Software pricing will never be the same

The world of software pricing and business models is topsy turvy, but not because the trends are slow-moving, it's because the trends are powerful.
Written by Dana Gardner, Contributor

The wizards of stock picks and the mainstream press pundits have it wrong as to why a number of software trends are hot while the vendor's stocks are not. In this Business Week article, reacting to some picks for software stock winners and losers, the writer claims that software-as-a-service, Web 2.0, and SOA, are slow-moving trends, and that's why the IT vendors' stocks and fortunes are only tepid (historically speaking).

Wrong. The trends around software as a service, Web 2.0, DSO, and SOA are hot, hot, hot. However, they are productivity wins, with the majority of the spoils set to go to the adopters (after ramp up and investments), not necessarily a boon to the vendors as we've seen with past technological advancements.

The days of the software vendors that enjoy large volume sales of licensed code at high margins is about over, with a few holdouts (Microsoft, SAP, Oracle). However, ask any developer, architect, and datacenter operators whether they would rather have a skin rash or sign up for more per-server licensed commercial code, and they are apt to opt for the rash. SAP and Microsoft have yet to run the gauntlet on the enterprise pricing shift, while Oracle is in it now, but adjusting pretty well by having anticipated it well.

So those vendors and resellers in the business of pricing software licenses so that they get the best returns for their stockholders (read: fat margins) while also trying to seed the market to build up a high-volume and virally fast-growing market presence and share are in a bind. It was always hard to price high and grow volume, too, and enterprise software was one of the few places that it was possible for long at all.

But those days are gone (except if you sell oil and gasoline). They likely won't come back for mainstream software as we know it. Indeed, the pricing for per server (or per processor [or better, per core]) is under pressure ... down. Witness what Oracle did with per core licensing recently. Oracle would not do this unless the cow of pernicious add-on licenses due to multiple cores was thoroughly milked.

In addition to licensed software being under price pressure, the entire model of charging for software is under a rolling thunder build of an assault from open source, software as a service, Web services/SOA, and Web 2.0-type development. The new rule is that charging for software is a no-growth aspect to the business, even with high R&D spending requirements, and that more and more incumbent vendors like Sun recognize that services and maintenance is where the dough is. And this is not a high-margin (30%-60%) business, though it can be a good (10%-20% margin) business.

So the building notion that license fees for software is a baseline revenue source, but growth and margin come from services and maintenance, is sweeping over the industry. Even though it runs counter to the thinking for vendors until recently. This is why IBM is turning to business services and why HP is apparently eyeing CSC. And it is why stocks are roughly flat or worse for the biggest software vendors.

The public stock markets have not and will not move this current era of tepid earnings and revenue growth from the big boys, and the high-growth stocks will continue to be those like Google that mix up media, advertising, and business services, and so are on the receiving end of the productivity wave in IT -- rather than seeing their business models diminished by it. Intel is working hard now to do an end-run around the conundrum, and to see its growth associated with media and home entertainment growth. Viva la Viiv.

So the world of software pricing and business models is topsy turvy, but not because the trends are slow-moving. No, it's because the trends are powerful, apt not to be cyclical, and are moving very quickly into the mindsets of large enterprise IT buyers and specifiers. This does not mean that innovation -- or software vendors -- are over.

In fact, it's a fantastic time to be a savvy enterprise architect -- you remain in the driver's seat; it's a buyers' market, but you need to change how you procure, manage, and customize IT assets. Bargain hard with software contracts. Don't just sign up for services without careful examination of how the contract fits your needs; customize it.

Don't swap out license costs for services -- cut license costs with better services. Use open source (with proper license choice and indemnification) like mad. Give your developers lee-way to choose the tools and frameworks they want to use. Be platform agnostic.

This is also a great time to be a $30 million to $100 million software vendor, still private, that has a majority share of its revenues from subscription-based services and maintenance contracts. These types of firms will see vendor suitors willing to pony up high multiples for the acquisition, especially if the code products are open source (GPL), the technology fits into a swift ROI function for the operators, and appeals to developers. Big vendors may see it better to buy their way to a sizeable subscriptions businesses ( ie, Sun and StorageTek) than painfully convert high-margin license streams to lower margin services businesses.

This is, and will be for years, a disruptive time for the incumbent publicly traded software vendors. They will see their pricing power and revenue models in transition, while at the same time they will need to buy up the smaller software companies, and larger services companies, to shift their revenue models. But the transition will not necessarily put the well-managed vendors out of business, it will remake them into stronger and long-term players with modestly growing markert capitalizations.

Currently, the investment bankers are drooling at the chance to break up today's big vendors and then re-configure them into the next generation of vendors and service providers. Might as well reconfigure them along with the parts of telcos, media companies, and wireless providers, too. Lots of banking fees to be had.

Listen to the recent Charlie Rose interview with Lazard CEO Wasserstein. (From this chat, expect Time Warner to be eventually broken up and re-pieced together with parts of Microsoft or News Corp.)

So Larry Ellison, as usual, is probably right, there will end up being four major IT vendors left standing. It's just that it will take a few years, those companies will have slow-growth market caps in the meantime, and they will end up being the assemblers of larger portions of open source products that make their low-margin living from services, outsourcing, and maintenance subscriptions. They will also probably be very different companies than they are now, resembling media conglomerates more than traditional software vendors.

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