The Mixed Blessing of Subscription-Based Pricing

The Mixed Blessing of Subscription-Based Pricing

By Ken Phelan
Posted in Infrastructure
On June 20, 2019

Subscription-based pricing is all the rage and I think there are some gaps regarding expectations all around. Let’s start with the math and we’ll end on philosophy.

Traditionally, you might buy a piece of software for say, $100K. You would generally pay about 20% a year in maintenance, $20K. If you were amortizing this expense over five years this would be like a $40K a year budget impact ($20K amortization plus $20K maintenance). Easy enough, if the subscription price of this software is less than $40K a year, it looks like a good deal from a client perspective.

But, what if you’re thinking of it as a three year amortization? Still $20K a year in maintenance but it’s now $33K a year in amortization. So we’re at $55K a year in our subscription calculation. This is our first gap in expectations. Manufacturers are looking at this almost exclusively as a three-year calculation.

The manufacturer mindset isn’t really a mystery. You need only listen to any of the investor calls for a company transitioning to subscription. The basic story line is, we’ll see a drop in revenues this year as $100K sales turn into $55K per year deals. But, we’re creating a backlog of recurring revenue, locking those customers into three years deals. So, we’ve got another $110K coming to us, don’t worry. In fact, generally they’ll claim that net revenue per customer is going up. They’re likely to be charging something like $60K per year to make this claim true. If we look back at our customer with the five-year amortization, that’s going to feel a little onerous from a budget impact perspective.

On the customer side, they often talk about subscription as a more agile buying style where they only pay for things that create value, when they create value. This is obviously completely at odds with the manufacturer’s “locked-in” concept. They may even be open to paying a little more for this agility but there’s no reason to pay more and not have any flexibility.

So, where does that leave us?

To the extent that subscriptions focus the industry on customer success and value, I think this pricing model is great. Manufacturers and resellers selling subscriptions need to be focused on long-term value of the products or customers simply aren’t going to keep writing annual checks, regardless of how “locked in” we think these multiyear commitments are. This is good for customers, and frankly I think this shift in focus is good for the industry.

But I do think it’s worth examining these gaps as we enter these deals. Does the math work? Is there an expectation of agility and to what extent does it really exist? It’s worth airing out these issues up front. 

Ken Phelan

Ken Phelan

Ken is one of Gotham’s founders and its Chief Technology Officer, responsible for all internal and external technology and consulting operations for the firm. A recognized authority on technology and operations, Ken has been widely quoted in the technical press, and is a frequent presenter at various technology conferences. Ken is the Chairman of the Wall Street Thin Client Advisory Council.