Choosing the Best Pricing Model for Your Business: License vs. Subscription

How do you choose the best pricing model for your business?

No matter your business stage, choosing the right pricing model is critical to a successful business growth plan that helps acquire new customers and increase sales. The right pricing model can keep customers loyal and enable your business to grow at a sustainable pace.

The following guidelines can help you determine the best pricing model for your business:

• Define your business’s goals. Every business decision you make should start with your company’s goals. Once you’ve set your business goals, find ways to align them with your pricing strategy.
• Know your ideal customer. Consider your target audience and how much they can spend. Are you marketing a high-value service for which customers will pay a premium? This will affect the pricing strategy you choose.
• Conduct a competitor analysis. You must also take your market position into account. Conduct a competitive marketing analysis to determine the prices others in your space charge. A competitor analysis will also help you determine your unique selling proposition (USP) and how to set your company apart.
• Understand your costs. You must understand your fixed and variable expenses. If you price your products or services too low, that will affect your business’s profitability. 

What is the licensing model? 

A licensing model is an agreement between a software publisher and its customers that defines the use of their product. One common type of licensing model is the perpetual license, where customers pay a one-time, upfront fee to purchase a license for lifetime access to a specific version of the software. 

However, the business may also charge an additional yearly fee for software updates, security patches and technical support. Customers who opt not to pay the annual fee can continue to use the product but will not receive bug fixes, ongoing updates or support.

While perpetual licenses were once popular, many software products have shifted toward subscription-based models in recent years.

What are the pros and cons of licensing?

Licensing brings specific benefits and drawbacks for a company. 

These are the potential benefits of a licensing model: 

• Businesses can charge higher upfront costs with licensing. One of the benefits of licensing is that businesses may have the ability to charge higher upfront costs, especially if the software deployment is significant. 
• An annual fee can add recurring revenue. Businesses can make recurring revenue by offering an annual subscription fee in addition to the licensing fee. The annual fee would cover things like software updates and tech support. Customers can typically cancel the annual subscription anytime, but the software and their experience won’t be as optimal.
• A licensing model may appeal to some B2B customers. Some businesses and organizations may find the perpetual licensing model more attractive because they prefer a one-time investment over recurring payments. Additionally, they may feel more in control because they don’t have to depend on a vendor’s continued operations to use the software. 

Downsides to the licensing model may include the following: 

• Businesses will lose revenue if customers opt out of the annual fee. Customers may end up paying less for your product over time if they cancel the subscription fee. 
• Businesses must continually improve their offerings. Vendors may have to continuously release improved software versions to convince customers to upgrade their licenses with annual subscriptions. This may greatly tie up the business’s resources, and any recurring fees they collect may not cover those costs.
• The licensing model is only for desktop computers. Another downside to licensing your software is that it will only be available on desktop computers; customers won’t be able to access it from their laptops or smartphones. Now that an increasing number of people work via a remote work plan or while on the go, this could prove a deal-breaker for some customers.
• The licensing model is less agile. New product development isn’t as quick in a licensing model because products typically must follow a longer and more rigid release cycle. 
• Opting for a licensing model may affect market share. There has been a definite market shift toward the subscription model, and many decision-makers may be unaware of the licensing model. They may also prefer the flexibility and easy exit options subscription services offer. If a business opts for a licensing model exclusively, it may miss out on market share.
• A licensing model means less predictable revenue streams. Operating on a licensing model may make managing business finances more challenging. Cash flow may be inconsistent and fluctuate over time.

What is the subscription model?

A subscription model is a pricing structure in which customers pay a recurring fee to access software, services or content. While a licensing model is traditionally associated with software, a subscription model is also common for services and exclusive content. Streaming entertainment services like Netflix and Spotify are examples of industries that use the subscription model. 

Many companies charge a monthly or annual subscription fee. Customers can typically cancel their subscriptions anytime, but they lose access to the software or service if they do. 

A subscription model differs from a licensing model because customers in a licensing model receive lifetime access to the offering. Additionally, subscription offerings are usually cloud-based, so customers can access them from any device — a significant benefit of cloud computing. 

What are the pros and cons of the subscription model?

Licensing used to be the default pricing model for software companies. However, subscriptions have taken off because they offer significant benefits to the businesses selling subscriptions as well as their B2B and B2C customers. 

Here are some typical benefits of a subscription model: 

• Subscriptions help control costs. Businesses and individuals buying software or service subscriptions can better manage expenses and control costs. They know what costs they’ll pay monthly, so budgeting is more simple. Additionally, the company selling the subscription can easily project its revenue.
• Subscriptions have fewer security risks. As cyberattack threats increase, security is a critical issue for businesses. Both companies selling subscriptions and their customers benefit from fewer cybersecurity risks.
  • ​​Sellers: Subscription sellers won’t have to deal with the hefty costs and security risks of self-hosting traditional software licenses. Outdated legacy software hosted on internal servers is at greater risk of an attack that leads to stolen consumer data. 
  • Customers: Subscription customers — businesses and individuals alike — are less likely to be subject to a data breach, which presents an enormous benefit. 
• Subscriptions incur less hassle and expense. Vendors often sell traditional licenses alongside installation packages, upgrades, add-ons and maintenance. With a subscription model, the company selling the subscription won’t have to deal with the complexities of these additional offerings. And their customers avoid the hassle and extra expenses of buying traditional licenses.
• Subscriptions facilitate mobile work. Businesses and individuals who subscribe to a software solution or service want mobile access, so people can work on smartphones and tablets. Subscription services offer flexibility and support, especially with the increase in remote workers.
• Subscriptions have a lower barrier to entry. Subscription services cost much less to implement, which many B2B customers will appreciate. They can switch providers relatively easily, allowing them more freedom in choosing the right tools and platforms. 
• The subscription model boosts innovation. The constant need to innovate, add and improve is baked into the subscription business model. The consistent improvement of existing features couples with new features added continually, benefiting customers.

Downsides to the subscription model may include the following:

• The subscription model boosts customer churn potential. If customers sign up and keep their subscription for only one or two months, that can negatively impact a business’s revenue. Companies that offer subscriptions must constantly look for ways to build customer loyalty and create a great customer experience.
• The subscription model requires constant value delivery. Subscription sellers must constantly innovate their products’ features and functionality to meet expectations and keep up with the competition. 
• The subscription model may have lower initial revenues. Perpetual licenses are expensive, so they significantly boost the selling company’s cash flow. In contrast, subscription models generate significantly less cash upfront, potentially causing cash flow problems, especially when scaling your business.

Consider your business needs when choosing a pricing model

Software and service companies have a strong position to offer subscription services to businesses and consumers. Subscription pricing models allow you to offer a reliable service at an affordable monthly price. That’s likely partly why prominent companies like Microsoft, Dell and Adobe have all pivoted to subscription-based pricing models. 

However, while the licensing model may be less common, it could still be a good option for your company. Carefully consider your goals, your ideal customer and what your biggest competitors are offering. This will help you determine the best pricing model for your business.

Mark Fairlie contributed to this article.