When Hannu Kataja, the chief information officer of Finnair, wanted to update the Finnish airline’s ebusiness management software to make it easier for passengers to buy tickets directly online, he was prepared to take dramatic steps to link IT costs more closely to operations.

In an unusual deal struck in 2002, Finnair signed a contract with Computer Associates (CA) whereby, instead of paying an upfront fee for the software, the airline would pay CA regular fees linked to ‘revenue passenger kilometres’ (or RPKs, a key airline metric). The deal meant that CA had a stake in Finnair’s online success.

“This agreement has substantially reduced Finnair’s business risk by linking our software costs to a revenue metric, rather than a purely technical one,” says Kataja. The deal, he says, has helped the airline control its costs while also providing flexibility as its needs fluctuate.

He is not the only CIO in Europe exploring new and innovative ways of paying for software products. According to a poll by market researchers Aberdeen Group, one-in-five companies would prefer to pay for software through some form of ongoing subscription, rather than through a single, up-front licence fee.

The benefits, Aberdeen points out, include more flexibility, and a cost base that is more responsive to changes in demand – whether that is up or down. CIOs, the report suggests, also want to move away from long-term contracts that can constrain their ability to bring in new technologies as they emerge. Moving to a flexible software subscription – rather than an up-front, ‘perpetual’ licence (see box) – should also give software buyers more market clout. If a program is not up to scratch, the thinking goes, CIOs can switch to another supplier without having to write off large sums from pre-paid licence fees.

But the idea of pay-per-use software is not new. Application service providers (ASPs), which rent both software and hardware to businesses, were one of the hot tickets during the technology boom. Few ASPs survived the IT downturn, but the appeal of paying for software for in-house hardware on either an annual or a monthly basis did not disappear. Further back in recent history, software for mainframes was typically sold on a subscription basis, because this matched the financing models used by IBM for the mainframes themselves.

The classic example in the software sector is SAS Institute, the business intelligence package vendor, which has charged on a subscription basis ever since it started providing software for running statistical analysis on mainframes in the mid-1970s. As mainframes were gradually replaced by cheaper minicomputers and client-server systems in the 1980s and 1990s, most software suppliers switched to the formula of a one-off licence payment with its propensity to portray a fast, if lumpy, growth profile.

In recent years, the downside of a one-off payment model, however, has become more evident and many vendors have sought to wean themselves onto a more steady charging mechanism. Some have even been forced to do so.

Under pressure to make its sources of revenue more transparent and dilute a reputation for overcharging customers, Computer Associates (CA) introduced a subscription-based licensing model in late 2000. Sanjay Kumar, CA’s CEO, says that one key cultural shift the company made was removing extra sales incentives on longer deals or on contracts closed at the end of a quarter.

That meant that sales people were just as likely to close a subscription deal as a perpetual licence. Kumar says the hardware industry is now “grappling” with the move to subscription payments. And developments such as the shift towards utility computing (in which organisations pay for technology only as they use it) seem to demand the use of subscription models.

At this stage though, there has been no stampede, even though some major suppliers have taken tentative steps in the same direction of CA, namely Microsoft, Siebel and Sun Microsystems.

That more vendors have yet to embrace subscription pricing comes as no surprise to Stacey Schaeffer, manager of worldwide pricing strategy at SAS. “[With licensing] you must have the mentality of partnership at every touch point with your customers,” she argues. “And you must continually listen to your customers and be accountable for the delivery of solutions that meet their needs. That’s a robust commitment that not all organisations in the industry can make. But they’d see the benefits if they could.”

Higher fees?

With the subscription model, the clear impression is that customers pay a steady, predictable fee that is lower over the short term but which (as with any lease arrangement) costs more if the software is used for a longer period. Unfortunately, this is difficult to verify in CA’s case.

There is little market research or case study material that compares the different costs over a given period. CA does not comment on the split between subscription and perpetual licences, although evidence of the growing appeal of subscriptions comes in the average length of a CA software deal, which has fallen from six years before the introduction of the new licensing model to less than three years today.

But if details of CA charges are thin on the ground, the cost of adopting Microsoft’s two-year software maintenance model, called Software Assurance, has been endlessly picked over since it was launched in summer 2002.

At that time, some IT user groups called for Microsoft to be investigated by trading practices watchdogs, while Gartner, the analyst group, estimated that some companies would pay up to twice as much under the new system.

Microsoft disputed such claims, and argued that customers that regularly updated their software would actually pay less under the new model. In any case, it remains possible to pay for Microsoft software through a perpetual licence. “We have been chastised for having a range of licensing types,” says Mark Buckley, Microsoft’s UK licensing manager. “But we offer [subscriptions] because customers demand different types.” Microsoft also includes other services, such as e-learning and support, in its subscription model. And for companies that use all these services, subscription may prove to be the cheapest option for Microsoft applications, he adds.

A similar rationale lies behind moves to an annual fee at Microsoft-rival Sun. In October 2003, Sun began offering the Solaris operating system and a range of middleware and desktop applications on a subscription basis.

The unique thing about Sun’s approach is that payment rates are pegged to the size of the customer’s business, rather than the number of users of the software or the number of microprocessors it will run on. “For enterprise applications, we charge on a per-employee basis, but you can still buy per-portal user or per-mail client. But there is a whole change in the industry. It is about return on investment and it is also about utility computing. We felt that this was the way to do it,” says Paul Tempest-Mitchell, solutions technology manager at Sun UK.

Whether the new model is good news for all customers of Sun software depends very much on how they use the software, says John Rymer, a Forrester Research analyst. “Organisations with large capacity requirements and many CPUs relative to their headcounts will see the most obvious savings.” This scenario fits well with some of Sun’s core markets, such as telecommunications and financial services.

Rymer, though, stops short of an unqualified recommendation for Sun’s model – partly because not all Sun software is available through the new charging model, and partly because, for some computing-intensive applications such as scientific research, organisations might run a large quantity of expensive software on only a small number of CPUs.

Like Microsoft, Sun also bundles in extra services, such as a number of support ‘credits’, for no additional charge. That is weighed against the fact that, in some cases, organisations do not want to sign up for external support. A Forrester Research survey of Linux users, for example, found that only 43% of companies bought external support. It is unclear how many users of other applications would opt not to buy support, if it were not part of a larger bundle.

Keeping control

One of the most common arguments against subscriptions is the suspicion that companies will lose a degree of control over what could well be a strategic asset.

With open-ended subscription deals, vendors maintain a greater degree of control than they would do in a traditional perpetual licence arrangement, since the customer has to keep paying in order to use the software. That can be overcome by signing a fixed-fee contract that runs for, say, three years. But by doing so, businesses lose the flexibility to drop or switch software products or to negotiate reductions in licence fees.

It is largely for this reason that both suppliers and customers remain wary of a move to a new licensing model.

Certainly, enterprise applications giant SAP is cautious. “Some of our software is licensed using different metrics, but 90% of it is still on a per-user basis,” says Henning Kagermann CEO. “We have given clients the option to rent software per user, per year or per month, but hardly anyone is taking it up. They want to ‘own’ the software.”

And he adds: “They think there is a difference between what they want to own – which has strategic value – and what is a commodity. SAP software is strategic.”

Nor is this just the view of companies selling mostly to large enterprises. Filemaker, the US-based vendor of database software for small businesses, is trialling subscription pricing in Australia. But Tony Speakman, its general manager for northern Europe, suggests that even a relatively low-cost package can be a strategic purchase. “The style of our product means that Filemaker is a considered purchase,” he says. “If you need it to run the business, you will buy it.”

In other words, whether CIOs favour the flexibility and short-term cost savings that flow from paying for their software on a subscription basis may depend on where the package sits in the software stack.

The lower it is in the stack – be it an operating system such as Solaris or Windows, middleware or even management tools such as CA’s offerings – the more vendors seem willing to move away from the up-front, perpetual licence approach, say analysts. Move further up the stack and into the realms of an Oracle or an SAP application, and the technology is less of a commodity and therefore more likely to be customised to the individual business’s needs.

Just as utility computing in hardware is turning IT into a commodity, so subscription pricing seems to be finding the most support in areas that are the least customised and the most generic.

“If you look at where commoditisation is occurring, most of it is around the infrastructure components such as the network, storage or servers,” says Meta’s Pal. “That is where it is hardest to differentiate by hardware or software capabilities. So companies will also look at the viability of the vendor and its pricing flexibility. But the closer you get to the application, the harder it is to look at a commodity model.”

That could, of course, change. As utility computing matures, the pay-per-use concept can only move up the stack. If that happens – and there is growing evidence to suggest it will, eventually – businesses will stand to gain by partnering with a software vendor that is willing to embrace new flexible ways of charging for its wares.