Rocket Science

By choosing well from among the available payment and purchasing schemes, organizations can generate real savings. An example is the Jet Propulsion Laboratory at the National Aeronautics and Space Administration, which relies on a popular computer-aided engineering (CAE) tool for aerospace design. With about 600 potential users, JPL would have to pay more than $1.1 million to obtain perpetual licenses of the $1,900 software for each of them; then there's another $600,000 over a five-year period to license the roughly 300 additional users who might get involved in JPL projects for a short time, or who are replacing departing JPL staff. "Nearly $2 million for one program over five years is a big expenditure, but that amount highlights a key problem with perpetual licenses: They become orphaned and lost in the system," says Charles White, a system engineer at Northrop Grumman Corp., currently on contract to JPL in the computer-aided engineering office. "It's hard to keep track of which user holds which license if you have many different kinds of software. So when people leave, the software is often abandoned and unused—and the money we paid for the license is wasted."

Six years ago, in an effort to gain control over these expenses, JPL shifted its CAE software account to concurrent licensing, thus eliminating per-user contracts. Under the concurrent approach, the cost per license was $7,600—four times that of a per-user license—but the agency only needed to purchase 100 copies of the CAE software, the maximum number of people running it at any given time. All told, JPL, one of the first organizations to demand concurrent licensing, slashed its CAE software outlays more than 50 percent, and expects to reap further savings in the coming years. "In aerospace, we have a programming talent pool and once upon a time we never bought third-party products; we wrote our own software," White says. "If software again costs more to purchase than to build, we'll just go back to making it ourselves. For their survival, software companies realize it's a good idea to cooperate with us."

Only now are more mainstream buyers getting the same privileged treatment. Among companies with more than 1,000 employees, nearly 30 percent of the software bought in April 2003 was purchased with concurrent licenses, compared to about 20 percent for the per-user approach, according to IDC. (The rest of the software was acquired through various forms of subscriptions.)

"Software is a mature industry with considerable cost pressures," says Ken Berryman, a principal at McKinsey & Co.'s Silicon Valley office. "On the user side, this has resulted in increased demands for transparency, a reduction in pricing complexity and more scrutiny of total cost of ownership. For software companies, it has meant a more solutions-oriented approach. The way this significant transformation unwinds in the next 18 months will set the pace for how software will be priced and delivered in the foreseeable future."

The most radical change in pricing has been the tilt toward subscription plans and away from perpetual licenses. Customers pay for software licenses by the month, quarter, year or longer and can cancel or renew at the end of their term. In the third quarter of 2003, 46 percent of new orders at Mercury Interactive were subscription-based, compared with just 28 percent in the same period the year before. And even established software companies such as Oracle, which, in the past, quietly offered subscriptions only to large clients, have softened their stance in response to customer demand. "We've had some form of subscription pricing [for many years], but now it comes up more often," said Jacqueline Woods, Oracle's vice president for global pricing and licensing strategy, at a software conference in mid-2003.

This article was originally published on 02-01-2004
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