Www.idc.com October, 2004 The Recurring Revenue Revolution: How Much, How Fast, and Know-How Amy M. Konary Program Director Software Pricing, Licensing,

www.idc.com

October, 2004

The Recurring Revenue Revolution:How Much, How Fast, and Know-How

Amy M. KonaryProgram Director

Software Pricing, Licensing, and Delivery

AgendaAgenda

Key Trends Industry PerspectivesGrowth ProjectionsNext PracticesEssential Guidance

IDC BackgroundIDC Background

Global market intelligence and advisory firm on IT and telecommunications industries

700+ analysts worldwide

Founded in 1964

U.S. headquarters in Framingham, MA

50 offices in 42 countries

Subsidiary of IDG, an industry-leading media, research, and events company

In the Midst of Major ChangeIn the Midst of Major Change

Licenses Kill

TechWeb, 4/2004

“WW growth of software subscriptions will outstrip perpetual license…” Forbes,

7/2004

Software Licensing to Morph Information Week, 3/2004

Software-Licensing Market Taking New Shape

VARBusiness, 8/2002

Shift to Subscriptions Means More Choice for CIOs

CIO, 5/2004

Big Changes in Licensing?

CRN, 4/2004

Pay-as-you-go software at a VAR near you

Computer Dealer News, 6/2004

Software Licensing Grows Complex

Network World, 7/2004

“Software is dead”

Marc Benioff, Chairman, SalesForce.com

“Software is dead”

Shaun James Browne, SuperPowerNet.com

“Software is dead”

National Post Online

“Software is dead”

Bruce Fram, Silicon Valley Entrepreneur

“Software is dead”

Jack Mamais, Heavy Gear 2 Director

“Paying for software is dead, too”

InetBlog

Change is in the Air…Change is in the Air…

52%56%

65%

60%

67%

56%

0%

10%

20%

30%

40%

50%

60%

70%

Yes, wemadechanges inthe last year

Yes, we areconsideringchanges inthe nextyear

Q.- “Have you made changes or are you considering making changes to your licensing model?”

(% o

f re

sp

on

de

nts

)

35% of vendors that made changes in the last year are considering changes in the next year too

N = 107Source: IDC’s Future of Software Licensing Study, Q46 Vendor Survey 1, 2004

Change is in the Air…Change is in the Air…

14%

15%

42%

14%

15%

20%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Subscription/Maintenance

Simplified/UnifiedLicensing Approach

Pricing Meter (eg: per user,per CPU)

Last Year This Year

Vendor- “Please describe the changes”

N = 62 and 60Source: IDC’s Future of Software Licensing Study, Q54 Vendor Survey 1, 2004Note: Multiple Responses

Shift from One-Time to AnnuityShift from One-Time to Annuity

One-Time Annuity

REVENUE APPROACH

Indirect

Direct

SA

LE

S A

PP

RO

AC

HPREDICTABILITY

VOLATILITY

80%

15%

5%

Why the Revolution?Why the Revolution? It’s becoming increasingly difficult to make money as a software provider

Customers continue to be cautious with spending Discount levels are trending upward No “killer app” on the horizon

The lines between software and service are blurring New delivery models New competitors offering hybrid software/service models

Vendors are searching for sources of predictable, recurring, revenue Vendors want to get off of the “perpetual” merry-go-round The financial community is pushing for this… sort of

Before We Proceed- License DefinitionsBefore We Proceed- License Definitions

Subscription License- Subscription licenses are paid for with a recurring (often annual) fee to continue using the software. The customer does not own the software license.

Perpetual- Perpetual licenses are paid for on a one-time basis, giving the user the right to run the program as long as he/she chooses. It does not imply a right to upgrades, which are typically sold separately as part of a maintenance agreement or on a per-upgrade basis. Some vendors sell perpetual licenses on a term basis, which on the surface appears to be subscription based because the payments are spread out over time. However, from a deal perspective, it amounts to a financing approach in which either the vendor or a third party helps amortize payments over a specified period. The software does not stop running after that time period, and the customer is granted a perpetual license.

Maintenance DefinitionMaintenance Definition

Software Maintenance- An agreement between the licensee and software developer through which the developer continues to improve the packaged software product by repairing known faults and errors or enhancing, updating, or upgrading the product. It may also include technical support and is generally priced as a percentage of either the net or list license cost.

Vendors on Maintenance and SubscriptionVendors on Maintenance and Subscription

In the next year, will your maintenance revenues represent an additional 10% or greater of your total revenues relative to last year?

In the next year, how likely is it that your company will use maintenance as a primary vehicle to offer additional services, rather than just a version upgrade insurance

27% of vendors think this is highly probable

26% of vendors think this is highly probable

In the next year, how likely is it that the software industry will move toward subscription licensing?

33% of vendors think this is highly probable

The Macro Environment- CustomersThe Macro Environment- Customers

Suspicion abounds… conspiracy theorists flourish Dissatisfaction with vendor licensing practices Customer expectation that the vendor is trying to squeeze as much money out of

them that they can

In 2003, customers allocated an average of: 33% of their software budgets to new license 25% of their software budgets to upgrades 20% of their budgets to maintenance

From 2004-2005, customers will increase the % of their software budgets on maintenance at the expense of new license and upgrades

Software Maintenance IncreaseSoftware Maintenance Increase

5%

7%

11%

16%

33%

16%

9%

4%

0% 5% 10% 15% 20% 25% 30% 35%

(-20) - (-39)

(-1) - (-19)

0

1-9

10-19

20 - 29

30 - 39

50 - 59

Customer – “By what %, if any, do you expect the percent of your IT budget spent on software maintenance to increase or decrease from 2004 to 2005?”

(% of respondents)

(% in

crea

se o

r d

ecre

ase)

N = 57Source: IDC’s Future of Software Licensing Study, Q5 Customer Survey 2, 2004

Customers on Maintenance and SubscriptionCustomers on Maintenance and Subscription

Will vendors begin to use maintenance as a primary vehicle to offer additional services, rather than just a version upgrade insurance

Do you expect the cost of maintenance to increase?

48% of customers think this is highly probable

42% of customers think this is highly probable

In the next year, how likely is it that the software industry will move toward subscription licensing?

33% of customers think this is highly probable

Software Market ForecastSoftware Market Forecast

0

50,000

100,000

150,000

200,000

250,000

300,000

2003 2004 2005 2006 2007 2008

Maintenance

Product License

Worldwide Software Market Revenues, 2003-2008, ($M)

41%49%

Why Customers Purchase MaintenanceWhy Customers Purchase Maintenance

10%

18%

35%

35%

43%

0% 10% 20% 30% 40% 50%

Makes sense/saves moneyin the long run

To getupgrades/updates/support

Required in order to get adiscount

Company policy

Required as part of thesoftware purchase

(%) of respondents N = 40; Applications onlySource: IDC’s Future of Software Licensing Study, Q25 Customer Survey 1, 2004

Customer- “When you purchase maintenance/ subscription, is it because…”

Perspectives on SubscriptionPerspectives on Subscription

Vendor Predictable revenue Low up-front cost for

customer Upgrades

Customer Upgrades Relationship with or

support from vendor Low up-front cost for

customer

Subscription ProsVendor Revenue disadvantages Complexity or cost for

vendor Onus on value for vendor

Customer Long-term cost Unpredictable cost Automatic upgrades

Subscription Cons

Software License ForecastSoftware License Forecast

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2003 2004 2005 2006 2007 2008

Perpetual License

Subscription License

Worldwide Software License Revenues, 2003-2008, ($M)

81%66%

•Launched Software Assurance in 2003

Next Practices- MicrosoftNext Practices- Microsoft

•What they did right:Made the upgrade purchase process easier for customersIncluded additional services beyond upgrades that addressed customer pain points, such as eLearning, home use rights, and training

•Where they fell short:Did not ensure upgrades would be valuable to customersDid not communicate the benefits of the additional services effectively

•Company has offered a subscription model for decades

Next Practices- SAS InstituteNext Practices- SAS Institute

•What they do right:Philosophy- Move customers’ businesses forwardSimplicity (usage rights to the software during the paid period, including maintenance, Tech Support, bug fixes, updates and new releases)The model requires that SAS be accountable for innovative, reliable software year after year

•Why they have an advantage?They’ve been doing this all along

•CA moved to ratable revenue recognition

Next Practices- Computer AssociatesNext Practices- Computer Associates

•CA offers a licensing portfolioIncludes subscription for specific purposes

•Why they have an advantage?CA has factored their own receivables for years CA made the shift when the chips were already down

•Why they had a disadvantage?Reduces their market share in a revenue view Hard to anticipate market reaction

Essential GuidanceEssential Guidance

•Consider the benefits of maintenance or subscription:Revenue benefitsBenefits WRT your relationship with the customer and the customer’s allegiance to the softwareOpportunities to encourage customers to use valuable tools and services

•Consider how to build recurring $ without sinking the ship:Licensing portfolioIncrease maintenance renewalsEvery situation will be unique

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Questions?Questions?