IDC study, almost half of responding software vendors believe most worldwide software revenues will be subscription-based by 2010. Subscription licensing, however, can be a mixed blessing.

The software industry is embracing subscription licensing with the hope it will help software vendors manage their revenue streams. In the past, most software was sold with perpetual licenses – the customer buys the software outright and then pays an ongoing fee for support. The problem with perpetual licensing, however, is that it puts the software vendor at the mercy of two uncontrollable factors: the economy and product release schedules. Here’s why.

1. Economy. With perpetual licensing, when the economy is good customers buy more, but when it’s bad they buy less. Investors don’t like unpredictability, however, and are leery of poor sales quarters that are explained away as the result of a bad economy. By contrast, subscriptions offer predictable, year-after-year revenue, and therefore put vendors less at the mercy of economic cycles.

2. Product release schedules. With perpetual licensing there’s a period of slow sales while everyone waits for a new version to be released, followed by a sharp spike in sales when the product actually comes out. By contrast, subscription licensing results in an investor-friendly revenue stream because customers pay the same amount whether or not a new product is on the horizon.

Subscription licensing comes with a built-in downside – it makes it more difficult for a software vendor to take advantage of an improving economy or a new product release. To see how this can happen, consider the electronic design automation (EDA) software market.

EDA, which is software that helps electrical engineers design semiconductors, traditionally has seen a sharp increase in sales whenever semiconductor sales rise. The reason behind the upswing is simple. When semiconductor firms sell more chips, they upgrade their factories to get ready for new technology, which in turn creates demand for new EDA capabilities.

During the last semiconductor recovery, however, some EDA vendors were caught by surprise when the expected upswing didn’t materialize. For example, Synopsys recently was forced to reduce its 2005 forecast from $1.4 billion to $900 million, resulting in a shareholder lawsuit. Analysts attribute the missed forecast to the firm’s failure to understand a basic dynamic of subscription licensing: Customers aren’t going to spend extra money to purchase new technology when they’ve already been promised new technology under the terms of their subscription license.