Licensing Strategies for Independent Software Vendors

For the last several months, I have been involved with a particular very small ISV, almost a micro-ISV (mISV), as it prepares for growth. One of the key elements we identified is that its pricing model - unlimited free upgrades - is not exactly conducive to good revenues and profitability. Although it seems obvious, it needs to be stated, and for several reasons.

1. Founders sometimes feel that to charge for upgrades would somehow offend existing customers. This was not at all the case with this customer. Nonetheless, many are afraid to do so. The opposite is true. Most customers not only understand that the service a vendor provides is ongoing, and requires compensation, but want to ensure the vendor will be around for a long time. Wisely, this founder had been saying from the beginning that as of now, upgrades are free, but he reserves the right to change it.
2. People equate value with price. Sure, everyone looks for a bargain, but if something seems too cheap, too good to be true, they subconsciously, and sometimes consciously, assume it to be, well, cheap and worthless. For a great reference, see Joel Spolsky's article in the Inc magazine of July 2008.
3. Repeat customers are always lower cost to sell to than new customers, in every business.

It seems fairly simple, then, to charge for upgrades. But how to do it? We were left with two primary options:

1. Charge full price for a new customer, 40-50% off for upgrading customers at major revisions. This means buyers of 2.5 get 2.6 for free, but pay discounted price for 3.0. This is known as "sell the upgrade."
2. Charge full price for a new customers, give them 12 months (or similar) free upgrades, whether minor or major versions. When the 12 months are up, they get no upgrades or updates. At that point, they can buy another 12 months (or similar) of free upgrades at 40-50% off the then-current retail price. This is known as "sell the plan."

Sell the upgrade is cleaner to manage and implement, and is similar to what most large vendors do. When you buy Windows XP or Mac OS X Tiger, you get all the service packs for XP and updates for 10.4 for Tiger for free. You do, however, have to pay for Vista or Mac OS X Leopard.

Sell the plan has better revenue timing (it comes in earlier), and better cash flow. Further, it makes it much easier to sell to organizations that budget. Rather than a capital expenditure each year or two, it becomes a maintenance expense, built into the operating budget each year automatically.

For the above reasons, we went for sell the plan.