Valuation of Discount Options in Software License Agreements

Many companies rely increasingly on licensed standard software for system software and applications. Beside the regulation of the usage conditions the software licensing agreements incrementally include charged services, such as software upgrades and user training, as a part of the contract or optional with a fee, which can be drawn by the licensee during the term of the contract at a reduced price or as a free service. This right to a benefit is called a discount option and must be economically properly evaluated at the contract selection and design. This paper describes the basic valuation issues, as well as some weaknesses of previous approaches and shows on the basis of the real option theory a model that presents an assessment of the discount options with mathematical methods. The value of certain discount options may be determined with analytical methods. For complex options or option series a numerical solution method is presented. The approach of the model application is illustrated in the paper by two examples.