Whether subscriptions or perpetual licenses, it’s still about user-based pricing
Imagine for a moment that you are at IBM and a small supplier of components from the Far East has just submitted an invoice. It just shipped an order of printed circuit boards to IBM’s networking equipment division in upstate New York. IBM receives it and a clerk in its invoice processing department enters the invoice into its ERP system. Whether IBM bought a client/server or software-as-a-service (SaaS) ERP system doesn’t matter. The clerk has to fill out and navigate as many as 20 screens to enter the invoice so the purchase to payment process can move to the next step.
But go back to the distinction between client/server and SaaS applications. Conventional wisdom says that SaaS applications such as SalesForce.com and their subscription licenses represent a threat to the perpetual licenses and the business models of traditional client-server companies such as Oracle or SAP. Stretching payments out over multiple years, as SaaS does, makes it harder to show the profitability and growth that comes from the upfront payments of perpetual licenses. The reality is somewhat different. As many know, SaaS actually takes in significantly more revenue over the product’s lifecycle. But the pricing models have much more in common than their differences. They both charge based on the number of users accessing the application.
With SOA there are a lot fewer users involved in the same business processes
Before comparing SaaS and client-server pricing, a few words on SOA, on which the next post will elaborate. Now go back to that scenario with IBM. With SOA, its small supplier’s ERP system electronically submits an invoice at the appropriate time to IBM’s ERP system without any intermediation by clerks or any other types of users in between. This isn’t a completely futuristic scenario. The next generation technology that all applications vendors are already rolling out, called service-oriented architecture (SOA) – especially when reinforced with Event Driven Archcitecture (EDA) and Business Process Management (BPM), which we’ll explain later – contain the possibility to collapse application pricing for both client/server and SaaS vendors.
- SOA is what SAP is in the process of rolling out as Enterprise Service Oriented Architecture (ESOA) as part of its Business Process Platform (BPP).
- It is what Oracle is delivering as part of its Fusion applications.
- SalesForce.com also introduced SalesForce.com SOA and has started to open up its business processes as services.
Here’s the big difference between SOA applications and the others: client/server and SaaS applications license access to each and every user who interacts with the system through a screen in order to execute a transaction. In the SOA model, however, most of the interaction is between business processes talking to each other programmatically. In fact, they often talk to other applications and even those from business partners. In other words, for a given set of business processes, there are far fewer users than in a client/server deployment or a SaaS one.
Why subscription-based SaaS really isn’t a threat to client/server perpetual licenses
SaaS pricing has more in common with client/server than differences. For traditional back-office enterprise suites, traditionally no more than 10-20% of the employee base needs to access the system. Assume the blended average selling price per user is $1,300, given a mix 1/3 professional and 2/3 casual users. With 18% annual maintenance, the first year’s recognized revenue comes to $1,500 and years 2-5 are $220 each. The NPV for the whole revenue stream is $2,000 assuming a 5 year product lifecycle. Since all the license revenue is collected and recognized upfront, a given amount of sales & marketing expense required to acquire the customer will be a smaller share of the upfront revenue. As a result, during the growth phase when new customer acquisition overshadows maintenance payments from existing customers, the vendor will appear more profitable. At maturity, however, when growth is slow or non-existent and customer acquisition costs are low, maintenance payments from existing customers will dominate the revenue mix and the business will look like a subscription pricing model for all intents and purposes.
With SaaS subscription pricing pushing revenue out to future years, the same sales & marketing expense to acquire a customer means current year profitability is lower during the growth phase. At maturity, the when the subscription payments from existing customers dominates and the SaaS vendor also has few customer acquisition expenses, it should be even more profitable than the client/server vendor because of the premium for hosting and managing the application. Let’s assume SalesForce.com takes in a blended average selling price of $75/user/month or $900/user/year based on a list price range of $65-$125. This price will likely be a good deal higher for a full suite provider. By way of comparison, CODA, a European provider of financial applications, plans on starting its price at $125/user/month for its SaaS-based financials. The lower-priced SalesForce.com will take in $1,800 upfront for a 2 year commitment (though they’ll only be able to recognize $900/year). Note that client/server vendors take in only $1,500 up front, though they can recognize all $1,300 of the license revenue immediately. Over the five year product lifecycle, SaaS vendors take in an NPV of $3,500, which compares favorably with the $2,000 client/server NPV because the SaaS vendor gets to charge a premium for managing and delivering the service.
SaaS isn’t the end of the story
Increasingly, applications are talking to each other as they form online services. User-based pricing doesn’t work in that world. That’s the subject of the next post.
(June 17 – edits to clean up and clarify a few things but no substantive changes)