Traditional software licensing: Why you pay more and a look at your options

Traditional software licensing: Why you pay more and a look at your options

Summary: It's hard to believe that some of the most profitable software companies in the world--Oracle, Microsoft and SAP--are sitting on a licensing model that is untenable in the long run and will increasingly irk customers. But there may be a revolution in the cards that could tip the balance of power, argues Gartner.

SHARE:

It's hard to believe that some of the most profitable software companies in the world--Oracle, Microsoft and SAP--are sitting on a licensing model that is untenable in the long run and will increasingly irk customers. But there may be a revolution in the cards that could tip the balance of power, argues Gartner.

In a presentation, Gartner analyst William Snyder makes the case that software profit margins will erode. These software giants will fall to the same pricing pressures their hardware cousins. Snyder spoke at the at the Gartner Emerging Technologies Conference this week.

See more from Gartner:

Let's face it: The hardware market is commoditized, workers are being offshored and budgets are being cut. Yet you're paying more in support and maintenance of software. Snyder says something doesn't add up here. I'm inclined to agree, but there's a reason software pricing sticks: It's an oligopoly market dominated by just a few vendors--SAP, Oracle and Microsoft. And these software giants are just getting bigger via acquisition. These giants have the largest installed bases and feature applications that are difficult to uproot. Snyder argues that open source may change the equation. I reckon a little customer revolt wouldn't hurt either. Snyder hints at a budding revolution:

Software budgets remain one of the last stubborn areas of budget resistance. In other areas, such as hardware and networking, competition, standards and free market economics have improved costs during the past two decades. Even the human staffing line item has seen lower costs by moving selected work offshore. Through it all, software maintains high prices due to high switching costs and the method of commerce known as software licensing. Due to continuous pressure by enterprises, IT organizations will continue to look for ways to reduce software costs in whatever legal ways it can.

The problem: Software buyers are dealing with massive vendors where transparency isn't exactly the norm.

licensing.png

Ultimately, this situation is untenable. Snyder makes a good point: He says that loyal software customers are treated worse than new customers unlike other industry. There are no points for loyalty in the software business.

Snyder notes:

CIOs are struggling with the fact that so much of their budgets are consumed by maintenance and support commitments for utilities, and they are looking for ways to cut that back, to free up funds to innovate the business, as required by their CEOs. IT organizations face pressure to reduce costs permanently. This has often been achieved in hardware and services, but not in software - the only IT market that sustains 75% to 80% gross margins, and 25% to 35% net margins. When many companies struggle to make 25% to 30% gross margins in their core businesses, it becomes increasingly difficult for software procurement specialists to claim to be doing an excellent job.

The problem with this "software licensing is cooked" argument is that it's brain surgery to swap applications. Sure you could switch to SaaS, but that takes a lot of upper management buy-in if you're doing more than CRM. Today it's unclear how much negotiating power customers really have. You can play Oracle and SAP off of each other, but that may not get you too far after the pain of another implementation.

Snyder says there's hope. Here's a look at some of his key points:

Business process outsourcing will erode software licensing margins. Snyder says that business process outsourcing is the fastest growing market in IT. Why buy another HR app when you can outsource it? As these BPO options grow software vendors could find themselves in a bind. Another interesting thread: These BPO firms don't play the lock-in game with software vendors--after all it hurts the BPO margins. According to Snyder's presentation:

Several BPO companies have custom-developed software offerings that automate the processes they bring to market in their products. They do not use commonly available commercial applications from the major software vendors because, in many cases, they do not want to depend on a provider with such high margins, where lock-in is so extreme. This reduces the market opportunity for software vendors.

The takeaway: Use BPO firms as leverage when negotiating with software vendors.

Modular software architecture (SOA) could be a threat. Snyder argues that SOA can be a threat to traditional software vendors--especially if you use offshore resources to build the Web services. Another perk: Implementing a software module is a lot easier than a giant ERP system.

The takeaway: Use offshore firms and the threat of Web services in negotiations with software vendors.

SaaS vendors will ding licensing margins. The SaaS model is already changing the vendor-buyer relationship argues Snyder. With SaaS switching costs are lower and so are the upfront fees. Snyder notes that large software vendors that are tackling SaaS don't understand the profit margin dynamics in that sector.

The takeaway: SaaS vendors are negotiating leverage with your current software provider and may be a good replacement. However, there's a significant SaaS caveat. Snyder argues that SaaS providers will increasingly look like they are using a traditional software licensing scheme and if you don't pay attention your costs over five years could be as much as 30 percent or more higher than you expected. SaaS costs have been an ongoing theme on the Enterprise Irregular mailing list. Snyder writes:

Many SaaS providers offer great initial deals on hosted software. However, buyers face problems with locked-in, uncapped price hikes on renewal and hidden costs for increased use. When evaluating SaaS deals, don't be deceived by low per-user, per-month fees. Instead, explore the financial implications of issues such as setup costs, hidden license metrics and termination fees. Where feasible, obtain comparative estimates for an on premise implementation, or for an arrangement in which your company purchases the hardware and software licenses, and then contracts with an external outsourcing organization for management.

The open source movement will erode software licensing margins. To me, this open source argument is Snyder's most plausible--once the applications are comparable. Sure there are implementation and support costs with open source, but the bottom line is quality low-cost applications are increasingly coming down the pike.

Snyder cooked up the following prospecting chart:

licensing1.png

As you can see each type of application is different as a viable threat to traditional software vendors. For instance, JBoss' maturity would give you more leverage against your incumbent middleware provider. That chart, however, is likely to be fluid as open source moves up the software stack.

Takeaway: Open source is an option at best and negotiating leverage at worse. Snyder reckons that incumbent software giants will have to innovate at a rapid clip to show their worth.

Emerging markets will cut licensing software margins. Snyder argues that the current licensing structure just won't fly in emerging markets. That fact means that incumbent software vendors will either have to cut prices or watch these IT green field markets move toward open source and SaaS. And without legacy software to support customers in China and India can experiment with any of the aforementioned models mentioned above. In either case, software licensing margins are in danger.

The big question: What's the timing on this margin pressure? The answer will be determined by the economy and the desire of CEOs to undercut relationships with their existing software vendors. But additional cost savings can tip that balance pretty quickly.

Topics: Open Source, CXO, Cloud, Emerging Tech, Software, IT Employment

Kick off your day with ZDNet's daily email newsletter. It's the freshest tech news and opinion, served hot. Get it.

Talkback

172 comments
Log in or register to join the discussion
  • Message has been deleted.

    rtirman37@...
    • Lets bet on my Damian attribute that the Pope isn't a Windows user? more..

      Sorry about the optimism and yes we pay too much for Retail boxes of Vista. Really sorry I live in a white neighborhood that is loud on the weekends. --robz
      rtirman37@...
  • Yes, 20 years ago, software licensing was long term viable. That was then,

    this is now. For businesses NOW, going forward, software licensing is not long term viable. What they are saying is that what worked in the past, will not be viable for very many more years, ONLY the short term, from TODAY, not from 20 years ago.

    Quite simple, really.
    DonnieBoy
    • Saying it

      doesn't make it so. If the license model has worked for the
      past 20 years, then compelling reasons must be presented
      why it will not work for the next 20.

      "Customer support sucks" is not a compelling reason.
      frgough
      • Disruption is a compelling reason.

        Despite its currently minimal market share, MS still sees FOSS as a threat, if only because given enough time it's practically impossible for it not to fulfill most people's needs.

        They've tried vendor lock-in and even, shockingly, pulling their fingers out to a certain extent (hence the vast improvement of XP over previous Windows releases) but it's not going to last forever and at some point they're going to have to deliver better value for money if they want to survive.

        Who knows, maybe ten years down the road they'll have a similar market position to IBM.
        odubtaig
      • Main article provides good analysis

        The main article actually does provide a number of
        compelling reasons why the next 20 years will be different
        then the past 20. In summary, the oligopoly among
        enterprise software vendors will not likely be sustainable
        because:
        - SOA increases interoperability and reduces vendor lock-
        in
        - SaaS and BPO provide additional competition, which
        lowers pricing
        - Open source software is maturing and becoming
        increasingly viable
        - Emerging markets are not locked-in to the oligopoly

        I find the argument pretty convincing, and the end-result
        will be significantly lower licensing costs from the major
        vendors.

        In fact, the trend has already started: all the "Express"
        products (especially database and development tools) now
        available for free from Microsoft, IBM, Oracle, etc. are
        clearly a direct response to competition from open-source
        products.
        pointzerotwo@...
        • All that means is

          traditional licensing will get cheaper, not go away. Again, the
          argument against traditional licensing is that "support sucks"
          and "it's expensive."

          Both of those can be remedied without scrapping the
          paradigm.

          Thus, there is no compelling reason why traditional licensing
          will die.
          frgough
          • I think we agree on that point

            If you read the article carefully, all it's saying is that "profit
            margins will erode." In plain English that simply means that
            licensing will get cheaper.

            Still, the question of long term viability must then be applied
            to the companies that have built their processes, cultures,
            and campuses with the expectation of long term gross profit
            margins in the 75-80% range.
            pointzerotwo@...
          • Your argument is nonsense

            Essentially you're saying "Traditional licensing won't go away, instead it will just change into something completely unlike traditional licensing, but I'll CALL it traditional licensing, just so I can be right."
            bmerc
      • Competition is the reason

        You may have noticed that MS's only success was customer lock-in.
        fr0thy2
        • That begs the question..

          How did people get locked in in the first place. I remember a time not so long ago that Office was barely a blip on the map - REAL business users had Lotus 1-2-3 and WordPerfect.

          There's a piece of history missing in these arguments, and to ignore it makes one question the analysis.
          daftkey
          • Greed over progress

            Once the idiots take over, nothing progresses because financial greed takes over from actual development.

            FOSS proves that their game is completely wrong.
            fr0thy2
          • The only places FOSS

            is having any success is where it can reduce costs. In other
            words, feed greed.
            frgough
          • Well I guess ideally

            ..the "idiots" wouldn't do what's in the best interests of their employers aka the shareholders of the corporation.

            FOSS hasn't even come close to proving anyone's game wrong yet - they barely have their foot in the door, and most FOSS software outside of the "IT Infrastructure and Support" and "Software Development Tools" categories are far from mature enough to start passing as viable alternatives to their commercial counterparts.

            As someone else pointed out, FOSS' main selling point is still "it's free" or "it's not Microsoft" - not "it's better".
            daftkey
          • FOSS wins hands down

            What it doesn't have is the aggression to be the big man.

            Slowly slowly catch the monkey.....

            What's wrong with the world working together for the better of all? What's with the "I must be the biggest, hardest and richest?"

            Why kill progress for one man's greed?
            fr0thy2
          • Sorry but no...

            And 90% of ALL users say so.
            No_Ax_to_Grind
          • Those products

            lost when they failed to adapt. What gave MS Office the advantage (Word/Excel) was Windows 3.x. Wordperfect was slow to come out with a Windows version. Part of the reasoning was that DOS was the business platform and Windows was just for enthusiast (it was good toy, but not for the enterprise). Win 3.x changed that and older DOS software started to lose its marketshare. DBase, Wordperfect, Lotus 123, Wordstar and etc. all started to fall behind. There was also the issue of Microsoft holding back part the Windows API from the developers of the other software which led to antitrust suits against Microsoft from these vendors.
            But, probably what did most of these vendors in was they didn't see the market changing and they failed to adapt to it. History could repeat itself. Many will remember when IBM dominated the market. HP was just an upstart. NCR was number two after IBM. HP is now larger than IBM and IBM no longer dominates the market as it did in the past.
            alaniane@...
          • The missing link...

            is that MS winked at licensing violations to build market share. It's a longstanding practice, and it's been discussed all over the web for many years.

            Remember, in the early days, 1-2-3 had a very tight licensing scheme: you had a code on a floppy, and you could only use it once. You could only transfer that license by basically sending it back to Lotus and getting a new one. By contrast, MS was completely "open": you could install Office on any number of computers and never get nagged by license bots.

            Of course, when you wanted to upgrade, you had to buy a real license (eventually). Office 95 was easy, Office 97 had a longer code, Office 2000 started to enforce licensing ever so gently, and by the time we get to Office 2007, licensing is enforced pretty strongly (with Office Genuine Advantage just around the corner).

            That's the "missing history": MS relied on license violations to build a ubiquitous presence, and is now relying on strict license enforcement to keep that presence.
            mwgillespie@...
          • Absolutely Correct - Spot On.

            Absolutely Correct - Spot On.

            I've given an almost identical account on these pages in the past. Moreover, I gave blatant examples of how Microsoft repeatedly said in its Communiqu? Magazine that if you subscribe to the magazine then when you upgrade you didn't have to send back the first disk of the previous version. That's to say you didn't need proof of purchase of that earlier version.

            To upgrade, all one had to do was tick the appropriate box in a very long list of software products then fax or post it back.

            Effectively, you'd pay about 30% of retail price. Often small retailers went out of business, as they could not compete with that price as their wholesale price was far above this figure. When they complained to M$ about the anticompetitive behavior M$'s retort was that it trusted its subscribers.

            When it was clear that it has secured market share M$ closed the gap on the upgrade price and killed off the scheme.

            Reckon that if I or most of you readers did something like that then we'd quickly find ourselves in the slammer. However, when you're a multinational the size of Microsoft with the power to frighten governments then nothing happens. Being impervious to the law gave it even more clout.

            Nevertheless, eventually the specifics will leak out, then we'll find out how the details of how the biggest scam ever was perpetuated.
            Irritated_User
          • Here we have two perfect examples

            Of a perfect synopsis of how
            Microsoft scammed the world with
            their "licensing" scheme.

            Excellent summary and presentation,
            without fanfare or exaggeration.

            The plot thickens as they throw ever
            more money and lawyers at it. They
            are presently concentrating heavily
            in China. Very interesting
            information if one cares to look.

            Thank you mwgillespie@.. and
            Irritated_User ........ I may refer
            back to these posts from time to
            time.
            Ole Man