Schnitger Corporation

The ups & downs of license model choice

EarningsWe learned earlier this week what can happen when customers are offered a choice and pick something unexpected: Dassault Systèmes announced that it failed to meet its third quarter 2013 revenue goals, in part, because more customers opted for rentals/subscription than planned. That meant that license revenue was less than expected — the initial payment for a subscription is far less than that of a perpetual license, so the total didn’t reach the target.

DS’ miss was small in the greater scheme of things: a €24 million shortfall in a forecast of €520 million. Of the €24 million, DS attributed €8 million to small business customers who chose rental licenses and not perpetual/maintenance.

When customers suddenly pay a less upfront than expected it puts stress on everyone participating in the sales process. Getting a lot of money upfront lets the vendor and channel partners support the sales process more readily than does the subscription model. Paying out for marketing, demo jocks, sales calls and the like in the same period (roughly) as getting income from a sale smoothes cash flow; having to wait for 2 or so years to get the same total cash inflow puts more stress on the system. That stress can flow from sales into R&D and support, too, but it’s most obviously cause-and-effect in sales. Let’s be clear: DS’ cash flow is fine. It can absorb these shifts but partners further down the food chain will have to carefully manage their cash during this transition.

For investors the problem is that DS, which normally is so careful in its forecasting, didn’t meet its own numbers in Q3. Were they overly aggressive in managing the sales pipeline? How did they not know who’s going to opt for rentals vs perpetual? Did someone miss the signals that a deal was stretching out, that more approvals would be needed than originally thought? I also thought the tone on the conference call for investors was a bit troubling. Company management sounded downright gloomy. CFO Thibault de Tersant even apologized for the miss. If I were an investor, I’d be looking for management to come on a bit stronger, saying “we know what happened and we’re fixing it”. DS shares took a 10% hit after the pre-announcement, the biggest intraday drop since January 2009, but they’ll bounce back. Almost all of the miss was, after all, deals that slipped but weren’t cancelled, and licenses that shifted from short-term to long-term agreements.

It’s, of course, all about buyer choice. If you’re a software buyer, look carefully at what you’re buying. Subscription agreements differ greatly from vendor to vendor; some are monthly while others have varying lengths and are non-cancellable during that period. It all shakes out in roughly 3 years, so if you’re looking at a short-term project, subscriptions may make sense even if they’re more expensive per month. Otherwise, look at perpetual or at financing perpetual through your sales partner, if you can’t manage the entire upfront cost at once. Perpetual usually comes out of the capital expenditures budget while rentals and financed subscriptions come from the operating budget — one of these may have more wiggle room than the other at your company. If you choose a subscription, though, realize that your sales person may not be able to lavish you with attention. Just like in your business, cash flow rules, and your reseller has to make sure that cash out is less than cash in.

DS’ miss is a stark lesson for all of the vendors looking at subscriptions as a way to offer customers choice and, perhaps, gain more total revenue per customer in the long run. For DS, rentals make up roughly 25% of recurring revenue, or just under 20% of total revenue, so far this year. It’s not a huge part of DS’ business but it is growing at around 10% year/year each quarter so is becoming more and more important in DS’ overall picture. DS needs to carefully manage the rental/perpetual process to keep revenue and costs in line.

Part of the shift towards rentals is due to customers that had previously, as a gross generalization, not been so keen on the concept. M. de Tersant told investors that DS saw its first rental sales in Asia in Q3, which has historically bought on a perpetual basis; the other regions performed about as expected with respect to rentals vs. perpetuals. Since many PLMish companies see 1/3 of their revenue from Asia, rentals really taking off there could seriously affect revenue reported in any given period.

It will work out in the long run, but in the short term there will, as DS discovered, be bumps.

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