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Having options is a good thing, but sometimes choice can be a bit daunting. Fifteen years ago, the perpetual license model was the only way that you could buy most business software. Subscription models started to become more prevalent in the software industry 10 years ago, and today almost every software package is available as either a subscription or perpetual purchase. The exception is public cloud software, or software as a service (SaaS), as this is almost always offered by subscription only.
On-premises software is traditionally associated with perpetual licenses, but software that is licensed via the perpetual model can be hosted by a cloud services provider, and a lot of on-premises software is priced via subscription. Often, a customer will make a deployment decision separate from a licensing decision. To maximize the utility of both models, most customers use a mix of on-premise and cloud software, and software vendors are responding with hybrid offerings that allow customers to choose the approach that makes sense today, with the ability to change course in the future if that is appropriate.
So, which is better—subscription or perpetual? It depends, of course. As a worldwide trend, total subscription revenue was much lower in 2011 than total license revenue — $48 billion versus $154 billion. However, subscription revenue in the software industry is growing at a much faster 5-year 2011-2016 growth rate than perpetual license revenue — 17.5% versus 4% respectively. And, because subscription and perpetual revenues are recognized differently on a financial statement, sizing them up can be an “apples to oranges” exercise.
Of course, the question of whether subscription or perpetual works better for you involves much more than a trend line. Each approach has its own strengths and weaknesses.
There are a few key characteristics of subscription that make it appealing to many customers. The upfront cost of a subscription purchase is typically lower than that of a license agreement. Also, subscription allows customers to purchase software from their operating, versus capital budgets. In addition, subscriptions typically renew annually, which encourages the software provider to demonstrate ongoing value and build a relationship with the customer.
The characteristics of subscription appeal to customers in companies of all sizes. While the lower up-front cost may appeal to customers in SMBs that can’t afford a perpetual license, the model also appeals to larger firms that would prefer to purchase their software in a different way. In addition, firms that sell their services or products via subscription may find the model appealing not only because of familiarity, but because it also allows them to match revenues and expenses. Applications that are well-suited for subscription include those that are updated on a frequent basis with enhancements that are meaningful to most customers.
Subscription is not always the customer’s preferred model. The perpetual license model is still relevant for many customers, and will continue to be so even as the popularity of subscription approaches increases. The main concern with subscription is the long term cost associated with it. I’ve looked at the spreadsheets behind subscription and perpetual pricing models for many years, and the break-even point is almost always somewhere between three to four years. At that point, subscription starts to cost more per unit of software than buying a comparable product via a perpetual license. (This analysis does not include the cost savings associated with SaaS or cloud deployment). At the same time, some customers have a preference for paying for software purchases from capital budgets, and others prefer to “own” the software license — a concept which is not an aspect of subscription.
Another concern of some companies is that by reducing capital spending, they risk losing a deferred tax benefit that some capital-intensive industries have historically used to offset taxable income. These tax benefits are linked to the depreciation schedules of capital equipment and can exist indefinitely as long as companies continue to spend their capital budgets. For capital-intense industries, a dramatic decrease in capital spending can result in cash flow problems as they can no longer claim related tax deferral benefits.
Furthermore, the perpetual license model itself is also being modernized in response to today’s ever-evolving IT landscape. As an example, Microsoft’s “License Mobility Through Software Assurance” was designed to make it easier and more cost-effective for customers to move their Microsoft applications to cloud service providers’ infrastructure-as-a-service (IaaS) environments.
Today’s software customers have a choice that would have been made for them a decade ago. In addition, there are benefits to both paths — subscription or perpetual. Understanding the differences — and leveraging the strengths of each approach to your advantage, is a winning strategy.