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Enterprise software distribution: Recurring models

In the previous post, I discussed basic licensing models, and why we would want to go with monthly licenses. Lets discuss the details of recurring models.

When you sell software for a monthly fee, there are 2 possibilities:

  1. No fixed term. Client stays as long as they require the service.
  2. Fixed term contracts.

No fixed term overview

If we assume no fixed term, the average time a customer will stay with you is 4-8 months (With 8 months considered very good), and the average rate of attrition is usually about 15-20% per month. Of course these numbers are very dependant on the market, but lets do some maths:

Let’s assume we charge $100 a month, and each client stays for 6 months (an average attrition rate of about 15%). Lets also assume we are signing 10 new clients a month.  If this is the case, you reach an equilibrium after 18 months where you are getting paid for 57 licenses each month (and you are netting $5700), and unless something changes, you will not grow beyond this point.

Fixed term overview

Now for a fixed term contract, you have a somewhat different picture. Generally, attrition rates are much higher, so lets assume an attrition rate of 90% (after the initial fixed period), 10 sales a month, and a fixed term of 12 months. Because of the fixed term, you only start losing clients at the end of the period (Not always true, but a good approximation).

This means that for the first 12 months you are growing by 10 licenses a month until you reach 120 after 12 months. At month 13, you lose 90% of your clients from month 1, so you only grow by 1 license. Unless anything changes, this will keep happening every month, and at the end of 18 months, you will have 126 contracts (for a monthly income of $12 600).

So what does this mean?

On the surface, it looks like it is much better to sell on a fixed term, since after 18 months, you will be getting more than double what you would if you had sold on a monthly. Unfortunately, this is not necessarily true. The first risk is that it is much harder to sell a fixed term contract,  but even if you assume it is twice as hard, and you can only sell 5 licenses, you still have 66 licenses after 18 months, so it still looks like a better model.

Here’s the big problem though. You always have to sell at least as many licenses as the same month last year. Let’s assume you have a great salesperson for the first year and he sells 15 licenses a month and then leaves for a new job. Now a new person comes in and only does 5 sales a month.

Now you have 180 licenses after 12 months, but only132 after 18 months and 84 after 24 months, at which point it starts growing by 1 license a month again.

So what, you’re still making more money

While you are still making more money, the problem is that you have wildly fluctuating net incomes, and you just can’t be sure what your income will be in 3 months time. This isn’t conducive to a long term business.

If you factor in the licenses that will be canceled in the middle of the license period, you could have negative growth very easily. This can happen because businesses go bankrupt, owners die or emigrate, they find a better deal and just stop paying, etc.

This is true for both models of course, but changes will tend to be more sudden and dramatic with the fixed term contracts.

To a large degree, both models are pretty similar. The only real differences are the initial growth periods before we reach equilibrium, the number of licenses at the equilibrium, and volatility of your income.

Click here to view a spreadsheet with the maths

Graphs to show what the growth curves will look like:

In the next post I’ll explore ways to increase your income in both of these models.

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