Trends in Delivery and Pricing Models for Enterprise Applications: Pricing Options

Introduction

The licensing and delivery of enterprise software products are making a fundamental shift from traditional up-front fees to incremental, per-transaction, and even success-based pricing. These are popular alternatives especially for small businesses and startups that lack the IT budgets of larger, more established companies. With these models, smaller companies can acquire software for a lower entry cost, paying more as business expands. At the same time, despite the many hiccups experienced by first generation application service providers (ASPs), vendors are also developing evermore creative hosted or managed "software as a service," and other delivery approaches in terms of on-demand availability, appropriate pricing models, etc.

Those who have long followed IT will likely see this as a sort of a "back to the future" phenomenon—a return to the old concept of computing service bureaus, which emerged in the late 1950s. At the time, computers were exorbitantly expensive and beyond the reach of all but the largest companies. To combat this problem, larger computer giants such as IBM, Burroughs, Univac, and Control Data Corporation began to set up service bureaus to sell time-shares for computer use. Today, given the decreasing and affordable prices of hardware, the major predicament is now with enterprise software applications, such as the pesky enterprise resource planning (ERP), product lifecycle management (PLM) or customer relationship management (CRM). While smaller companies may be able to afford the necessary hardware, these systems are often too expensive and intricate for small companies to govern. They cannot handle the IT staff and infrastructure required to support such major enterprise application.

Consequently, recent moves by the most prominent market players may be another sign of enterprise applications evolving into "software as a service" and related hosted/managed models. The market may be experiencing the beginning of the end of user-based licensing that is hosted on the customer's premises and constrained by a time period and product version. Namely, the majority of business application software vendors generate most of their revenue by selling software licenses based on the number of named or concurrent users or seats. Sometimes this is on a per module basis, but is often based on an unneeded "wall-to-wall", "all you can eat" functional scope. Other revenue generators include accompanying implementation and post-implementation service, support and maintenance priced as a percentage (and more often multiples) of these software license fees.

However this model may be wearing out its welcome on both the vendor and customer side. For one, it tends to be cyclical. Vendors first sell their present product versions into the market, and then sell subsequent upgrades. Logically, sales revenue should peak after each major upgrade, and then drop until the next one (on average of every 1218 months). This creates a cyclical, erratic revenue stream, which, in turn, has ramifications for business performance, such as cyclical, volatile stock prices for public vendors.

On the other hand, many user companies are unhappy with the rigidity of the model, especially in terms of the tiresome and endless upgrade process; maintenance fees that keep creeping up; and non-standard pricing that calls into question the deal they got particularly when paying for functionality that will not be used any time soon. It becomes analogous to buying a lifetime supply of already-brewed coffee all at once. It will only languish on the shelf and go rancid. Why not approach software applications la carte: get only what you want and minimize waste.

This is Part One in the Trends in Delivery and Pricing Models for Enterprise Applications series a four-part note.

Part Two will discuss utility computing.

Part Three will detail the effect of the transition on vendors.

Part Four will cover software as a service business model and make user recommendations.

Different Pricing Options

Since fewer than one in four enterprise application projects deliver workable solutions that last six years or more, clients are increasingly wary of committing huge sums of money before obtaining a measurable return on investment (ROI). Moreover, to level revenue streams, vendors have been looking for different business and pricing models for on-premise and hosted software. One emerging pricing model is based on whether the user is a power or a casual user. This stratified pricing model promises that users will pay only for what they use. A driving force behind this is the Internet, since it makes software accessible to a new realm of casual users who become like authorized visitors to a company's secure Web site, may they be remote employees or business partners.

Another pricing option variation is based on what users actually use and not what they can get—the so-called "pay-asyou-go" option. Typically, enterprise software comes with switches that can be set based on need. These switches are set at the "software factory" to limit the available functionality, as outlined by the contractual agreement. For example, users in a small or medium enterprise (SME) can have multicurrency, financial consolidation, or standard or actual costing switched on or off. If, at a later time, the company decides it needs a particular functionality, such as actual costing, to be switched on, it will have to pay for it to be enabled. Arguably, through this model, SMEs that use less functionality will need less support.

In addition to the stratification and pay-as-you-go models, some prominent companies are trying to alleviate the upgrades conundrum. For example, Microsoft is attempting a model where customers are guaranteed upgrades during the licensing period. Yet, while this model can stabilize a revenue stream, it does little to break the dreaded upgrade cycle, since an upgrade's protracted postponement can put it outside of a license period making it a chargeable item.

Ironically, the major benefit of this model to the customer is the free upgrades, but, since implementing upgrades incur other related costs, any upgrade must have enough added value to justify its implementation. Consequently, the new features may be of little or no value to some customers and they will elect not to upgrade even if it is free of charge. For more related information, see The Old ERP Dilemma—Should We Install The New Release?

The widespread use of personal computers (PC), the Internet, and the ensuing Web-based applications have especially impacted how business applications are sold and delivered. The development of Web-based applications has decoupled the user interface (UI) from the business application logic and its underlying software and hardware platforms. Now, for the cost of a mere Internet connection, any user working at a PC with a Web browser can basically access a variety of business applications that are run on different software or hardware platforms from any number of different locations. As a result, enterprise application vendors have begun to change their business models from traditional, on-premises software license sales to delivering software as a service.

Rise of the ASP Model, Again

To that end, applications hosting is a model where another company runs the software for a user company that may or may not own the software license. The hosting party may be the software vendor or a third party, often called an applications service provider (ASP). ASPs emerged on the Internet in the late 1990s in response to such enterprise applications woes as support expenses, huge licensing and hardware investments, endless software development and subsequent upgrade cycles, the need for quick regulatory compliance, misbehaving applications, and random server downtimes. By managing and distributing software-based services and solutions from a central data center over a wide area network (WAN), ASPs are a way for companies to outsource some or almost all aspects of their IT needs. For SMEs, the value proposition is that the in-house complexity of maintaining the application is passed onto the third party. ASPs may be commercial ventures that cater to customers, or even to not-for-profit or government organizations, providing service and support to end users. In fact, they could be classified as

1. Enterprise ASPs, which deliver high-end enterprise applications.
   
   
2. Local/regional ASPs, which supply a wide variety of application services for smaller businesses in a local area.
   
   
3. Specialist ASPs, which provide applications for a specific need, such as Web site services, e-mail and messaging management, or human resources (HR) management.
   
   
4. Vertical market ASPs, which provide support to a specific industry, such as healthcare or insurance.
   
   
5. Volume business ASPs, which supply general SMEs with prepackaged application services in high volumes.

Other Services Provider Models

Another relevant term is hosting services provider (HSP), which is an ASP dedicated to providing hosting services. It typically operates a Web server farm, either at a data center or co-location facility. A server farm is a group of networked servers that are housed in one location. This streamlines internal processes by distributing the workload between the individual components of the farm and expedites computing processes by harnessing the power of multiple servers. The farms rely on load-balancing software that can track the demand for processing power from different machines; and prioritize, schedule, and reschedule tasks based on the priority and demand users put on the network. In other words, when one server in the farm fails, another can step in as a backup.

Also, a managed service provider (MSP) is a company that manages IT services for other companies via the Web, whereas an MSP client may use internal operations or an ASP to run its business functions. In any case, the initial idea is that, assuming a user organization ports all application functionality to an ASP, the only real concern for internal IT individuals is to ensure a rich and stable connection to the Internet. ASPs use a "thin client" UI configuration, which means that any hosted application accessed by an end user, such as e-mail, applications monitoring, computer aided design (CAD), or word-processing application, is transmitted to the desktop through a series of streaming screenshots. Subsequently, it minimizes the need for excessive bandwidth and software installations on the client machine.

Due to the drawbacks of traditional on-premise perpetual licensing, some vendors are hosting enterprise applications that companies can access over the Internet. By paying a subscription price per user per month (or year), or per number of transactions within certain software categories, user companies dispense with buying software licenses. Such a model might be compelling because it has lower entry costs, and if the company is not realizing value from the software, it can always stop using—and stop paying for—it. Like on-premise licensing, software-as-a-service provides a steady stream of revenue for the vendor in the form of recurring monthly payments, but, unlike on-premise licensing, this model requires the vendor to assume the cost of hosting the application.

The Cost of "Leasing" the Service

The downside of "leasing" is the long-term cost for customers. After a period of time, the subscribed system will cost more than an "in-house" production system. Despite this, the software-as-a-service business model still offers several advantages to both the customer and the vendor that offset its eventual higher costs. By purchasing a software service (as opposed to purchasing a software license), the customer has little or no up-front acquisition costs, no hardware or software to buy, and no numerous support IT staff to hire and train. The cost of the acquisition is basically reduced to the cost of training employees on the application and converting or migrating existing data. Moreover, smaller companies have the opportunity to use virtually the same solutions as those of their bigger brethren.

Because of the lower acquisition costs, these software services are affordable to a broader range of prospective customers, thus vendors have a greater opportunity to sell their services. Also, because the vendor or ASP is hosting the application, customers see only one instance of the software; with the on-premise model, the software is distributed to the customer and is installed in a variety of environments, which are out of the control of the software provider. The alternative reduces the number of hardware and software platforms that the vendor needs to support, often to only one platform, and greatly reduces development costs. A single instance also means that the vendor can introduce software enhancements one at a time, breaking the dreaded major upgrade cycle and eliminating the associated costs. Further, this reduction may allow the vendor to charge more for a software service then for user-based licenses. All these cost savings should make up for the cost of hosting the application.

This concludes Part One of a four-part note.

Part Two will discuss utility computing.

Part Three will detail the effect of the transition on vendors.

Part Four will cover software as a service business model and make user recommendations.