Software Licensing Models
Not to be confused with pricing methods or business models
There are many licensing methods that can be used for software systems. This document will explore the most popular and explain the pros and cons of each.
If you don't sell software, don't despair! Many of the licensing methods contained herein can also be applied to other types of intellectual property including video courses, ebooks and even databases of information.
- Concurrent Licensing
- Device Licensing
- Full Ownership
- Pay per Use
- Perpetual Licensing
- Restricted Licensing
- Site Licensing
- System Capacity Licensing
- Time-Based Licensing
- User Licensing
- Combined License Schemes
This strategy focuses on raw numbers of users rather than the identities of specific individuals.
Under this licensing scheme, organizations purchase licenses with an upper limit on the number of people who can use the system at the same time.
The mechanics for enforcing this scheme have changed over the years. Modern SAAS applications simply check each login against stored access limits. Desktop applications have traditionally used network license servers, or specialty hardware (often in the form of proprietary dongles or USB keys).
Sometimes this approach is referred to as floating licensing or network licensing.
- This method ensures a low administrative overhead for the buyer and seller.
- This strategy provides a high degree of staffing flexibility for the buyer. This can be especially desirable for customers who experience significant levels of turnover or have the need to use the software for very small increments of time.
- Buyers may experience system unavailability during times of peak user demand.
- Buyers may tend to underestimate the number of licenses required to support their business needs.
Some systems are restricted to only run on a specific hardware device.
These systems often perform scans to verify the system by unique hardware or software characteristics. Common hardware system checks include the ID of the CPU, and the ethernet MAC address. Software verification efforts are typically focused upon various characteristics of the operating system.
- This methods limits unauthorized distribution to third parties.
- This strategy can potentially provide a useful source of information for estimating the value of the software installation. For certain types of software, the more powerful the computer, the more value will be extracted by the system's users.
- This method has the potential to de-incentivize hardware upgrades, due to the need to purchase new licenses. This may reduce customer value by artificially limiting system performance. For this reason, a means of upgrading or transferring licenses is recommended.
- This type of license will often require some form of activation process. Any such activities that require access to the internet will cause significant difficulty in non-networked environments.
- Any hardware failures will cause excessive system unavailability, as the software cannot be re-installed on alternative hardware. This limitation can be addressed through the use of temporary keys.
This strategy provides software at no cost.
Many in the technology field subdivide free licenses into the following two categories:
- Free as in beer - Users may execute the software without charge.
- Free as in speech - Users may execute, copy, adapt and redistribute the software without charge.
The plethora of free licenses occasionally blurs the lines between the two, but the differentiation can be a useful means of categorizing the various free licenses.
It is important to note that although software may be released for free without any profit motive, several business models utilize free software in order to earn profit. For instance, the freemium model provides software at no charge, with the intent of convincing a portion of the user base to upgrade to paid plans.
Free software systems typically use pre-defined licenses that vary in restrictions. Some of the most well-known are the Apache, GPL, BSD, and MIT licenses.
- This method knocks down many barriers that would otherwise hamper wide distribution.
- The lack of upfront costs may encourage experimentation and usage by interested parties.
- Software released for free may be viewed with suspicion. Many potential users will wonder why valuable software would be given away for free.
- Vendors utilizing this type of licensing may not be able to earn sufficient revenue to maintain profitability.
- Apache Web server
While most licenses merely grant permission to use a software system, the vast majority of software is not licensed in this manner.
Most software is never sold on the open market but is instead built in-house or under contract.
In these cases, a given system generally becomes the property of the party that commissioned the work.
Buyers in the United States should go to great lengths to ensure that any custom software development is considered "work for hire." Doing so will provide full legal ownership, rather than a license to use the system.
- This license is the most straightforward to understand.
- This system allows for the creation of systems tailored to the exact needs of the buyer.
- Software released under this system tends to be extremely expensive to build and maintain, as all costs are borne by a single party, rather than being spread across many customers. In some cases, this financial penalty can be reduced by ensuring that multiple parties share joint ownership. This method of cost reduction can involve a significant risk of incompatible forks.
- Custom spreadsheets
- Internal data processing systems
Pay per Use
This license scheme is just what it sounds like. Users are required to pay based upon some metric of usage.
Potential metrics include:
- Number of analyses performed
- Number of downloads requested
- Length of time used to perform an action
The selection of the appropriate metric is vital to success using this licensing scheme. The ideal is to charge proportionally to the value provided for the users.
Several variations of this method are commonly seen in the marketplace.
- Some systems use pre-paid billing, while others utilize a post-paid system.
- Some systems operate on a credit system, while others use native currency.
- Some pre-paid systems allow users to store credit until needed, while others expire after a set time.
- There are very low barriers to adoption, as no fees are incurred until value is delivered. Additionally, the service may be evaluated without requiring large up-front payments.
- There is a potential alignment of incentives of buyer and seller. This can ensure that income is only earned when value is provided.
- Customers may feel nickel-and-dimed when activity is billed at a micro-level.
- Some firms may wish to handle the administrative overhead of irregular billing patterns - especially if there is no upper spending limit built into the license.
- This license provides no guarantee of income for the vendor. This may result in vastly irregular income streams.
- The metered nature of the billing process may cause users to only access the system when absolutely necessary. This may reduce familiarity with, and dependence on, the system.
- Canva - Inclusion of premium graphical elements requires payment.
This methodology is one of the oldest and most well-understood licensing systems in use for software and other goods.
It involves a single, up-front payment in exchange for a non-revocable right to use a software system.
- This license provides buyers with a known upper limit on the system's lifetime cost.
- This method reduces the risk resulting in vendor bankruptcy, assuming that no vendor resources are required to use the system. Note that copy-protection schemes may invalidate this benefit.
- This method will cause uneven income streams for vendors. Firms will see huge spikes of income upon release of each version, followed by periods without much income.
- This strategy requires substantial up-front investment by the buyer. Additionally, the price of the software will likely be treated by accountants as capital expense, rather than an operational one.
- This system will push vendors to release new (and often incompatible) versions of software in order to earn additional income. This will occur whether or not customers receive any additional value from the subsequent release.
- This method provides minimal incentives for the vendor to provide free updates, fixes and other value-added services as a given release ages.
- Perpetual licenses are generally unsuitable for web applications. Vendors pursuing such a strategy risk ongoing hosting and support costs surpassing the one-time fees that have been charged. Note that there are a few exceptions.
- Due to the high up-front cost, customers may push back on pricing and require a higher touch sales process.
- Given the disincentive for users to upgrade, vendors may be forced to support many different versions of the software system.
- Fallout 4
- Microsoft Windows
One of the most well-known examples is the licensing for academic versions of software systems. In exchange for a significantly reduced price, customers agree to limit their usage of a given product. For instance, they may agree not to use the systems for any profit-making endeavor.
- This method allows substantially similar versions of a software system to be sold at vastly different prices.
- This license can be used to get users "hooked" at earlier stages. This will allow prices to grow as customer ability to pay increases.
- Customers may simply ignore the limitations of the license. Some systems attempt to combat this through the liberal use of watermarking output.
- Adobe Photoshop
This license allows an organization to provide access to a software system without restriction.
Sometimes access is limited to a single physical location or administrative subdivision.
Nevertheless, the software is made available for a fixed price, irrespective of the number of potential users in the organization.
- Administrative overhead is minimal for both vendor and customer. Neither license tracking nor monitoring is required.
- The vendor may find it exceptionally difficult to price the system in such a way as to accurately reflect the value that will be received by the customer.
- Vendors will likely undercharge firms that are undergoing growth.
System Capacity Licensing
Some systems are priced differently depending upon the characteristics of the hardware upon which they run.
This strategy is often used so as to allow vendors to earn higher prices when the software runs more quickly on faster hardware.
Common characteristics include:
- Network bandwidth
- Available RAM
- CPU clock speed
- Screen size
This method is often used for enterprise analysis software, as well as for operating systems.
- If the system capabilities are proportional to customer value, this method can prove both efficient and administratively simple to implement.
- This license can dis-incentivize hardware upgrades, leading to lower levels of customer satisfaction.
- This license can inject administrative overhead for owners of systems that undergo many changes over time. For instance, a video game enthusiast may make several hardware modifications to his desktop computer each year.
This is the traditional go-to method for SAAS. It has proven so popular that many forget that other licenses even exist.
Under this scheme, software systems are made available for a set length of time. The most popular increments are by month or year, though large enterprise agreements will often span multiple years.
Pricing is often permanently fixed and grandfathered in for as long as the customer continues to pay. That said, enterprise contracts often specify an escalating pricing structure over the course of the contract.
In order to increase the immediacy of revenue, many firms operating under such a license offer discounts to consumers who prepay for extended periods. Many vendors wave two months worth of billing when users sign up for a year of service.
- This system generally requires lower up-front expenditures by customers.
- This scheme often allows customers to categorize their spending as operational, rather than capital funds.
- Vendors using this licensing system will have significant predictability with respect to their revenue cycles.
- Vendors will be incentivized to continuously increase the value that their systems provide.
- This licensing strategy does not guarantee an upper limit on total expenditures. Although not common, vendors can raise their prices at any time.
- Similarly, this system does not guarantee that users will continue to pay for the system for long periods of time. With little capital invested, they may be more willing to move to alternative systems.
- This system can be challenging to enforce for vendors of downloadable software, especially if network availability is unavailable.
Under this licensing scheme, only specific and named individuals are allowed to use the software system.
This method has proven to be a very common component of SAAS licensing schemes.
- This method is very simple to explain.
- This method is well suited to selling to individual users.
- This license can prove cumbersome and overly expensive to organizations with many potential users or significant levels of staff turnover.
- Many organizations selling expensive software using this license will be forced to deal with the common, but illegal, practice of account sharing.
- Microsoft Office 365
Combined License Schemes
It is almost unheard of for firms to use a single licensing scheme to the exclusion of all others.
In almost all cases, companies will create licenses that contain elements of multiple "pure" licensing schemes.
This practice allows vendors to offer licenses that best fit the needs of both vendor and customer.
- Can better fit the needs of both vendor and buyer than any "pure" license type.
- The more complex the license, the more difficult it is to explain to potential customers.
- Too much creativity in licensing schemes may result in perverse or otherwise undesirable incentives for both buyer and seller.
This system offers software under multiple, mutually independent licensing schemes.
Multi-licensing is typically best suited for vendors selling in highly segmented marketplaces. For instance, a software firm may offer one license to individual buyers, but a different one to firms that wish to bundle the product into another offering.
This method is especially common for sales of software libraries and operating systems.
This type of licensing is often referred to as dual-licensing even when more than two types of licenses are offered.
- This strategy allows vendors to target multiple customer segments with different pricing strategies.
- This license allows vendors to offer trade-offs that target multiple strategic objectives.
- This scheme requires a higher degree of administrative and analytical complexity on the part of the vendor.
- This system may cause cannibalization of existing sales channels or product lines, if implemented poorly.
- Multi-licensing may increase the complexity of the sales process for buyers, unless license offerings are well differentiated.