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Software Licensing

Customers have more leverage than ever. Even so, caveat emptor.

With customers eager to strike better deals, IT firms have responded with a spate of new licensing options. But analysts say that can sometimes resemble a shell game. “When you look at the details, less has changed in the licensing market than people might believe,” says Scott Lundstrom, CTO at AMR Research.

The software community in particular has been loath to surrender the classic model: firms pay a substantial license fee up front and then fork over an annual maintenance payment. That approach allows them to recognize revenue early in the client relationship, while maintenance revenue has helped ease the pain of declining new-license sales.

But tough times necessitate invention, and customers have more leverage today. In September, Sun Microsystems announced a new license program in which customers pay $100 per employee per year for a combination of products; one Sun executive dubbed it the “Happy Meal” approach.

New approaches to licensing often hinge on the functionality of the software, so HR management software, for example, might be priced based on the total number of employees at a client company, while supply-chain software might peg its price tag to the cost of goods sold. That can sound sensible, but it also places a new burden on clients to parse through a new pricing scheme and see if it ultimately makes sense. “You’ll find a number of users question whether the metrics defined by the vendor represent the values the application delivers to them,” says Mary Welch, senior strategy consultant at Saugatuck Technology Inc., based in Westport, Connecticut. “You can no longer simply decide on the best technology and make the purchase. You must do a lot of investigation into the terms and conditions.”

Microsoft was among the first major software firms to tinker with its licensing formula, many would say to ill effect. More than two years ago, it announced a new scheme dubbed Licensing 6.0, which Microsoft claimed would save most companies money over the long term. But customers decided otherwise, and the company was forced to delay the program twice. As recently as last month, Microsoft was still seeing sluggish corporate acceptance of its long-term licensing program. “You’re merely prepaying your next upgrade and buying some liability protection from an audit because enterprise licensing becomes more difficult to violate,” says Lundstrom. Microsoft also touts its willingness to license the user versus the device, but Lundstrom says the marketplace went there a long time ago. Still, the company continues to refine and market its Software Assurance plan to corporate customers, providing in effect a microcosm of the current state of the industry, with vendors concerned about how to respond to sluggish sales and customers demanding better terms.

Some companies offer “free” software, especially those that sell multiproduct suites. But Lundstrom says sparing customers the initial cost means little, given the prevailing model of hefty maintenance payments. “I’m surprised at how the market in general has stonewalled users with its unwillingness to dramatically change the prevailing maintenance rates in the industry,” he says.

Various pay-as-you-go approaches have been touted for years and are to a large degree the defining characteristic of the application service provider market, which has found some traction. “Software as a service” has generally been synonymous with hosted services, which are essentially a form of outsourcing, but the concept may morph in 2004. Soon, for example, IBM Global Services will price its customized software around peak loads experienced by customers versus a flat fee for a deliverable. Customers still own and operate the software in the traditional sense but pay based on how many transactions flow through it.

Going forward, expect to see even more options. While many will be driven by the need to respond to slower growth, some will be motivated by the related need to stem software piracy. Selling software via an “E-license” is one way—it’s downloaded over the Internet with various copy protections attached.

Many corporate customers admit noncompliance is an issue, but say complex licensing rules and lack of standard agreements contribute to the problem. Research firm IDC says noncompliance costs software firms $19 billion annually. They’ll be looking to reduce that in ’04.

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