No Money Down, Zero Percent Financing

If you think objectively about pricing trends in enterprise software you can easily come to the conclusion that almost all software should be free or nearly free. I’ll sidestep the entire topic of open source because while that segment is certainly a participant, I don’t believe it’s the main driver. Also please note that this post is pretty rough in terms of having thought it all through… in other words, I’m thinking out loud here.

Let’s look at a couple of realities in enterprise software, first and foremost being that license sales are simply a proxy for the future annuity that a maintenance base is. If you could offer core application functionality that is competitive neutral as free, not only would you go a long way to eliminating a major obstacle to building a large installed base – the actual sales cycle – but you would also be able to reconfigure your entire strategy for going to market in the first place.

Enterprise software selling is a nasty and inefficient process that favors the large vendors at the expense of the rest of the market (one reason why Oracle bought all those companies, to become the largest “share of IT wallet” in their customer base). Current enterprise sales processes don’t facilitate selling across the entire market spectrum and that’s the only reason software companies ever had partners selling for them in the low end of the market, they couldn’t afford to do it direct. is turning that on it’s ear but even they have some challenges ahead of them as they grow up in enterprise accounts, and in the end they may end up looking a lot like Oracle and SAP rather than different.

If you could dramatically lower the cost of sales while horizontally scaling the customer base you could, ideally I admit, transform a hunter/killer sales force into a farming operation where the objective is the upselling of components and maximum penetration of existing accounts. In just such a scenario the sales force becomes an extension of customer support because what they are monetizing is the support part of the deal and that’s just long since moved away from the promise of upgrades. Customer advocacy in these companies could take a dramatic turn for the better if the software license component was removed, but there is the risk that it could worsen because the investment a single customer is making is considerably less and therefore the vendor may in fact re-calibrate what the expectation of satisfaction is. Another scenario is that the support side of the business would be subject to a new range of competitors that could price cannibalize the entire business… it’s a possibility but I’m not going to pretend that I can predict every unintended consequence.

The other aspect of enterprise software sales is that customers are already conditioned to expect a huge discount on the list price for the software, so going to zero, or close to it, synchronizes the actual price list to the official one… it’s like acknowledging that nobody pays MSRP so why bother having it.

There are considerable obstacles to this concept, the most direct being that you are effectively cannibalizing billions of license revenue for the prospect of rewards in the lower margin services business. Not an easy decision, I admit, but if you accept the premise that license revenue is a dead man walking then it would be irresponsible to not anticipate how to structure your business when it’s gone because of market conditions. Having said that I am also forced to admit that taking out a few billion in license revenue, even if the unit economics are improving, creates a major problem that is only fixed through dramatically upsizing the support and services side of the business, which being more people intensive could end up eroding the economics (I guess this could the call “the Dell dilemma”).

The other obstacles are tactical, such as how to compensate a sales force and report financial results. Largely solvable but hugely disruptive. Another interesting challenge is how to price support/maintenance when you don’t have the license cost denominator to work with, but again this is an opportunity for a new and creative approach to support pricing.

Lastly, not all your software should be free, just the what we would call the “core” which in our case is ERP. The segment of software products that do deserve the traditional pricing models are the “context” pieces, such as industry extensions and truly proprietary components, including analytics. I’m hesitant to even suggest this, but in many ways this is like the bubble-era tactics for “buying eyeballs” but in this case there is a rationalization that is rooted in the true economics of our market, not just the hypotheticals of a B-school case study.

15 thoughts on No Money Down, Zero Percent Financing

  1. Jeff, you’re hitting on the major dilemma facing enterprise software companies going forward. In order to transcend, one has to be willing to leave behind your current form, right? But in this case, the current form is a massive profit engine that, even if it last for just a few more years, means hundreds of millions to shareholders (both internal and external).

    Frankly I think this model can/will be tested by some of the ever-increasing private software vendors. With private equity firms lining up to take a hold of lots of mid market, slow-growing apps and tools vendors and milk their maintenance streams, one would think at least a few are going to try what you’re suggesting.

  2. Jason:
    This is an incredibly brave post given your position. I do however think the economics you propose don’t reflect the history of enterprise software and specifically the SAP experience since 1992/3. I’ll say more at my place but good for you in starting what I hope will be an intereting debate.

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  4. Jeff,
    I don’t agree with your analysis here at all.

    1. The upfront price of software is not a major obstacle to the purchasing decision, merely one component of the overall cost over the life-time of the product. Surely everyone buys on that basis. (Even if many peole forgot this in the 90s).
    2. Switching costs are very real, so the buyer’s bargaining power decreases (collapses!) immediately on purchase. Hence, I don’t think buyers are going to be induced with offers of “free software”. Its what comes next that’s just as important. Frankly, I preferred your arguments on this issue of “free” in a previous analysis of yours on open source “free”, noting it was actually a very similar business model to the traditonal model.
    3. Vendors sell BOTH initial licences and upgrades/add-ons. They are not mutually exclusive.
    4. Why should “core” software be free? It cost money to build, huge risks were taken in building it, it is still maintained, it represents IP. Its value is a function of supply/demand, but there is no basis to say it “should” be free. Just because something is a commodity, doesn’t mean it should be free. Frankly, this is what I dislike about the most common form of the open source model: the code is free, but we’ll make it back on services. Aaarrgghh. I find that as compelling and sophisticated an argument as my local pizza joint offering “free delivery”: pizza delivered free, only $15 (pick-up $10).


  5. Presuming that product development follows customer dollars (at least in the long run), does the “core” product end up getting pruned of functionality to the point where it has no value by itself? …just a razor without a blade? Is that a bad thing?

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  7.…. Run! Run!! Run!!!

    As I said on my blog a few weeks back, the threat of co-option is the single biggest threat facing botht SaaS and open-source vendors. SAP, Microsoft, Oracle and IBM are all very smart companies that can see the future especially when its right here and has billions of dollars riding on it. Jeff at SAP and similar Jeff’s at other companies are telling their emlpoyers and bosses about SaaS and Open-source and explaining the economics. It is only a matter of time before large software vendors sell software on a subscription basis and the question then becomes Is SaaS only about the payment model? or is there more to it- for example, cost of hardware, IT staff, support model etc.

    On Margins: Yes, as the industry matures the margins will get squeezed for ‘core’ offerings be it the OS, Database or ERP. Much like the utilities. What you will pay extra for is reliablility, business continuity, support, ease-of-use etc.

    Very interesting conversation… I will follow up on my blog too.

  8. I don’t know why anyone would be shocked that I would make such an argument. On one hand I think it’s pretty obvious that I am prone to independent thought and more significantly I am a huge fan of open source ideology. Dennis and Vinnie, I know your criticisms against SAP but at the same time you can’t look forward by only looking back… it’s be like driving your car looking through your rearview mirror.

    I really do believe direct selling is flawed because of the extent we (all of us) rely on it. Some amount of relationship management is good, but customers should also be able to go to a website, pick out the right products and buy them. If the process were that straightforward everything would be less expensive from the simple fact that we would not have a huge cost of sales to absorb.

  9. Dana,
    You make an interesting point, this is ultimately a packaging decision that is unavoidable given the SOA path we are on.

  10. Jeff,

    Yes, but you need a hell of a lot of marketing to get them to your website in the first place.

    Unless. Its not customers picking out components to place in their shopping trolleys, but SAP’s ISVs. In fact, I have always thought that this was Shai’s plan and model. ISVs pick out the components they want, and then add to them with their own IP and skills. And, place back on the shelves any clever components they have built so that others in the club (ISVs) can buy them. Your ISVs become your de facto sales force. Speaking of which, this is the best part of Salesforce’s AppXchangemodel.

  11. Andrew,
    We already spend a hell of a lot of $$ on marketing, I really can’t find any evidence to suggest that this would be any more complex that what we are already doing.

    Re Appexchange. Bingo.

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