From Product- to Service-Oriented Strategies in the Enterprise Software Market

The recent surge of subscription-based software o¤ering, as an alternative to the traditional product-selling model, has attracted wide attention, especially the web-based on-demand model. In February 2006, Europe’s biggest software provider, SAP, made its …rst push into the ondemand CRM market, and hence became the last to join Microsoft, Oracle and the other top enterprise software providers in the emerging market for on-demand software services. IDC predicts that revenue from subscription licensing will grow at 16.6% annually from 2004-2008, and reach $10.7 billion by 2009. The trend is gaining so much momentum that Merrill Lynch software analysts have come up with a new method of assessing and valuing software companies, On-Demand Index, which takes into account the growth in deferred revenue that results when vendors use subscription-based licensing. This transition can have a far-reaching in‡uence for the whole IT industry. The outsourcing service providers, software integrators, enterprise hardware vendors, among others, are all at the forefront of the challenges brought by the transition. To act strategically, it is crucial for …rms to understand what are the driving forces behind the transition, and how it restructures the market. The current study asks the following questions: 1. Why did large software vendors sell only to the high-end market in the pre-on-demand era? 2. Why are these vendors changing their optimal pricing strategy now? 3. What is going to be the future of the enterprise software market? Will the on-demand model dominate the market? I identify and model two features of the enterprise software market: high upfront implementation cost, and consumers’uncertainty about their true valuations for the software prior to adoption. Enterprise software implementation often requires signi…cant upfront investment in purchasing hardware, and hiring outside consultants to incorporate the software with other applications. Firms often spend over 100 million dollars to implement an ERP system (Robey et al, 2002). Brynjolfsson et al.(2002) …nd that for each dollar spent on a software product, an additional 9 dollars value is created by complementary tangible and intangible assets. Moreover, it is risky to implement enterprise software packages. Approximately one half of all ERP projects fail to achieve anticipated bene…ts (Appleton, 1997); 25% of software projects are cancelled outright; and three-fourths of all large systems are “operational failures”(Gibbs, 1994). The web-based on-demand model signi…cantly reduces the upfront implementation cost by centralizing the resources required for implementation on the vendor’s side. Indeed, anecdotal