Software December 9, 2009, 9:31PM EST

SAP Sets Pace on 'Flexible' Software Pricing

The German software maker is blazing new trails by letting customers pay for licenses over longer stretches. Microsoft, Oracle, and Adobe aren't far behind

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A bruising third quarter convinced German software vendor SAP that it needed to take swift action. After license sales dropped 31%, the fourth straight quarterly decline, SAP (SAP) started selling new kinds of contracts that are easier on customers' wallets.

Not long after the end of the period, which closed in September, SAP began pitching "flexible licensing agreements," to 500 customers that spend at least €1.5 million ($2.2 million) annually with SAP, the world's biggest supplier of business applications. The arrangements let customers pay quarterly or monthly fees to use SAP products, instead of buying the software outright and paying for it at the outset.

SAP for years has been giving big customers some leeway in how they pay for software, but the recent slump convinced the company that the flexibility needed to be extended more broadly. These subscription licenses are appealing to companies that may not have the budgets to spend hundreds of thousands, or millions, of dollars in one sitting for the rights to own business software in perpetuity.

Instead, more customers want to rent the software and spread out payments. "The customers that are choosing this didn't have capital dollars in the first place" to spend as a result of the recession, says SAP President and executive board member Bill McDermott. "We adapted to the trend."

Disrupted Recovery

Yet the increasing popularity of subscription deals could throttle near-term growth for business software companies as the economy recovers, since they curtail vendors' ability to collect large software licensing fees at the beginning of contracts. Companies including Microsoft (MSFT), Oracle (ORCL), and Adobe Systems (ADBE) are adding more flexible payment arrangements for customers. "It's going to disrupt the entire software industry," says Brent Thill, managing director for software research at UBS (UBS).

Growth in new software license sales—a commonly used measure on Wall Street of software vendors' business health—may not accurately reflect demand for products because subscription deals require vendors to book revenue over time. "License growth rates may not be where everyone would like to see them," says Thill. "Companies could disappoint [investors] during the recovery."

Companies looking to save money in the near term are willing to sign up for subscription software deals even though they end up being more expensive than traditional licensing arrangements, analysts say. "Cash flow is king," says Yun Kim, an analyst at Broadpoint AmTech (BPSG). "Companies will do anything they need to do to decrease up-front costs, even though it's more expensive in the longer run."

Vendors are offering the subscription arrangements in response to customers' desire to reduce the bite application software takes out of their information technology budgets. Pay-as-you-go licenses also give customers the flexibility to pay more as additional users come online with a system, instead of paying in advance for workers who aren't yet set up to use the software. "Customers want to pay for the software they consume," says Rob Enslin, president for North America at SAP.