If you’re a traditional on-premises software company, you’re in the right place. Today, I will talk about how cloud computing can transform your business. In a subsequent Cisco Blog, I’ll discuss the implication this move will have on your sales and distribution strategy.

Model One Business Model

Traditional software companies have operated in a Model One Business Model. In this on-premises model, the customer buys a perpetual license for software and then pays annual support and maintenance fees, which turn out to be another kind of subscription revenue stream.  While that might seem to be the end of the cost to the customer, it’s not. The customer is going to have to spend money managing the software – and it’s not cheap.

Cost to Manage Software is 4x the Purchase Price Per Year

A good rule of thumb to managing software costs is 4x the purchase price of the software. So, if you pay $4,000 to license the software, then you’re going to spend 4 times the purchase price of that software per year to manage it. By manage, I mean managing the security, availability, performance, change of that software and everything underneath it. So if you spend $4,000 per person to buy the software, then you’ll spend $16,000 per person, per year to manage it. Or in four years you’ll spend $64,000 to manage the software you bought for $4,000.

This is why if you go into any business and ask the CIO about their discretionary budget, they’ll most likely say between 5 to 15%. Why? Because the bulk of their budget is spent managing the software they bought the previous year, the year before that, and the year before that.

So as a software company, how then can you use cloud computing to reduce that cost of management and speed the adoption of your application?

There are fundamentally three different approaches:

  • Add a Model 4 or 5 Business
  • Build a Model 6 Application
  • Buy a Model 6 Application Business



Add a Model 4 or 5 Business

Adding a Model 4 or 5 Business is good for existing software businesses with an installed base. Here, the ISV/software company takes on the management of its application and all of the supporting components. If your engineering team standardizes the stack, and the management of security, availability and performance, then you can dramatically reduce the cost of the customer doing it in a one-off custom manner (2-10x).  Why? This is because standardization can lead to automation – reducing cost and improving quality. Model Four is very useful to go after an installed base and move into the cloud.

Some people will say Model Four is not a subscription model, since you have to pay the perpetual license up front. As a result many companies have created a Model Five business, which is just essentially a different payment plan for the same service.

The transition to a Model Four or Five businesses requires changes in your R&D organization as you attempt to standardize and automate the management of the security, availability, performance and change of your application.  Furthermore, while the Model Four business Model is complimentary to your existing sales model, you will need to have sales people who can sell the service and on why your company can do a better job managing the software you wrote than the customer. Model Four is also easier for your finance organization because they can treat it as an extended support contract with the same issues regarding revenue recognition.

Buy a Model Six Business

The second thing you could think about doing is to buy a Model Six Business. This is faster than trying to build a Model Four or Model Five Business, A good Model Six Business is based on software, which was architected to be delivered only as a cloud service – therefore can achieve much higher degrees of standardization than in Model Four or Model Five. The implication is that operations cost structure can be reduced by up to a factor of 10, allowing you to enter markets that demand lower cost solutions. There are many current examples of this strategy, including:

  • Convio acquired by Blackbaud
  • Successfactors acquired by SAP
  • RightNow and Taleo acquired by Oracle

Build a Model Six Application and Business

This leaves us the last category – building a new Model Six Business.  If you’d like to learn more about the implications in building a Model Six Business, consider watching Chapter 5 on Software (ISV) Transformation in my Cloud Computing Transformation Cloudbook.

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Timothy Chou

Lecturer at Stanford University