Software Licensing:
Problems, Opportunities and a Winning Formula

One of the key concerns in the software industry is how to deal with the issues of "software licensing". Increasingly customers are putting more pressure on software development firms to provide them with software solutions in a manner that matches their use of the software. This pressure is intensifying as IS managers pay more attention to managing their software costs.

Software development firms see the issues from a different perspective. They are greatly concerned with unrealized revenue and excess costs in the form of software piracy, unauthorized use, excess discounts and lengthened sales cycles. And both sides see high administrative costs. These factors have led to a situation where many costly, adversarial relationships have developed between software firms and their customers.

The Problems

There is an increasing need for software development firms to be engaged in the questions of "How do we remove software licensing as an obstacle to sales?" and "How can we build long term, profitable business relationships with our customers?" These questions must be answered in the face of a rapidly changing technological environment.

The answer lies in context and a commitment to an ongoing licensing process as technology and business requirements change. Software developers must provide products and services to customers in a manner that fits their customers' business. They must recognize that their customers are not homogenous; that they may have different use patterns of the software and that they may have different business requirements. The consequences of not taking this approach is to be vulnerable to the "price/discount death spiral" and to jeopardize the potential future financial well-being of the firm.

To uncover the best solutions to the issues surrounding software licensing, we first have to look at the business transaction between the software provider and customers. There are two components of value for which a price is paid: value for function (technical problem solution) and value for product delivery (business problem solution).

Product delivery for software is made up of a number of components, pieces of which are often referred to as "software licensing." These components are:

• Physical delivery
• Pricing
• Metrics Discounts
• License periods
• Support and Maintenance
• License management
• Tech support
• Change in use level
• Bug fixes
• Platform Migrations
• Product enhancements

Metrics (e.g. per user, per node, per transaction) and license periods form the basis of value while pricing and discounts create the degree of value.

Software product delivery is analogous to a manufacturing process where a supplier can rewarded with price premiums for "just-in-time" delivery. If the delivery value is inferior or does not meet customer needs, the effect is to devalue the functional or technical value by giving higher discounts or creating expensive special deals.

The apparent driving force behind the changes in software metrics is and has been the pressure applied by customers on software providers to have costs correspond to actual use. However, on closer examination the driving force is more the opposite side of the same coin. Customers have been primarily reacting to paying for excess capacity. This is caused by a number of things, including situations where metrics and license periods do not match use, purchase for peak use leads to idle assets, and fear of contention for licenses leads to ever purchase.

An example of the changes caused by the pressure from customers has been the movement from node locked licenses to concurrent use licenses in the UNIX market. This change however did not satisfy the entire capacity issue. Many customers still have a concern with peak loading and are unwilling to pay for peak loads when their average use is much lower. This has lead some firms to offer monthly use licenses as an option to perpetual or annual use license periods.

In addition, some customers have begun to realize that when purchasing a floating license, they are actually purchasing 24 user hours. This again gives rise to capacity concerns. In some cases, customers want to float licenses across the world for 24 hours or pay less for the licenses they have for use in a specific location. Unfortunately, the business assumptions (often unarticulated) underlying software providers pricing decisions assume a 8-10 hour use day. In response, many are trying to prevent world wide 24 hour use, again creating an obstacle to sales.

The bottom line for customers is that, at some level of cost relative to problem importance the unwillingness to pay for excess capacity drives the purchase decision and decreases the software providers' leverage.

This, in turn, leads to problems on the provider side. When metrics and license periods do not approximate use, the sales cycle lengthens and becomes more costly, and excessive discounting occurs to get the deal. Special deals may also be created and these often result in high administrative costs.

Even if the metrics and license periods match use, without the software asset management tools to measure the use according to the metrics and periods, a great deal of unauthorized use may occur. This comes primarily from customers not knowing what they are using, rather than outright piracy. As an example, some software providers have sold their software based on the number of concurrent users without administrative tools. With neither customer or software provider knowing the actual use, costly, adversarial relationships can develop.

The piracy issue also needs to be addressed since it can be source of unrealized revenue. Before a decision regarding how best to manage the selected product metrics can be made, it is important to uncover the software provider's beliefs about piracy and unauthorized use across account category, geography and channel of distribution. It is important to articulate beliefs regarding each of the intersections to formulate appropriate business decisions. For example, many software providers believe that piracy in not a major concern within major accounts in the U.S., even though unauthorized use does occur. In this situation, benign license management may be much more effective than the hard core control and compliance required in the Third World to combat piracy.

The bottom line for software development firms is that at some level of revenue loss or excess costs, the unwillingness to suffer this loss drives the adoption of new delivery methods and appropriate license management.

The Opportunities

Software metrics and license periods that approximate use along with appropriate license management decisions can bring the business transaction equation back into equilibrium. When this happens the business transaction gets less costly and more profitable for both sides.

The metrics or basis of value decision is the starting off point for establishing value for product delivery. The initial step is to determine whether a software product should be considered as a "tool" or as an "asset" that should be managed according to a dynamic usage metric.

Software products that that fit the "tool" category are usually relatively low cost and/or the product's value is driven by the ability to solve potential problems at any time rather than actual use. Typical products that fit this category are word processors, spread sheets and even compilers. Typical metrics are either node based or named user (not floating) based. For these static metrics, the number of licenses required is relatively easy to determine for the salesperson and the customer. In most cases these metrics are much easier to administer than dynamic licenses.

As value increases, products are viewed more as assets. In order to manage these assets well, dynamic licensing metrics need to be chosen that closely approximate use or "work accomplished". These software products can be segmented into categories according to functional characteristics and usage characteristics; different licensing metrics may fit each of these segments.

Client-side software tends to be interactive intensive while server-side software tends to be more compute intensive. For interactive intensive applications the performance of the system running the application has relatively little effect on the use or amount of work accomplished over a specific period of time. For these applications, license metrics (e.g. concurrent users) should be independent of processor performance.

Conversely, for compute intensive applications that operate primarily on a server, processor performance significantly effects the amount of work accomplished over a specific period of time. For these applications processor performance must be taken into consideration when selecting metrics if revenue to the software developer is to correlate closely to work accomplished using the software. Some developers of this application category are selling their products on a user basis, but the cost per user varies with system performance.

Dynamic licenses can require a much greater level of administrative support and can be more difficult to sell. Without good usage data, neither the salesperson nor the customer may be able to determine the number of licenses required to support the users on a system at the initial sale. As a result, the sales cycle can become longer and more costly. To effectively sell products according to dynamic metrics generally requires a dedicated sales force that has a good understanding of customer usage patterns.

Because of the difficulty in selling dynamic licenses and the potential administrative burden, it is sometimes wise to consider static metrics that approximate the underlying use. One example of these static metrics is from the human resource market where the software is sold by number of employees. This metric approximates the underlying work accomplished regardless of where the software is running or how many users are accessing it at any time. The metric is easy to understand, sell and administer.

The key to metric selection is to choose metrics that approximate use where use is defined as work accomplished. Current literature emphasizes the benefits of user-based licensing, but the decision maker must be aware that users approximate use in only certain situations. For instance, user based license metrics may approximate use well for OLTP applications, but when the same product is used at night in batch mode the approximation no longer holds up.

Metrics, license periods and metric management decisions can all be made independent of pricing decisions. However, this is the critical point where the process of change to new software delivery methods often breaks down. The key element that is missing is customer usage data. Without viable usage data, it is difficult for the software provider to select a price for the new metrics. Without usage data, the CFO at the provider can, and often will, stop the process until the impact to the bottom line can be determined.

Often the customer also is not aware of usage patterns for specific products and as a result has a difficult time determining if the new model and the price is a good deal or a bad deal. This puts another roadblock in the path of a successful business transaction.

The customer is in control of the usage data, but may or may not have access to it. This again speaks to the need for software providers to develop strong long-term business relationships with their customers so that usage data can be shared. Without this sharing of usage data, the roadblocks and adversarial relationships will continue to block successful business partnerships.

Software license management systems, originally developed as tools to ensure control and compliance, now are transforming into software asset management systems. They can be used to collect usage data and ensure revenue integrity for the software provider. Prior to making any shifts in licensing methods, it makes sense to use software license management systems to gather usage data so sound business and financial decisions can be made later as the new metrics are introduced in the future.

The Winning Formula