On-Premise Vendors Eye Subscription License Model

In the coming year, there will be a new focus on partnerships among SaaS vendors, and large ISVs will spin off on-demand versions of their products. Those are among the trends most likely to manifest, says analyst firm IDC in its new study, "Top 10 Predictions for 2006: Software as a Service."

The tenth prediction on the list -- that the SaaS model will help encourage a transition to subscription licensing -- has implications for the entire software industry, not just the growing SaaS portion.

For many buying organizations, SaaS and the subscription license model have come to be synonymous. In truth, the two are mutually exclusive, says IDC Software Pricing Program Director Amy Konary.

"You have some SaaS companies -- such as RightNow Technologies (Nasdaq: RNOW) -- that offer perpetual licenses for their on-demand products," she told CRM Buyer. "You also have some on-premise companies, such as SAS Institute, Computer Associates and BMC, that offer subscription licenses."

The Twain Meet

These firms are the exceptions, for the most part. Generally, if you want to buy a SaaS vendor's product, you have to buy it as a subscription. The majority of on-premise vendors, meanwhile, remain firmly wedded to their own license models.

Now, as SaaS becomes more and more popular, it appears as though the twain are finally going to meet.

Offering subscription licensing is one of many approaches that both SaaS and on-premise vendors are taking to increase penetration in markets where high upfront licensing costs prohibit adoption and increase deferred revenues, Konary said.

Subscription licenses will remain the minority of software license revenues for the next several years -- "but that growth will accelerate," she believes.

Pros and Cons

There are both advantages and drawbacks to a move to subscription licensing, Konary said. "Selling licenses via subscription increases the predictability of software revenue and makes it easier to demonstrate future health."

At the same time, "moving to subscription revenue can have a negative impact on revenue and, ultimately, share price," she pointed out. "Unless a software vendor already sells via a subscription license, doing so will involve a transition to recognizing software license revenue ratably, over time."

Ratable contracts create a backlog of revenue, she explained, as a new line item on the balance sheet appears under a ratable contract arrangement: deferred revenue.

"Although the financial community is slowly beginning to evaluate software companies more holistically," Konary noted, "right now, vendor rankings and EPS [earnings per share] calculations are based on recognized revenue in addition to bookings."

Although it would represent a significant change for any individual company, IDC does not expect a shift to the subscription model to have an immediate, major impact on the software industry. Not all vendors would make the switch at once, she said. Nor, for that matter, would all customers.