IDC Report: Hardware Companies Face Unique Challenges in Growing Software Revenue

by Amy Konary

IDC Opinion

With shrinking margins on hardware sales, manufacturers are increasingly looking to leverage the software assets embedded within their devices in various ways. However, in the past, this software may have been given away with the hardware or bundled with the hardware in such a way that the value of the software was not called out separately. Beyond the challenges of establishing value and developing a pricing scheme, these firms find that licensing software is a lot different from selling hardware. These companies are finding that monetizing or licensing their software can:

  • Provide an additional high-margin revenue stream
  • Protect intellectual property (IP) from misuse
  • Simplify product packaging while allowing for more flexible configurations
  • Lower inventory costs by decreasing the number of SKUs needed to satisfy unique customer demands

IN THIS STUDY

This study discusses some of the unique software licensing challenges faced by hardware companies. The issues discussed in this study could apply to any technology company where the primary business is not software but where software is monetized separately. This document includes recommendations for elevating the value of software in hardware companies as well as licensing trends that impact these firms.

SITUATION OVERVIEW

Companies for which software has not been their primary business are increasing their focus on selling software. As an example, Cisco's CEO said in December 2012 that he expects the company's software revenue to double in the next five years from $6 billion to $12 billion. Ten years ago, software made up less than 5% of Cisco's total revenue, according to IDC. Now, it is closer to 15% of the total revenue.

Most traditional hardware companies also develop software that enhances the value of their offerings. With shrinking margins on hardware sales, manufacturers are increasingly looking to leverage the software assets embedded within their devices in various ways, including monetization as well as using software to protect and control the feature set delivered to customers. In the past, this software may have been given away with the hardware or bundled with the hardware in such a way that the value of the software was not called out separately. Beyond the challenges of establishing value and developing a pricing scheme, these firms find that licensing software is a lot different from selling hardware.

It is a long journey from an "everything is a box," rigid mentality to one that is more closely aligned with selling a more fluid product such as software. For example, even though a company's management may start to understand that there is real value in the software, the sales infrastructure and back office may be set up for shipping boxes.

In addition, unlike physical hardware SKUs, software entitlements have a life cycle that makes them important to manage and track them accurately. In order to monetize the embedded software separate from the hardware, technology is needed to provide (and deny) access to the software as well as turn features on and off as appropriate for the purposes of packaging.

When it comes to licensing models, however, customers are looking for the same things from the hardware companies that they work with as they are from pure software companies. These licensing models include subscription, usage, capacityon- demand, and all-you-can-eat models. The ability to offer flexible licensing models such as pay-per-use or capacity on demand can be a competitive necessity: a fall 2012 survey of software publishers and device manufacturers found that for those companies planning on changing their software approach in the next few years, subscription and pay-per-use approaches were top on the list (see Figure 1).

For example, one company was competing against a similar firm for a hardware and software deal that involved the company's highest-end product. The company's software license model is a one-size-fits-all perpetual approach, while the competitor was able to offer a capacity-based model that offered the prospect more flexibility and aligned more closely with its expectations for how and what it wanted to spend. The only leverage that the company had was to discount the perpetual license very aggressively, but it still lost the deal to the competitor.

As someone within the company that was familiar with the deal said, "The competitor was in there for 110% of their perpetual price, while we were in there for 60% of our perpetual price. Sometimes, we are our own worst enemy."

Licensing Organization

When a hardware company starts focusing on the business of software, a key step is the development of a software licensing organization. This organization should be centralized, at least initially, and led by a high-level individual who is tasked with building definitions, structure, and policy around licensing, as well as determining the appropriate license management approach and enabling technologies. A sample organizational chart is shown in Figure 2.