The Many Opportunities and Few Risks of Software Subscriptions

My first version of MS Office still came on discs in a box and was paid for with Deutschmarks. It served me well for a long time, until my mail provider decided to change the security standards and my old and dear MS Outlook stopped working. This meant that I had to buy a new version of MS Office. I was very upset about having to pay good money for new versions of a software that I had been using for such a long time. In all other walks of life, nobody bats an eyelid at having to buy new versions of old products. The average European buys more than 10 cars over their lifetime. And we keep buying our favorite albums again and again, first on vinyl, then on cassettes, then on CDs, as downloads, and now streams.

The key to solving this conundrum is a subscription service: The subscriber pays only a fraction of the cost of a software package in exchange for the ability to use the software – always in its latest version – for a defined period of time. No need to pay full-retail every few years, and the subscriber still gets the newest security and safety standards guaranteed. On the other side of that relationship, the provider gets a dependable revenue stream and the certainty needed to plan and budget for future developments and new products.

Which models are there?

In the software scene, maintenance subscriptions and software subscriptions (and any combination thereof) have established themselves as the typical models on offer. With maintenance subscriptions, the user would buy the software outright in the first place and then enter a maintenance contract for access to regular updates and, frequently, exclusive services. As long as the maintenance contract is active, the user will always get the latest version of the software, and when it ends or is cancelled, that latest version will be the one the user is stuck with (but that they can still use).

With software subscriptions, the user enters into a regular subscription contract without having to buy the software first. However, the right to use the software would be lost as soon as the subscription ends; even older versions are not available anymore. This means that the threshold for becoming a user is far lower, but the threshold for cancelling the subscription is far higher than with a maintenance subscription. The technology behind both options is identical: Upon ordering the subscription, the user will get a license that is regularly refreshed as long as the contract is active. With maintenance subscriptions, the period of access to maintenance services is extended (Maintenance Period); with software subscriptions, it is the license for the software itself (Expiration Time). When the contract is cancelled, the licenses will not be refreshed anymore, or the Expiration Time is set to the end of the contract.

Which pricing policy will work?

In recent issues of this magazine, we took a closer look at the technical niceties of subscription licenses. Now we need to take a closer look at the commercial considerations: Pricing and revenue. Take a concrete example: A software product that is sold for €5000.00. Without a subscription option, the user can buy updates to the software, usually at a 50% discount for the first two to three years from the original purchase. In our case, this would be a price point of €2500.00. If a user skips too many updates or exceeds the three-year period, they would have to buy again the entire package at full cost.

For maintenance subscriptions, the annual maintenance fee would be 12% to 25% of the purchase price, i.e. the user would pay an addition of €600.00 to €1250.00 for maintenance services on top of the original €5000.00 product license.

Monthly maintenance subscriptions would usually range between 2% and 5% of the purchase price, i.e. €100.00 to €250.00 per month in our example. Depending on the contract, payment can be per month, quarter, six months, or year.

Which opportunities and risks should be expected?

Consider the opportunities and risks for this specific example. We assume that our business gets a hundred new customers purchasing the product in the first year and that we will be able to increase these numbers by 5% year on year. We also assume that updates are offered for half of the purchase price and that half of our current customers will take us up on that offer. This immediately shows one of the typical risks of a purchase model: Without exciting new “killer” features, very few users will be tempted to buy every single update.

For a comparison with maintenance subscriptions, let us assume that 75% of our users buy a maintenance contract at 20% of the purchase price and that 10% of these will exit their contracts every year.

For a subscription license, we can assume a monthly fee of 4% of the purchase price, only 5% churn per year, and 25% more customers attracted by the more appealing payment option. Since users who cancel their software subscription cannot enjoy their product anymore (compared to maintenance subscribers), far fewer of them will take this drastic decision and stop using the software altogether.

The comparison shows how subscription licenses outperform conventional purchases in the long run – even if only 25% more new customers can be sold on the new model. The data does reveal that a revenue slump needs to be expected in the first years, especially if an established product needs to be transitioned to a subscription service. Introducing subscriptions needs persistence and perseverance. A good compromise is to introduce new products or new markets under the subscription model and to let older products slowly run their course.

Maintenance subscriptions, by comparison, are essentially risk-free, while also promising attractive revenues over the long haul, especially if customers can be kept on board. It is not unheard of for established companies to get substantially more revenue from maintenance subscriptions than from new licenses. The eventual business plan for a new subscription service has to take the market and customer preferences into account in every case, and any sample calculation or projection can only serve as a general point of reference for decision makers.

Everybody Wins?

The advantages for providers are plain as day: With maintenance subscriptions, but even more so with software subscriptions, they win new, lasting, and predictable revenue streams at lower commercial risk. But the users also benefit, again especially with software subscriptions. The most immediate gain for them is the far lower entry cost. Instead of spending €200 to €300 for the full suite of MS Office products, they only need to pay €10 a month for the subscription. Another advantage may not be as obvious at first, but will soon make itself felt: Subscriptions usually mean constant access to the most recent software versions with the most recent security standards. No need to buy a new software version again when the next update rolls around.

A greater feature set is another typical advantage. The typical buyer will only spend for the applications and features that they need at that moment, whereas a subscriber can get access to a larger, often complete set of features and functions. This can be as simple as certain functions in Excel that most would have never noticed if they had not been included in the subscription – but which quickly become a favorite choice if one has them available.

Subscriptions have become the norm in the music industry, and they are becoming normal in the car industry. Who still buys CDs? Most people subscribe to a streaming service to get all the freshest beats without spending a penny extra. True, most people will not listen to all of the music library. Who in the world would be an avid fan of Brazilian metal, Europop, and 80s one-hit wonders at the same time? As these examples and the success of video streaming sites have shown: The subscription age is here to stay.

 

KEYnote 43 – Edition Spring/Summer 2022