Perpetual vs Subscription based Licenses of Software
All Software are originally written plain vanilla, without any inbuilt or self generated codes to check validity for any license or any expiry date. However considering commercial factors, additional codes are introduced into a software to validate for licenses and/or expiry dates.
Consider the economics of Licenses, which are of two types – paid licenses and unpaid licenses (free to use licenses).
Consider the economics of Licenses, which are of two types – paid licenses and unpaid licenses (free to use licenses).
Let us also examine the difference between perpetual licenses and subscription based licenses.
In perpetual licenses, there is perpetual validity for the license or in other words, there isn't any expiry date. This ensures that if we purchase a software having perpetual license, then it is upto us to use it lifelong, without incurring any additional cost, except and unless we propose to upgrade it with the patches and builds that the OEM of the software releases from time to time, released usually for fixing reported bugs or any other enhancements that they might have carried out as an outcome of their regular innovations and R&D.
In the subscription model, the subscriber has to pay to the OEM, a fixed amount at regular periods of time so as to maintain the continuity of the subscription. Any default by way of discontinuing the subscription at any point could attract penalty as well as discontinuity of services subscribed to. The OEM might also charge reinstatement charges if the subscription were to be renewed for another term.
Whereas in the perpetual mode, there would be an initial investment which may be proportional or according to the cost of the development and other marketing costs that the OEM might wish to build upon, as the price of the software. In the subscription mode, the developmental costs are usually spread out in time so that the initial investment cost by the subscriber would be reduced considerably.
Subscription licensing are targeted mostly to fly-by-night service companies, start-ups or small companies (viz. SMEs, MSMEs etc.) who themselves might not exist in their respective field of business more than the age of the software they intend to purchase.
Perpetual License models are more welcome in large organizations of the like of Global Fortune listed companies, who look for long term investments, with short as well as long terms gains and without the need for employing resources more frequently, encountering the pains of repeating implementation cycles. It would rather be more ideal for them to focus on their core-business than to go for cycles of re-purchases & re-installations often.
Subscription licensing are targeted mostly to fly-by-night service companies, start-ups or small companies (viz. SMEs, MSMEs etc.) who themselves might not exist in their respective field of business more than the age of the software they intend to purchase.
Perpetual License models are more welcome in large organizations of the like of Global Fortune listed companies, who look for long term investments, with short as well as long terms gains and without the need for employing resources more frequently, encountering the pains of repeating implementation cycles. It would rather be more ideal for them to focus on their core-business than to go for cycles of re-purchases & re-installations often.
Subscription Licenses could be thought of as akin to the EMI that we pay for Loans taken. The overall outgo would be much higher, but the initial outgo would be much lower.
Where the interest rates are comparable, quite often than not, the EMI would turn out to be costlier than the single initial investment. Though the catch would be, about the availability or not of outright funds.
Where the interest rates are comparable, quite often than not, the EMI would turn out to be costlier than the single initial investment. Though the catch would be, about the availability or not of outright funds.
How to equate?
Very often one would think as to how to decide on which model to go for – whether the perpetual model or the subscription model. For example, when tenders are called by profit making companies or organizations that possess sound investment capability and can also leverage the benefits of depreciation, it becomes very essential to differentiate and ponder over the benefits and demerits, before taking the decision to pick from amongst the two. Public Sector companies would be all the more interested to assess both, as they are responsible for their investments to Govt. as well as the Public and are subject to scrutiny.
Following is an attempt to address the problem so that it could be handled satisfactorily.
We will see that there is no doubt to the fact that perpetual licensed software have lesser total outgo than a subscription licensed.
However, following tries to find out a minimum viable ratio between Perpetual License cost and Subscription License cost for a same or similar product, above which Subscription License should be preferred over Perpetual License.
However, following tries to find out a minimum viable ratio between Perpetual License cost and Subscription License cost for a same or similar product, above which Subscription License should be preferred over Perpetual License.
The formulation:
A software product is usually priced with the following components.
SNo.
| Description
|
Symbol
|
Remarks
|
|---|---|---|---|
a.
|
Price of the Product
|
P
|
Includes the developmental cost of the product, its marketing cost, and other operational costs.
|
b.
|
Price of AUS – Annual Upgrade and Update Services as a percentage of the price of the product
|
U
|
AUS includes the cost of R&D and continual improvements and feature enhancements that the software takes up as per feedback from the users from various quarters, bug fixes, version and build updates etc.
|
c.
|
Price of AMC – Annual Maintenance Contract Services as a percentage of the price of the product
|
M
|
Relates to services on account of addressing tickets raised for issues, L1, L2, L3 support resources, resolution of the tickets etc.
|
d.
|
Rate of Escalation to be applied Year-on-Year on the AUS price
|
V
|
AUS Escalation could be due to various reasons, viz. USD fluctuations, rising cost of research and development etc.
|
e.
|
Rate of Escalation to be applied Year-on-Year on the AMC price.
|
N
|
AMC Escalation could be due to various reasons, viz., rising cost of human resources for support, maintenance of infrastructure for grievance redressal, ticket raising, bug fixing etc.
|
f.
|
Rate of Depreciation is the rate of depreciation as a percentage that is allowed by rules of the laws of the land.
|
D
|
Depreciation brings down the value of the asset / software and contributes to the P&L (Profit & Loss) Account of the organization.
|
g.
|
Time value of Money – Discounting rate and that including any other that contributes to depreciation of money value over the period
|
T
|
Rate in percentage also includes the Discounting rate, considering the borrowing rate etc.
|
h.
|
Rate of Escalation of AUS plus 1.0
|
V1
|
V1 = (1 + V)
|
i.
|
Rate of Escalation of AMC plus 1.0
|
N1
|
N1 = (1 + N)
|
j.
|
Time Value of Money plus 1.0
|
T1
|
T1 = (1 + T)
|
k.
|
Asset value after Depreciation.
ie. Depreciation rate deducted from 1.0 |
D1
|
D1 = (1 - D)
|
l.
| Rate of Appreciation - any annual appreciation in the software asset as a percentage of the price of the product | A | If any annual appreciation can be assumed by virtue of say, upgrading the system etc., then this may be used. (If allowed as per law, AUS itself may be one of them) |
m.
| Rate of Escalation to be applied Year-on-Year on Appreciation | B | Escalation Year-on-Year on the Annual Appreciation |
n.
| Escalation on Appreciation plus 1.0 | B1 | B1 = (1 + B) |
Case 1: Perpetual License
When a product is purchased based on perpetual license, it means that we have to consider the following.
- The Purchase Price of the product ⤍ P
- AUS to be paid yearly ⤍ U
- Escalation on AUS year-on-year ⤍ V
- AMC to be paid yearly ⤍ M
- Escalation on AMC year-on-year ⤍N
- Depreciation ⤍ D
- Appreciation ⤍ A
- Escalation on Appreciation ⤍ B
- Time Value of Money ⤍ T
- (1 + V) ⤍ V1
- (1 + N) ⤍ N1
- (1 + T) ⤍ T1
- (1 - D) ⤍ D1
- (1 + B) ⤍ B1
Let us observe the cash outflow step by step.
Initially we start with total outgo Factor on account of the Principal (i.e.,for Perpetual License), year on year.
Year
|
Amount paid
|
Remarks
|
|---|---|---|
Y0
|
P
|
First AUS is usually included. Hence Y0 is initial outgo.
|
Y1
|
P(U + M) / T1
|
AUS plus AMC is the first year end outgo. Divided by T1 to get the Present Value (PV).
|
Y2
|
P(UV1 + MN1) / T12
|
AUS with escalation applied and AMC with escalation applied. Divided by T12 for PV.
|
Y3
|
P(UV12 + MN12) / T13
|
AUS with escalation applied Year-on-Year and AMC with escalation applied Year-on-Year. Divided by T13 for PV.
|
Yn
|
P(UV1(n-1) + MN1(n-1)) / T1n
|
AUS with escalation applied Year-on-Year and AMC with escalation applied Year-on-Year. Divided by T1n for PV.
|
∑Yi = |  | ||
 |  | ||
 |  | ||
We now examine the Depreciation Factor year on year. At the end of First Year the principal would have depreciated. However, for the purpose of creating a generalized function, let us assume that there is an appreciation factor applied along with the depreciation. (Note:- If AUS be considered as appreciating component, then 'A' could also take the value of AUS).
Year
|
Amount paid
|
Remarks
|
|---|---|---|
Y1
|
PD / T1
|
Depreciation charged. Divided by T1 to get the Present Value (PV).
|
Y2
|
PD(D1 + A) / T12
|
Net Asset = A + D1 which has to be applied to P to arrive at the Current Asset Value (WDV). Depreciation is thereafter applied on it. Finally, Divided by T12 for PV.
|
Y3
|
PD(D12 + AD1 + AB1) / T13
|
Multiplied by D1 on Previous year WDV. Added Appreciation with Escalation of Appreciation Year-on-Year. Finally Divided by T13 for PV.
|
Y4
|
PD(D13 + AD12 + AD1B1 + AB12) / T14
|
Multiplied by D1 on Previous year WDV. Added Appreciation with Escalation of Appreciation Year-on-Year. Finally, Divided by T14 for PV.
|
Y5
|
PD(D14 + AD13 + AD12 B1 + AD1B12 + AB13) / T15
|
Multiplied by D1 on Previous year WDV. Added Appreciation with Escalation of Appreciation Year-on-Year. Finally, Divided by T15 for PV.
|
Yn
|
PD { D1(n-1) +
A(D1(n-1) - B1(n-1)) /
(D1 – B1)
} / T1n
|
Multiplied by D1 on Previous year WDV. Added Appreciation with Escalation of Appreciation Year-on-Year. Finally, Divided by T1n for PV.
|
∑Yi =
|  | ||
 |  | ||
 |  |
Case 2: Subscription based License
When a product is purchased based on subscription license, it means that we have to consider the following.
- The Subscription License Price of the product ⤍ S
- Escalation in Subscription License Price ⤍ X
- AUS & AMC are included in the Subscription License and hence need not be taken at all.
- There is no Depreciation that can be charged.
- Time Value of Money ⤍ T
- (1 + T) ⤍ T1
- (1 + X) ⤍ X1
Year
|
Amount paid
|
Remarks
|
|---|---|---|
Y0
|
S
|
Initial Subscription License Fee
|
Y1
|
S X1 / T1
|
Subscription License Fee for the 2nd year. Escalation applied. Finally, Divided by T1 for PV.
|
Y2
|
S X12/ T12
|
Subscription License Fee for the 3rd year. Escalation applied. Finally, Divided by T12 for PV.
|
Yn
|
S X1n/ T1n
|
Subscription License Fee for the (n+1)th year. Escalation applied. Finally, Divided by T1(n-1) for PV.
|
∑Yi = |  | ||
 |  | ||
If T <> X, then
 |  | ||
If T = X, then
 |  |
The Comparison & the Multiplying Factor:
Let us assume that there exists a ratio between perpetual and subscription license that could be used as a thump rule.
In that case, we would have the SP-Maximal Ratio:-
Total Outgo on Perpetual
Total Outgo on Subscription
Therefore considering Break-Even point, we can equate:
Equating it from the principal values, we get:
 |
 |
The Corresponding Excel formula is as given below:-
=((1 - (SubscriptionEscalationMul/TimeValueMul)^(year+1))/(1-(SubscriptionEscalationMul/TimeValueMul))) / ((1+AUSrate*(1-(AUSescalationMul/TimeValueMul)^year)/(TimeValueMul-AUSescalationMul) + AMCrate/(TimeValueRate-AMCescalationRate)*(1-(AMCescalationMul/TimeValueMul)^year)) - DepreciationRate*((1-(DepreciationMul/TimeValueMul)^year)/(TimeValueMul-DepreciationMul) + AppreciationRate / TimeValueMul * ((1-(DepreciationMul/TimeValueMul)^year)/(TimeValueMul-DepreciationMul) - (1-(AppreciationEscalationMul/TimeValueMul)^year)/(TimeValueMul-AppreciationEscalationMul))))
For the following values the Graph is as follows:
Description
|
Rate
|
Multiplier (Mul)
| |
AUS (Software Upgrades/Updates) Rate
|
8.0%
|
8.0%
|
108.0%
|
AUS Escalation - YearOnYear Rate
|
5.0%
|
5.0%
|
105.0%
|
AMC Charges - Rate
|
8.0%
|
8.0%
|
108.0%
|
AMC Escalation - YearOnYear Rate
|
5.0%
|
5.0%
|
105.0%
|
Interest/Inflation Rate for Calculating Present Value of Money
|
10.6%
|
10.6%
|
110.6%
|
Capital Depreciation Rate for Software
|
40.0%
|
60.0%
| |
Appreciation Rate
|
100.0%
| ||
Appreciation Escalation - YearOnYear Rate
|
100.0%
| ||
Subscription Escalation Rate
|
5.00%
|
105.0%
|
As it can be seen from the above, for the assumed values, a minimum of 7 would be a reasonable multiplying factor considering that the benefits of having perpetual licenses will always ensure continuity of operations especially when the operations are critical in nature. In other words, in the specific example, asking for a 7 year or more upfront subscription could be considered as equivalent to a perpetual license, provided that the subscription could be extended every year by paying subscription license fees every year from the first year onwards itself, so that at any point in time, the validity of the license would be minimum of 7 years.
In the context of an organizational requirement, clauses like the following would add strength & safeguards to our interest in the long run if at all we have to go for subscription based licensing model in the purchase of any software system that is intended to have long shelf life (or end-of-life (EoL) as it is popularly known).
Note:- The TWENTY and SEVEN are indicative only and corresponds respectively to Expected Life of Software and the policy on mandatory data retention period for audit purpose.
In the context of an organizational requirement, clauses like the following would add strength & safeguards to our interest in the long run if at all we have to go for subscription based licensing model in the purchase of any software system that is intended to have long shelf life (or end-of-life (EoL) as it is popularly known).
Note:- The TWENTY and SEVEN are indicative only and corresponds respectively to Expected Life of Software and the policy on mandatory data retention period for audit purpose.
Perpetual License is understood as, That the software will NOT STOP performing & shall CONTINUE TO WORK as it has been working in its last known working state, post implementation & go-live, even if any licenses applied on the software might have expired anytime.
Subscription License is understood as, That the software shall at any time have a validity, before which it shall NOT STOP PERFORMING & shall CONTINUE TO WORK as it has been working in its last known working state, post implementation & go-live, for a period of not less than SEVEN years and that the validity shall further with continuity get extended by another year, on payment of each & every annual subscription charges quoted herein, without any break in the period of extensions & by maintaining continuity for an effective overall validity of not less than TWENTY years.
"In case of Subscription License Option, if a break in continuity inadvertently happens, proportionate subscription charges for the broken period is also payable inorder to maintain continuity; however re-instatement charges or any other charges would not be payable.
The annual subscription charges are payable every year till TWENTY years or till that year it is declared to the OEM in writing, that the specific software has been shutdown, removed from production deployment and will not be used except for historical record verification as per extant policies of data retention, and shall be permanently deleted from all instances wherever it was permitted to be installed, after the expiry of the data retention period."
The annual subscription charges are payable every year till TWENTY years or till that year it is declared to the OEM in writing, that the specific software has been shutdown, removed from production deployment and will not be used except for historical record verification as per extant policies of data retention, and shall be permanently deleted from all instances wherever it was permitted to be installed, after the expiry of the data retention period."
| AUS (Software Upgrades/Updates) Rate | % | AUS Escalation - YearOnYear Rate | % |
| AMC Charges - Rate | % | AMC Escalation - YearOnYear Rate | % |
| Cost of Capital / Interest,Inflation Rate for calculating Present Value of Money | % | ||
| Capital Depreciation Rate for Software | % | ||
| Capital Appreciation Rate (if any) | % | Capital Appreciation Escalation - YearOnYear Rate | % |
| Subscription License Escalation - YearOnYear Rate | % | ||
|
Proposed Life of Software / Expected Utility Age : | years
| ||
|
Minimum Multiplying Factor for Equating Subscription License to Perpetual License for the above parameters = (This means that considering above lifetime of the software in years and other parameters as input above, Subscription License should be preferred only if the product of Annual Subscription amount and the calculated Multiplying factor is LESS than the Price of the Software available on Perpetual License Model. In other words, the calculated Multiplying factor is the minimum that should be considered inorder to derive the advantages/benefits of Perpetual Licensed software even in a Subscription Model.) |
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