Sage North America’s dilemma – changing its licensing model while keeping the reseller community on board

March 17, 2012 Richard Boardman

Having speculated in my previous post that Microsoft might start offering rental pricing for its CRM software, coming on the back of SAP suggesting a third of their revenues could come from subscriptions by 2015, it appears as if Sage North America will be launching the option of subscription pricing for both its on-premise financial and CRM applications.

Traditionally Sage has charged an up-front licence fee for its software, which is topped up with an annual maintenance charge of about 10% of the initial fee for those customers who wish to receive new versions without further charge.

While this model has worked well for Sage over the years, the success of the software as a service (SaaS) vendors, like Salesforce.com, has helped establish an alternative payment model whereby software is paid for on a per user per month basis for as long as the customer chooses to use the software.

The problem for Sage is that this looks a much better business model. Assuming the average CRM implementation is likely to be in place between five and ten years, then the maths suggest the monthly model is likely to be a lot more lucrative.

For example, let’s hypothetically say an on-premise license costs £750, the revenues over 5 years, assuming a 10% annual maintenance charge, would be £1,125, on the other hand a rental model of say £25 per month would generate £1,500 revenue over the same period. Run these figures over ten years and the figures diverge even further with the rental model generating £3,000, versus £1,500 for the up-front license.

The rental model has another big advantage. It’s predictable. Because there’s a constant stream of revenue coming through the door, there’s protection from the gyrations of the marketplace and the software developer can manage the business with considerably more certainty.

But Sage has another problem. The new generation of SaaS vendors while happy to work with implementation partners, offer little in the way of margins for selling their subscriptions. Sage on the other hand has paid resellers north of 40%. That’s a big difference in retained revenue. Retained revenue that could be reinvested in product development or sales and marketing.

In principle the margins Sage pays to its reseller network should guarantee it a highly motivated channel with thousands of salespeople anxious to promote its products. But here again market forces may have moved against it. With organisations increasingly resistant to being sold to, success is increasingly dependent on a vendor’s ability to centrally orchestrate its marketing. The achievements of Salesforce.com seem to be a function of a brilliantly coordinated marketing strategy supported by a heavy commitment to on-going sales and marketing investment – something that Sage has struggled to counter.

Details from a CRN article suggest that Sage North America will reduce margins to 35% for the first year’s rental, and 20% thereafter. This would mean that resellers face a double hit: a significant reduction in margin percentage and that it will be staggered over time rather than received up-front.

While Sage may argue that the rental approach will benefit resellers over the long term, in the short term they would take a hit until they built up a steady revenue stream. This might not be an issue for well funded software developers, but resellers tend to lead a much more precarious commercial existence and a significant change to cash flows could have a devastating effect.

The impact of these changes will depend on how many organisations take up the rental model, and particularly how many of these are customers who wouldn’t have otherwise purchased the up-front licence. My best guess is that the average customer is sophisticated enough to understand the likely life expectancy of a system, and will realise, given the choice, that the rental model is likely to be a more expensive approach (particularly if the CRN figures are correct), so I’d figure therefore that there won’t be a huge uptake for this option (though I’ve been wrong plenty of times before).

It’s debatable therefore whether the unrest this new approach is likely to generate in the reseller community is likely to outweigh the benefits of an increase in revenues over the long term, but at least it shows that the new management team recognise the issues they face. Perhaps the most effective strategy would be to simply remove the choice and only have rental pricing, though this needs to be calibrated on what the customer is willing to pay rather what might be simply attractive to Sage. The key dilemma of course is how much change can Sage North America afford to make while keeping the reseller community on board, at a time when doing nothing may no longer be an option.