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September 07, 2012

Capitalizing on the Challenges of Software Monetization

Despite a challenging economic climate, the software industry has continued to thrive largely because independent software vendors (ISVs) have been able to help their end users cut costs through flexibility in how the package and sell their software products.

IDC (News - Alert) expects software subscription revenue to grow at a 17.5 percent five-year compound annual growth rate (CAGR) to reach $108 billion by 2016, representing 24 percent of total software revenues by 2016.

Trends driving growth in the forecast include the adoption of software as a service (SaaS (News - Alert)) – or public cloud services – offerings, as well as the increased availability of subscription options, and the improved maturity of subscription offerings.

Actual subscription revenues in 2011 were slightly higher than forecast, exceeding expectations by $5.5 billion or 13 percent. This is the second year in a row that subscription revenues have exceeded growth expectations.

But today, many software providers are not fully monetizing their product and are potentially missing a big piece of the revenue pie without a successful software monetization strategy of which flexible packaging should be a critical element.

In a recent interview Amy Konary, Research Vice President of IDC’s Software Licensing and Provisioning program, explained that the software vendors who are doing the best job monetizing their applications are the ones who understand the importance of product packaging flexibility and transparency between the software vendor and the end-user.

Flexibility, as Konary explained, is the cornerstone of an effective software monetization, and Michelle Nerlinger, Director of Marketing for SafeNet (News - Alert) agrees. According to Nerlinger, “The software applications offered by many organizations today can and should be sold into a variety of diverse industries. The issue is that not each industry or market segment will use a product in exactly the same way, frequent the same features, and see the same value provided by the application. Which is why it is so important that a software vendor is able to leverage flexible packaging options – without re-engineering – to find the right price, the right feature set, and the right value for every market segment, every time.” Nerlinger believes that this will result in maximum market applicability and therefore maximum profitability for software vendors.

When asked about determining the value of software Konary responded very similarly “The way the software is valued is based on the kind of company using it and what they are using it for,” she told TMCnet.

Nerlinger went on to explain that flexible software packaging is about much more than which features are bundled together at which price point. Flexible packaging must also take into consideration how a software vendor intends to allow customers to consume their applications. Most businesses are given the option to buy via a subscription as well as the perpetual licensing option where they can pay up front and use it forever. As cloud-based services continue to rise in adoption, a subscription-based model is more appealing to many companies, as it allows them to compete with business models offered by their cloud-based competitors without having to introduce a cloud-based service themselves.

With cloud computing changing the landscape of software monetization, Konary also discussed the significance of global pricing strategies. Since cloud has risen in adoption, she said IDC has seen an accelerated trend toward subscription-based models.

“When it comes to cloud, the way you primarily pay for cloud computing, that’s going to be a subscription model,” Konary explained. “Another element that cloud is bringing to the table is that all-important transparency with pricing. It’s much easier to figure out what a cloud service might cost upfront as opposed to if I wanted to buy an SAP (News - Alert) [or similar type] application, especially if I am going to run it on-premise.”

Cloud has accelerated the demand for usage-tracking transparency from end users. As a result, software publishers must take into consideration how to track application usage at a granular level and then determine when and how to expose users to that data.

“There needs to be some technology in place because tracking [licenses] manually is not something companies want to be doing,” Konary said. Software publishers need a easy, automated way to track license details, entitlement activations and product usage right down to the feature level.

However, software policy in terms of tracking usage compliance is one path where Konary sees ISVs often take the wrong direction. Software publishers are usually hesitant to build usage-based billing models or to expose end-users to usage data out of fear that they will see a drop their revenues. For example, if an end-user is under the assumption that all users are active once they have activated their software, but then see a report that more than half of their users log in less than one a month, that could fuel a decision to reduce the number of licenses purchased for the application in question.

When asked about this phenomenon, Nerlinger indicated that SafeNet’s customers are seeing the opposite effect. “Software publishers have every reason to be nervous about moving from traditional lump-sum pricing models to subscription models – it will change the flow of their revenue dramatically. Rather than getting paid the full value of a customer contract up front, the revenue becomes staggered and more predictable. We have helped many customers make the transition from perpetual and other more traditional licensing models to pre- and post-paid usage-based models and very rarely have we seen an overall decrease in revenue. In fact, we have seen just the opposite – most customers have seen that over time their application was being used much more than they anticipated and revenues actually increased within key accounts, and up-selling and cross-selling became a much easier task.”

When asked to further discuss tracking best practices, Konary commented, “One mistake I see software publishers make is creating a software policy that is difficult for customers to follow. The ISV can track usage for billing purposes, but there is no mechanism for customers to track or report on it,” Konary said. “This happens across the software industry. If you are tracking per user, your strategy is complex. If you don’t have a mechanism in place for customers to track their usage you are never going to be able to make them happy. Tracking is stressful.”

However, on the flip side, allowing for too much flexibility might cause ISVs to sell themselves short, which can result in lost revenue after a software usage audit.

“Too much flexibility puts them in a difficult position. Most software companies realize that,” Konary said.

For example, they might be asking how to add simplicity, but there is no need for them to offer three different pricing schemes or provide 60 definitions of what a user is, she said.

In summary, the software industry it is not that old compared to other industries. Forty years ago, it was not as an important part of our lives as it is today.

“One of the things that we’ve seen in working with software companies under 10 years old is that they are focused on growing revenues really quickly in the beginning. Either they wanted to go public or get funding right away. But they did that at the expense of having a solid structure – there’s been a lot of smoke and mirrors from the sales perspective,” Konary said.

Konary likened today’s software industry to the “Wild West.” “It’s an old ghost town where the front façade on the street looks good, but if you walk around back, it doesn’t look quite as good,” she said. The same applies to having proper support for a monetization strategy.

“Things look really pretty from the outside, but in order to compete with a more established industry they might do that at the expense of a structured monetization strategy,” Konary explained. However, looking inward, there might be lot of spit and bubble gum holding it together.

“It’s not the sexy stuff that management wants to focus on in fixing the guts of a software company. It’s not a huge, sexy big type of reward kind of a thing,” she said. However, “it’s important to fix it, because if you don’t you can have a ghost town. You will cripple your ability to successfully compete.”

Konary will address this topic at the upcoming SafeNet LicensingLive! Event being held Oct. 2-3 in San Francisco. Konary will speak at the “The New Look of Software Monetization” session.

Edited by Peter Bernstein

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