Enterprise software distribution: Recurring models

In the previous post, I discussed basic licensing models, and why we would want to go with monthly licenses. Lets discuss the details of recurring models.

When you sell software for a monthly fee, there are 2 possibilities:

  1. No fixed term. Client stays as long as they require the service.
  2. Fixed term contracts.

No fixed term overview

If we assume no fixed term, the average time a customer will stay with you is 4-8 months (With 8 months considered very good), and the average rate of attrition is usually about 15-20% per month. Of course these numbers are very dependant on the market, but lets do some maths:

Let’s assume we charge $100 a month, and each client stays for 6 months (an average attrition rate of about 15%). Lets also assume we are signing 10 new clients a month.  If this is the case, you reach an equilibrium after 18 months where you are getting paid for 57 licenses each month (and you are netting $5700), and unless something changes, you will not grow beyond this point.

Fixed term overview

Now for a fixed term contract, you have a somewhat different picture. Generally, attrition rates are much higher, so lets assume an attrition rate of 90% (after the initial fixed period), 10 sales a month, and a fixed term of 12 months. Because of the fixed term, you only start losing clients at the end of the period (Not always true, but a good approximation).

This means that for the first 12 months you are growing by 10 licenses a month until you reach 120 after 12 months. At month 13, you lose 90% of your clients from month 1, so you only grow by 1 license. Unless anything changes, this will keep happening every month, and at the end of 18 months, you will have 126 contracts (for a monthly income of $12 600).

So what does this mean?

On the surface, it looks like it is much better to sell on a fixed term, since after 18 months, you will be getting more than double what you would if you had sold on a monthly. Unfortunately, this is not necessarily true. The first risk is that it is much harder to sell a fixed term contract,  but even if you assume it is twice as hard, and you can only sell 5 licenses, you still have 66 licenses after 18 months, so it still looks like a better model.

Here’s the big problem though. You always have to sell at least as many licenses as the same month last year. Let’s assume you have a great salesperson for the first year and he sells 15 licenses a month and then leaves for a new job. Now a new person comes in and only does 5 sales a month.

Now you have 180 licenses after 12 months, but only132 after 18 months and 84 after 24 months, at which point it starts growing by 1 license a month again.

So what, you’re still making more money

While you are still making more money, the problem is that you have wildly fluctuating net incomes, and you just can’t be sure what your income will be in 3 months time. This isn’t conducive to a long term business.

If you factor in the licenses that will be canceled in the middle of the license period, you could have negative growth very easily. This can happen because businesses go bankrupt, owners die or emigrate, they find a better deal and just stop paying, etc.

This is true for both models of course, but changes will tend to be more sudden and dramatic with the fixed term contracts.

To a large degree, both models are pretty similar. The only real differences are the initial growth periods before we reach equilibrium, the number of licenses at the equilibrium, and volatility of your income.

Click here to view a spreadsheet with the maths

Graphs to show what the growth curves will look like:

In the next post I’ll explore ways to increase your income in both of these models.

What everybody ought to know about software distribution

Ok, maybe not everybody… But everybody that publishes or distributes software needs to understand the inherent risks in their business.

As a software developer, this is obviously a problem I can relate to.  This is what I’d like to discuss in a bit more detail:

  1. How are software sold. The easy way and the way that will make you money.
  2. Understanding monthly licensing models.
  3. Increasing monthly incomes and growing your business.
  4. Summary of opportunities and problems.

First, how are software sold?

Software distribution isn’t necessarily difficult. Let’s say you’re selling a product for $30, All you need to do is find people that are interested in your product, sell them on the idea, collect their orders, and then get the product to them.

This is the basic model for selling anything, but with software, it’s usually even easier, since there is no physical product, so you can automate the whole process.  You can find prospects by using Google adwords or through a web page optimized for search engines for example, you can sell them on the concept on the web page, and you can have automated systems that get them to pay using a credit card and then give them access to download the product they paid for.

Ok, so where’s the problem? It sounds simple.

It is simple. It’s also wrong. You can make money this way, but you’ll never have a long term business. If you stop actively selling the software, you’ll run out of money pretty quickly.

If you want to make more money (And isn’t that always the goal in business?), you have to sell to companies at a higher price, and you have to sell at a monthly fee. This means you need to convince a company to pay $100 a month (For example), rather than pay a once off fee.

What about hardware?

On top of that, lets say that you need some hardware bundled with your software. Now you have new problems:

  1. You need to pay for the hardware.
  2. You need to warehouse the hardware.
  3. You need to ship the hardware when a sale is made.
  4. You probably need to pay more for packaging of a physical product.
  5. You (or the client) need to insure the hardware.

From this, it is clear that you didn’t just increase the amount of money it costs to distribute your product, you also added a great deal of new logistics.

So how do you deal with this extra complications?

  1. Charge more per month.
  2. Charge an upfront fee for hardware and shipping.
  3. Contract for a fixed term (e.g. 1 year).
  4. Any combination of the above.

Of course, by doing any of the above, you make it harder to close the initial sale, which probably means smaller closing ratios and more sales visits to the client until you can convince a decision maker to buy your product (Assuming you are actually going to your clients and selling that way).

However, these problems only really make it harder to close the sale, and they add extra costs and logistics, but they don’t significantly affect the licensing model.

In the next post, I’ll explore the licensing model on both fixed and variable term licenses so we can understand how much money we’ll make, and then after that, we can look at how we can increase those amounts.

Is “Free” really the future?

I just saw an interesting article by Seth (Malcolm is Wrong), and figured I’ll put in my opinion as well. So, I’m going to comment on an article by Seth Godin where he comments on a review by Malcolm Gladwell on a book by Chris Anderson. Still here after that? Ok, let’s carry on then – This gets less confusing (I think).

The debate so far

Essentially, Chris claims in his book “Free” that often businesses can profit more from giving things away than they can by charging for them. He argues that giving away things for free is more that a promotional strategy, and that it will be key to the survival of your business in the future. He argues that because cost of storage, bandwidth and processing power has been reduced to a number small enough to zero, that information tends to go in the same direction and wants to be free.

Malcolm’s opinion

Now that you have the basics, lets start with Malcolms opinion. And you should really read his article, it is quite interesting (Priced to sell). In a nutshell, Malcolm believes that Chris ignores the fact that other infrastructure and the creation of that info will still cost money.

I don’t know if it was intentional, but Malcolm also seems to hint at the fact that humans are usually greedy, so companies will generally do their utmost to resist this trend.

Seth’s Reply

Seth starts out by stating that we are asking the wrong questions. We ask whether free should be the future, when that doesn’t matter, because it is already, what we feel is irrelevant. And we ask how this will support the world as we know it, which is even more absurd.  Since it is happening, the world will have to change. Now this reminds me of the media companies trying to get the betamax/VHS banned (I forget which), because it could be used to pirate their movies… Eventually those companies had to change their world to accommodate the new technology, and ultimately that made them a lot of money (Now think about their current fight against P2P sites and you may start to see a trend).

Now essentially, Seth is arguing that because of low barriers to entry and the fact that anybody can produce information will mean that people can provide that information for less (or even free), either because they can still make a profit, or because they just love what they do and don’t care about a profit. Because of this, for businesses to compete, they will have to be able to offer information for free as well.

So, essentially, free is here to stay because somebody will always provide free information. You’d still be able to sell information by packaging it differently or selling it as a kind of souvenir, People will always pay for something tangible if they love the topic enough. Although there is a lot of confusion right now, there are also a lot of opportunities for the brave.

Ok, so much for the history lesson. You can follow the debate here.

Free makes me think of piracy – How do we link this to The Pirate Bay?

I thought this was interesting in light of the recent Pirate Bay trial, subsequent guilty verdict and then sale of The Pirate Bay to Global Gaming Factory.  Now while the trial was an interesting study in exactly how much power the media companies have and exactly how little regards for the law or the judicial system they have, that is not what this post is about.

What this is about is Global Gaming Factory’s vision of what they want to do with The Pirate Bay.  Essentially, their reasoning is that they are buying the 20 million or so users that already use The Pirate Bay, and then they can use that as a seed group to launch a business using a strategy that has never been tried before.

Global Gaming Factory’s vision for The Pirate Bay

Essentially, Global Gaming Factory wants to license the content on The Pirate Bay with the various media companies and pay them their royalties for every download. To do this, they now obviously need to sell this content to the users. Then where they get clever, and I think this is the first business model that could successfully make use of file sharers, Is that they will pay users for uploading and sharing the files they bought with other users that paid for that file. This means that media companies are now getting their customers to pay for the bandwidth and storage and giving the customers less money for doing that than they would have paid for it themselves.

Global Gaming Factory will also put filters in place to try and stop illegal uploads, and they have bought Peerialism who was busy building an upgrade to the Bittorrent protocol that would try to download from peers that are geographically closer to you, maximising download speeds and minimising costs to ISP’s. They even suggest that ISP’s would buy this upgrade from them to manage their traffic and minimize costs internally.

Why this can never work

Now this all sounds viable, and I definately think this could be a model that we’ll see a lot of in future, but, I also think that Global Gaming Factory has just wasted $8 million.

They assume that a significant percentage of the 20 million pirate bay users that has been downloading for free for the last several years will start paying for their downloads now. Even though Global Gaming Factory will pay for their uploads, it obviously has to be less money than the content will cost in the first place, otherwise media companies are paying you to download their content (And for some reason they are opposed to that idea).

I think the model is viable, but you need to pitch the idea at people that are willing to pay, not the people that have been pirating your stuff for the last decade…

Update (29 July 2009):  You can now download free versions of various digital formats here:
http://www.longtail.com/the_long_tail/2009/07/free-for-free-first-ebook-and-audiobook-versions-released.html

Apparently the unabridged audio will always be free. The other versions will only be free for a while (based on sales).