There are numerous ways of selling software these days. Software as a Service (SaaS) has been in the consumer market for a while, and is now making significant inroads into the enterprise software space. If you’re considering purchasing or using software, you should understand what SaaS means and how it differs from software products of the past.
This article is not about the challenges of product management for a SaaS product, nor is it about multi-tenant architectures and other SaaS implementation details. This article looks simply to compare—from the customer’s point of view—software purchased as a service versus software purchased as a product.
Software as a Service is an interesting concept. It implies that, instead of purchasing the software, you are purchasing it as a service—which really means the right to use the software.
You are also (usually) purchasing a hosting and infrastructure service along with the rights to use the software. SaaS providers maintain the hardware, perform upgrades, backup your data (sometimes), and otherwise perform all of the “keep the lights on” services and activities required to keep the software running.
Imagine a typical, 1990s style software purchase:
Now imagine that you’re outsourcing all of the “keep the lights on” activities above:
That’s one of the benefits of purchasing SaaS. To really grasp the economics of SaaS you have to contrast it with the economics of software license purchases.
There is a widespread misunderstanding about purchasing software. In the last section, we used the word “purchase,” but that isn’t completely correct. You don’t purchase a copy of the software; you purchase a restricted license to use the software.
You probably have heard the phrase “site license,” which means that you are purchasing the right for everyone in your building (or company) to use the software.
Sometimes software is sold in terms of “numbers of seats”—the number of people that are licensed to use the software at any one time. You might have 100 engineers who share ten seats (single-seat licenses) of analysis software. Since each engineer only spends about 5% of his or her time using the software, they can easily share licenses. At any given time, five engineers (on average) will need to use the software. With a license for ten simultaneous users, each engineer is likely to be able to use the software whenever he or she desires.
So, even when you think you are purchasing software, you aren’t. As with SaaS, you are purchasing the right to use the software.
There are infinite creative ways to purchase a software license. The most common situation is that you purchase a license, and then later purchase upgrades.
An obvious example is Microsoft Office (productivity software). Microsoft releases a new version of Office every couple of years. If you own the previous version, you can purchase an upgrade for less than the cost of buying the software for the first time. You are not required to purchase an upgrade, of course, but you may want to in order to capitalize on the latest features and fixes—and to stay current. If the people with whom you work all upgrade, you may want to upgrade, too—so that you can use the documents they create.
Microsoft does a good job of providing free utilities to read documents from the newer versions, and allowing people with newer versions to create documents that can be used by people with older versions. Microsoft, therefore, gives you a choice. They rely on market forces to create the pressure to upgrade, but you never have to upgrade.
On the other hand, Intuit, makers of Quickbooks (small business accounting software), is a little pushier. Intuit releases a new version of the software every year. Once a new version of Quickbooks is released, support for some or all of the integrated online services is dropped for older versions of the product. You can continue to use your old version, unless you want to use one of the integrated services.
When companies sell software (licenses), they usually sell a version of the software, and then make updates to that software with some frequency—anywhere from daily to annually. Companies also manage those updates as two distinct types of updates:
To understand the economics of software license purchases, you have to look at both the value over time and the costs over time of purchasing a software license.
To keep this simple, we’ll assume the model described previously—minor updates happen frequently and are free, and major updates require the purchase of an upgrade to the latest version of the software. We’ll also assume that every new update introduces something valuable to the customer.
Scott has been helping companies achieve Software Product Success since 1997, and started Tyner Blain in 2005. Scott is a product management and strategy consultant, and a visiting lecturer for DIT's Product Management program. Scott has managed teams from 5 to 50, and delivered millions of dollars in value to his customers. You can reach Scott at.