Software Business models

Hub owner: BRUNO SANTOS - Last updated on: 9th December 2022

While technical teams have the difficult role of evaluating software systems based on solutions' technical value, for procurement people comparing offers from different suppliers with a mix of business models is also not an easy task. To help with their selection process it's common to work with Total Cost of Ownership (TCO) estimates. The latter is a very complex exercise, comprised of many variables that also go beyond just simply the business model.

In this article we will outline the differences in business models, and how they can be evaluated and interpreted in the context of a larger overall Total Cost of Ownership (TCO) exercise.

Commercial Model

Whether the intent is owning, renting or subscribing software, there's a commercial model for that. And selecting the most suitable model for your specific case largely depends on the type of commitment you're looking to have, how you will use the software (ranging from experimentation to permanent long-term use), and your corporate financial investment strategy. 

Perpetual or transactional 

Software is bought on a one-off basis, giving the user perpetual ownership over the license granting him the use of the software. Price is commonly based on server-based licensing, a capacity variable (e.g. number of users) and licensing of optional features or add-ons.  Usually, the software maintenance or support is charged separately, on a recurrent basis. 

Term-based (e.g. renting and leasing) 

Price grants the right-to-use specific software licenses for a given fixed term. Subscriptions can be seen as a type of leasing, but it's not uncommon for term licenses to exclude support services, whereas this would be included in a Subscription.

Subscription 

The term subscription is often used interchangeably with SaaS, but they are not the same, SaaS refers specifically also to the way the service is delivered. The subscription price includes the costs to use and consume software services, usually charged monthly or yearly. 

Subscriptions are commonly offered in tiers or packages, i.e. from basic functionality or low-caps to fully featured and higher caps (e.g. light, advanced, enterprise...). Subscription can also include floating licenses i.e. a pool of licenses that can be shared and consumed freely on an as-needed basis. This is commonly the case for software licensed per number of concurrent seats, but it can be applied to anything that can be quantified and measured. 

Subscriptions' minimum commitment ranges from monthly to multi-year, although for B2B applications and enterprise software there's usually a higher minimum; often the customer is rewarded for a longer-term commitment, getting in return predictable (and, considerably smaller) fees for steady usage. 

Pay-per-use or metering 

The most flexible model, where the charges are directly related to the actual use of the software or service and consequentially to the value the user receives. Anything that can be metered can be used to set the cost - aggregate time, number of users, CPU usage...   

Because the charges are tied to usage a user can stop at any time. It's a good fit for varying capacity needs, testing software platforms, or development platforms. 

Delivery Model

This is a key factor to factor into the TCO calculation for a given solution. It answers two important questions: where the solution will be hosted and who is responsible for it?

There are numerous factors to consider when estimating infrastructure costs and, most organizations have done this exercise, but here are a few examples for two main TCO categories:  

• upfront costs: compute, storage, networking, IT services (design, deploy) ... 
• operational costs: facility costs, electricity, internal IT staff - maintenance and operations (monitoring, patching, upgrading, updating, troubleshooting…)

It’s a decision between, Run, Contract, and Consume.  

Run - Self-hosted on-prem software or private-cloud  

Run your own infrastructure - full ownership and control over infrastructure but also full accountability. Requires internal IT staffing and has the highest upfront costs. Many variables weigh in on the operational cost. 

Contract - Hosted-application software or public cloud 

Hosting is directly contracted with the cloud service provider or other 3rd parties. Hosting fees make up most of the Operational costs. This model can benefit users with enterprise or corporate agreements with CSPs, as procurement and billing are directly between user and CSP.

Consume - On-demand 

​​​​​​​Software and hosting are a single service from the same provider, the cost is typically bundled into an all-inclusive, carefree, ready-to-consume service.  

Although there's normally a considerable premium on the service cost, this delivery method implies less commitment for the user and a "carefree" package, the upfront and operational costs mentioned above have a minimum impact. It also accelerates the delivery - no time nor budget is wasted with deploying, testing, and validating.

Examples of on-demand software include:

IaaS (backend support) - on-demand access to cloud-hosted backend infra (compute, storage, networking). Example Storage-as-a-Service. 

PaaS (build - for DevOps) - on-demand access to a shared software development environment platform for developing, running, maintaining, and managing applications. The hosting organization (service provider) is still responsible for backend infra (compute, network, storage), virtualization, OS, frameworks, 3rd party tools, security, and support services (updates, upgrades, patches…) 

SaaS (Consume) - on-demand access to ready-to-use, cloud-hosted application software.​​​​​​​ 

Accounting

As it will have implications on a company's budget it's important to understand how the expense of purchasing a certain solution is recognized. Depending on the choices made in the above delivery and commercial models, the investment in the software and/or services may fall into one or in both categories.   

CAPEX

refers to the purchase of new assets and improving existing ones. Capex is seen as a long-term investment that need to be written off over prolonged periods. Typical examples include property, equipment, and technology fixed assets (e.g. hardware) or intangible assets (e.g. software licenses, patents,…). 

OPEX

refers to expenses to support the day-to-day functioning of a business. These may include things like the lease of assets, subscription services, hosted services, engineering services, or maintenance.

It's important not to run conclusions or confuse terms - it's not because a solution is offered as a subscription that it will be a SaaS or result in 100% opex expense.