CRMBuyer: Catching the Next Wave in Software Licensing

Users are fed up with the way vendors sell them software. How upset are they? A recent survey by software management provider Macrovision found that only 28 percent of enterprises were satisfied with their vendor's pricing and licensing strategy.

That means the door is open to a number of alternative, emerging models, notably subscription and per-use schemes. Meanwhile, changes in where and how software runs -- including SaaS (Software as a Service), virtualization and multicore processors -- are accelerating the rate of change.

The Macrovision study gave a clear idea of the way users' licensing choices are going. About 7 percent fewer enterprises than the previous year said the expensive perpetual license was their preferred choice, whereas the same number opted for getting more of their software through monthly, yearly, or term subscriptions.

Users are fed up with the way vendors sell them software. How upset are they? A recent survey by software management provider Macrovision found that only 28 percent of enterprises were satisfied with their vendor's pricing and licensing strategy.

That means the door is open to a number of alternative, emerging models, notably subscription and per-use schemes. Meanwhile, changes in where and how software runs -- including SaaS (Software as a Service), virtualization and multicore processors -- are accelerating the rate of change.

Take SaaS, for example. Typically, SaaS has a per-seat, per-month scheme that averts the up-front costs incurred by conventional licensing. That low cost of entry -- reduced even further by the lack of hardware and installation costs -- is clearly a key reason why, according to a recent Aberdeen Group study, more than half of companies surveyed were either using SaaS or actively exploring its use.

Other areas, such as virtualization, have yet to arrive at a consistent licensing model. The main purpose of virtualization is to run multiple sessions -- and/or multiple operating systems -- on one machine to vastly increase server utilization. But most of that advantage could be blown if traditional per-machine or per-processor licensing were applied, which is why both vendors and users are struggling to find a sensible answer.

Adding to the complexity is that big customers are enjoying the fruits of new licensing models favorable to them before anyone else. Many vendors are dragging their feet in introducing such schemes to the wider world for fear of disrupting predictable licensing revenue streams, which themselves have been shaken by a tough enterprise software market.

"Software companies can't afford to change their licensing models too quickly for fear of them affecting revenues," says Alvin Park, research vice president at Gartner (NYSE: IT) Research. "They know they'll eventually have to go to utility pricing, but they don't want to cannibalize revenues from other models."

Change they must, however, if they want to retain their increasingly cranky customers.

Enterprises are under the gun to improve productivity as IT budgets shrink, and that means they need to cut costs or squeeze more out of their IT dollars. These emerging models, even with some details still to be worked out, offer an opportunity to do just that.

Pay as You Go

The Macrovision study gave a clear idea of the way users' licensing choices are going. About 7 percent fewer enterprises than the previous year said the expensive perpetual license was their preferred choice, whereas the same number opted for getting more of their software through monthly, yearly, or term subscriptions.

It also showed that vendors are listening. Some 40 percent of those surveyed said they were offering subscription models in 2005, up from 33 percent in 2004, and fully 60 percent expect to be doing so in 2007.

Mad Catz, a fast-growing international supplier of video game peripherals, went the SaaS route when it needed to roll out a new help desk system. After analyzing what such a project would have taken to do internally, it eventually decided to go with Service-now.com, a 3-year-old on-demand provider.

It wasn't easy, says Larry Herrmann, chief information officer of Mad Catz and a big believer in the benefits of the "people-process-technology" triangle that internal IT departments bring to companies. But the numbers just didn't add up.

The company has only a small IT department, he says, and experience from previous service desk implementations showed it could have taken the company as long as a year to get the system where it needed to be by itself. Herrmann says Mad Catz needed something that would work right out of the box.

The Service-now.com hookup was an education in other ways. "Licensing software this way brings out the difference when other organizations change their licenses, which they tend to do on a regular basis," Herrmann says. "We're going through that with Adobe (Nasdaq: ADBE) now. It shows us there is a simpler way to license software, because this [subscription] model obviously works."

The desire to solve a business problem, as Mad Catz did, is the reason many companies are now using SaaS, says Beth Enslow, Aberdeen's vice president of enterprise research. Cost is generally a secondary consideration, she says, but most who use the on-demand services would find they did save once they calculated the "fully loaded cost," which includes license maintenance and other IT costs related to software and infrastructure upkeep.

If a customer is diligent in tying down the details of the license from the start, then the price of the subscription should be their least concern.

"Our customers very quickly try to understand what's involved in the typical 36-month contract," says Fred Luddy, CEO of Service-now.com. "For example, they want to know that the price won't go from (US)$70 a month to something like $1,000 after the first term expires. And that's a legitimate concern, since they've built a business around our service." Service-now.com puts a guaranteed cap on any option year price rises into the initial contract, he says.

Moving to Multi-Core

Multi-core processors will certainly be as disruptive to software licensing as SaaS, although it will probably take longer to have an effect.

Dual-core processors are standard for new servers after chipmakers Intel (Nasdaq: INTC) and AMD (NYSE: AMD) started selling them last year. Both companies expect to introduce quad-core processors soon, Intel later this year and AMD in early 2007. Market researcher IDC expects enterprises' hardware infrastructure could be as much as 50 percent dual-core by 2008.

Vendor concerns are that these new processors will cut into their revenue because they can do substantially more with the software they run than single-core processors. User concerns are the opposite: that any new license schemes not based on per-processor pricing will turn out to be more expensive.

The first stab at designing licenses for this multi-core environment run the gamut from plain vanilla to bogglingly complex.

Companies such as BEA Systems (Nasdaq: BEAS) and Microsoft (Nasdaq: MSFT) , for example, have opted to keep pricing based on a single license per processor, at least for dual-core systems. A server with two processors each with two cores, for example, will still be charged only for two licenses.

Oracle (Nasdaq: ORCL) has gone to a scheme based on what it calls a "processor factor," which uses a multiplier based on the number of cores in a processor to determine how many licenses are needed. An eight-core processor has a factor of 0.25, which means it needs two software licenses per processor; a quad-core processor has a factor of 0.5; and so on. Oracle claims this will actually save users money because the previous per-processor licensing scheme resulted in a greater number of required licenses.

IBM's (NYSE: IBM) approach is among the most complex. Right now it prices its software on a per-core basis -- actually on half a license per core. Later this year, beginning with the introduction of Intel's new quad-core Xeon processor, it will start charging according to a measure called "PVUs" (Processor Value Units).

"Our customers have been looking for a way to do utility computing and for some kind of usage-based pricing," says Rich Lechner, vice president of IBM Virtualization solutions. "For that we need to have granularity in our pricing methodology."

That granularity comes through a complicated formula that attaches a number of PVUs to individual processors according to an evaluation of each new chip that IBM will apply as they are introduced. This evaluation will represent what IBM believes is the true processing power of each chip.

The lower the number of PVUs, the less customers will be charged for software that runs on that processor. Despite the apparent complexity of all of this, Lechner argues that customers will eventually find it provides a measure of the true value they get in their software licenses along with a new level of cost predictability.

Virtualization Dead Ahead

Amy Konary, program director of software licensing at market researcher IDC, thinks IBM and other vendors are using these first runs at multi-core licensing to also position themselves for virtualization -- and perhaps even to tie them together somehow.

"Vendors want to avoid doing things with virtualization that they will have to undo once multi-core comes into play," Konary says, although how or even if that will happen will take time to work out.

And virtualization will become an issue soon, as it moves out of the test and development phase and into production environments. Lechner says 54 percent of IBM's customers have told it that they plan to start applying virtualization this year.

Forrester Research believes new licensing models based around virtualization will be introduced by vendors -- and will be accepted by large enterprises -- by the end of 2008.

Tim Grieser, vice president of system management software at IDC, sees two approaches as the favorites for how virtualization licensing will eventually be decided: either a base license price based on some average of virtual machine images a user decides to employ, or a tiered, per-server hardware price that doesn't take virtualization into account.

Whichever way this goes, Grieser says, users are adamant they don't want to be charged more for virtualized vs. non-virtualized environments.

That's certainly the view of Nicholas Tang, director of operations at Community Connect, which builds community Web sites for ethnic audiences that post some of the biggest hit counts on the Web. He's using virtualization to build out a cost-effective infrastructure to handle the demands of the company's 22 million users.

"Software vendors are telling us we will have to pay a license for every single virtual machine, but if I am still using the same [physical] machine as before, why should I do that?" Tang asks. "Vendors are trying to take a free ride with virtualization, and they can't do that."

In the end, all virtualization does is give you a cleaner interface and a standard, segmented way to do what people have done before. "That's why we pay for the virtualization software," Tang says. "But I don't see why we should also pay more for other software."

Some software companies are trying to bridge the differences. Microsoft, for example, announced late last year a scheme that is based on licensing for virtual machines, but which it claims more closely matches the actual demand of its customers.

It uses what Microsoft calls a "running instance," where an instance refers to a virtual image, installation, and/or copy of the original software. Instead of users having to pay for a license for every stored instance of a software product, they can create and store an unlimited number of instances but only pay for those they use at any given time.

"Our customers tell us that what they want [with licensing] is predictability and no surprises," says Sunny Jensen Charlebois, senior product manager of worldwide licensing and pricing at Microsoft. "They also want an idea of how these emerging trends might affect their business. It's hard to find customers currently using virtualization, frankly, but we felt we had to come out with this now."

There should be areas for a reasonable compromise between what vendors and users are looking for, Community Connect's Tang says. He would pay more for the support and features that helped him get more out of his virtualized environment, for example, "but I can't see us paying for every virtual machine," he says.

"It will take a while to sort this out, maybe as long as a year or two, and I'm sure some people will end up paying for licenses that way," Tang says. "But they'll have to worry about someone like me, who won't."

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