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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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The Knives Your Sales People Should Have

Comments (27)

In December, I wrote a post titled Give Your Sales People All The Knives.  While I let you draw whatever conclusions you wanted from the post, I thought I’d follow through and give you a little more detail about what I meant by the statement.

I framed the problem with the struggle many software companies have been going through over the past few years (or decades – depending on who’s version of history you believe) around selling perpetual licenses vs. subscriptions.  I inadvertently included the construct of the deployment model (desktop, server, or SaaS / hosted) which, while a key part of the evolution of the software business, was not the part of the problem I was referring to when I suggested you should give your sales people all the knives.

A few people wrote me concerned that I was suggesting that the sales organization should determine the deployment model and that I was suggesting a company shouldn’t differentiate between desktop, server, or SaaS.  Don’t be concerned about this – it isn’t my argument or suggestion.

Instead, I’m focused entirely on the licensing and pricing model (which I’ll simply refer to as the “licensing” model – which includes price.)  I’ve been in more conversations that I care to count about how to price software, regardless of the deployment model.  The licensing model and the deployment model inevitably get tangled up when they shouldn’t. 

In 2009 (and going forward) customers will buy software using both perpetual licensing and subscription licensing, regardless of how the software is deployed.  In addition, customers will buy perpetual licenses but pay periodically (monthly, quarterly, annually) and customers will buy subscription licenses but pay in single payments up front.  If you can parse all of that, this is the exact opposite of the theory of how the software licensing and deployment were intended to line up.  Of course, this is nothing new as software leasing has been around since the beginning of the software business, as have prepaid services.

While I know all of this gives the auditors great pleasure because it means they get to spend more time lecturing companies about revenue recognition and enforcing accounting policies that distort the true financial picture of the company under the guise of complying with GAAP, it’s irrelevant.  Your goal as a company is to create great products that your customers will pay you for.  The goal of your sales organization is to sell these products; they shouldn’t care how the customer wants to license the products.

That’s the essence of what I mean by Give Your Sales People All The KnivesWhile it makes good business sense to have a religious point of view about the deployment model (there are fundamental differences between a SaaS deployment model and a software license / behind the firewall / on premise / whatever you want to call it deployment model), customers buy each deployment model a variety of different ways and your licensing model should accommodate.

I regularly hear the argument that the economics aren’t the same.  Baloney – they are approximately the same.  A typical perpetual model is $x in year 1 with 0.2x in year 2 and year 3.  A typical subscription model is 0.4x in year 1, year 2, and year 3.  Tweak this however you’d like; you get a roughly equal cumulative payment stream over four years.  I understand the cost of capital argument – you’d rather get the money up front, but remember that some customers want to pay for the subscription model up front (three year pre-pay for the subscription – or a single check of 1.2x) while others want to pay for the perpetual model in equal payments over three years (0.467x / year). 

Cash flow follows this logic.  The customer wants to pay in different ways to manage their cash flow.  Some want to pay monthly; some quarterly; some annually.  The deployment model doesn’t matter; the license model doesn’t matter – how the customer wants to pay is what drives this.

Fundamentally, the customer is managing two things.  First is cash flow.  If the customer has a use it or lose it budget, they want to pay now.  If they have no (or minimal) budget but really need the software, they want to pay monthly and try to bury the expense in a cumulative budget, or get a budget exception for a small monthly payment.  Second – and more subtle – is how the customer accounts for the purchase.  Many companies (whether they should be or shouldn’t be) want to capitalize the software purchase and put it on the balance sheet to manage short term earnings, especially in down markets.  Others are perfectly happy to have the purchase be an income statement item.  The two issues drive customer purchase behavior much more than your licensing model does.  As a result, I’m suggesting you should set up your licensing model to be flexible to accommodate your customer’s needs, rather than the other way around.

Bottom line – if you make software for a living, regardless of your deployment model, you should be able to provide either a subscription or perpetual licensing model, with any type of payment approach.

Many companies have only been giving their sales guys the brown handled knives (e.g. they are limited to using one type of licensing model.)  Selling software into a downturn is always harder.  Now is the time to give your sales people all the knives. If they don’t carve up enough business, they’ll at least have enough knives to put themselves out of their misery.

  • http://intensedebate.com/people/martin_edi18731 Martin Edic

    Brad, I'm a little confused. What if you sell software that cannot be replicated inside a firewall or on a desktop? Are you implying that we should offer a perpetual license in that case? I just don't think its an either/or situation.
    And, in case it matters, we don't sell into IT departments and we have never had a request for an alternative to a subscription model. It's the "I need to own it" IT attitude that drives this discussion, not the market reality, IMHO.

    • http://intensedebate.com/people/bfeld bfeld

      Yup – you should definitely have a perpetual license in your sales toolkit. It’s great if you never get asked for it, but if you ever do, it’s nice to be able to say “sure – we can license it that way – here’s what it costs and how it works.” If IT never gets in your way on a purchase, that’s great. But, I’m seeing this more and more across all business units (not driven by IT) in companies making purchases that have lifetime value > $250k.My simple point is that your religion should be around your deployment model, not your licensing or pricing model.

  • John Ball

    Perfect, fantastic, and other serious accolades. We are so keen to innovate with product features and accept that clients may or may not use certain features while remaining stuck on inflexible business models.

    Offering customers (providing sales professionals) with different licensing models is nothing more than ensuring you address the "unmet" market need.

  • http://intensedebate.com/people/RyanGraves RyanGraves

    Is it foolish to think you won't need knives or sales? I'd like to focusing on increasing the "virality" of our product and talk about who, what, and why on our blog. Is this a recipe for a new tone of software company or a recipe for success?

    • http://intensedebate.com/people/bfeld bfeld

      I think knives and sales are going to be around for a long long time.

  • http://intensedebate.com/people/john_mccart7589 John McCarthy

    Makes sense to allow potential customers determine how they want to pay you. A big part of that is making sure the sales people have the proper pricing and contracting tools at their disposal so they can quote quickly and easily, regardless of what pricing model a potential customer chooses. Also need to make sure that sales compensation plans are set so that the sales people are economically indifferent to which pricing model a customer chooses.

  • Phil Sugar

    Having lived this my short answer is that if you let the salesperson decide which way to price you are going to have three MAJOR problems.

    The first is that they will spend all their time negotiating with customers around price instead of delivering value, this hurts sales.

    The second is there is a major difference in revenue recognition and they will spend all their time trying to game the system if you pay them any sort of commission….i.e. if its December on sale would get you $1M in revenue and one $100k (remember only one month 1/12th of revenue)

    The third is you build your company one way or the other….seriously two very senior guys at two publicly traded software companies that worked for me admit they can't change the model once you go down one path.

    • http://intensedebate.com/people/bfeld Brad Feld

      1. If this happens, it’s a weakness in the sales organization and, more specifically, sales leadership. Excellent sales leadership knows how to address this. It’s quite simple – you have a primary licensing approach that you lead with. You only fall back on an alternative later in the process if the customer forces the issue. Defining “forces the issue” is key.

      2. Same as #1 – this is easy to deal with if you have strong sales management that understands incentives and how to structure them. You should be able to comp the sales organization in a way that that they are indifferent to licensing. If you want to incent a type of licensing, you can always lean the comp toward that one, but I think that undermines the idea of giving the sales people all the knives.

      3. This is an assertion that obviously is different than mine. I think you have to build your deployment model one way or the other (it’s extremely difficult to have both an SaaS and a behind the firewall deployment model in the same company). But – I think you can mix licensing models easily.

  • http://www-2-speed.com Will Herman

    Here, here, Brad. I totally agree. Yes, it makes sales comp plans harder, but that's a one-time effort to resolve (and resolve again when you realize the unintended consequences of the original plan). The only downside I've experienced with multiple selling strategies/models is for public companies that have to explain such to analysts. The analysts often have a perception and bias to one particular model. If the company is not aligned with that . . . well, you get the idea.

    • http://intensedebate.com/people/bfeld Brad Feld

      Thanks Will. That’s nice validation coming from you as you are one of the CEO’s I most respect about selling (and managing a sales organization).

      Regarding the public market stuff – I’ve completely given up on the validity of public market analysts. As an investor and entrepreneur, I just don’t care about them anymore. My goal is to build companies to maximize cash flow as that’s the ultimate driver of economic value.

  • Phil Sugar

    1. I think its easy to say: "Defining "forces the issue" is key" doing it is impossible.

    2. I think Joel Spolsky is much more eloquent than me on unintended consequences of bonuses. You have to pay commissions to get good experienced salespeople, I think as soon as you add another order of complexity you can't make it work.

    3. I think you take the tech view and they are both as difficult I agree with your SaaS and behind the firewall comment.

    • http://intensedebate.com/people/bfeld Brad Feld

      Well – we have different perspectives. We can argue endlessly, but I can’t debate assertions like “doing it is impossible” since you aren’t explaining why it is impossible. Since I have empirical data that it is possible (from my experience) I can disprove your statement!

      Re: paying commissions to get good experienced salespeople – I agree. However, I’ve never run into a great sales exec + great sales force that has struggled with multiple licensing approaches when the comp plan is clear – and I strongly believe you can create a clear comp plan to address multiple licensing issues.

      • Phil Sugar

        There are four quadrants…two are the norm.

        SaaS subscription model, Behind the Firewall perpetual license.

        The next one is harder but doable. I'll agree that you can go behind the firewall subscription. In fact, I think its better to start that way, but given you're in a perpetual model and you want to move to subscription ok, get ready to feel the pain from the finance types but doable.

        I want to see how you deliver SaaS in a perpetual license. The definition of perpetual is continuing forever. So the organization can buy once refuse the 20% support and continue to use. Just like Windows XP. How does that work?

        • http://intensedebate.com/people/bfeld Brad Feld

          Remember – it’s “licensing / pricing”. So – in this case, the buyer has to pay the maintenance to continue to get the service. If it’s SaaS and they don’t pay the maintenance, the service stops. It’s a different case than desktop software (like Windows XP) where you “can’t turn off the service easily.”

        • http://scottschnaars.com/blog Scott Schnaars

          In my company, Socialtext, it is a bit easier. We have a managed appliance that, in 95+% of cases is deployed behind the firewall and licensed in a traditional SaaS model.

          While the appliance is installed behind the firewall, as Brad points out, once you stop paying for 'maintenance', there goes support / updates.

  • Sue Kunz

    Brad, you nailed it on the head. Having been on the purchasing as well as the sales side of these decisions, in some organizations it's just easier to get OpEx; in others it's easier to get CapEx. Personally, I've never cared which bucket it came from, as long as it was $s.

    One other thing I learned for orgs that offer both is that it's extremely important to show the customer how the models are cash neutral after x years (x=3-5 depending upon your business). If you can't show this, some customers will spend an inordinate amount of time trying to figure out which is cheaper. They need to understand that this is all about being "easy to do business with", and that's it.

    Comp models are solvable. Even big public companies have been doing this for years. I've worked for a few of them.

  • http://scottschnaars.com/blog Scott Schnaars

    We adopted a similar philosophy last quarter – be frictionless.

    This stance has allowed us to deliver what our customers need in a manner that they require, not what we want to force on them. We have our ideal customers and our ideal deployments. We target them very aggressively, but should one come along that doesn't fit the mold perfectly, one that wants to buy ergonomic, left-handed knives, we'd be foolish not to have one or two available somewhere. Be easy to do business with.

    To Phil Sugar's comments, I have an amazingly rich, well structured comp plan (and hiring too). I have no incentive to push a deal one way or the other, simply to do what is best for the customer. As a rep in a small start-up, it is also important to do what is best for the company, so I try to structure my deals in a happy medium.

    Having all of the knives is a great position to be in. It allows me to deliver the right solution for my customers and allows them to pay for it on terms that work best for them. As a sales guy, it makes my life insanely easier as I don't need to jump through a bunch of hoops to make one off exceptions that ultimately become the rule.

    Great post, Brad.

  • Tim

    We'll I'll just add that Brad and I disagreed on this for about 3 years. He finally won me over about 6 months ago. Sales have gone up as a result. We sell On-Prem and Hosted. We sell 1 year term, 3 year term and perpetual both hosted and on-prem. Sell the way customers want to buy!

  • http://www.proofhq.com Mat

    Brad

    The subscription vs. perpetual analysis is sound, but missed out one key innovation of SaaS, which is the pay-as-you-use model.

    As you point out, perpetual and fixed rate subscriptions are really two side of the same coin, although the ability to cancel a fixed price subscription makes it much more flexible.

    At ProofHQ we have gone to market with a fixed rate month;y subscription model. We have different levels of pricing for different profiles of user based primarily on the number of documents that they send for "proofing" each month. All familiar stuff for users of Basecamp, Freshbooks, etc. Of course in a minority of cases we are asked for a more traditional perpetual license, even when we are hosting or managing the service and we don't turn those deals down.

    However, what has surprised us has been the number of people who want to buy a "block" of proofs to consume as and when they want. To me this is the most interesting direction that the SaaS payment model is going in – "pay as you consume". I guess the mobile phone companies got there first, then Google with Adwords and Amazon with S3 etc.

    They key to maintaining flexibility in pricing models is being able to define a product's "unit of value". In our case "proofs". If you get that right then you can apply it across a wide range of license models without too much conflict or inconsistency.

    • http://intensedebate.com/people/bfeld Brad Feld

      That’s a good example. It’s conceivable that you should still do a license like this under a perpetual model where the customer pays a single payment for a specific number of “uses” or “proofs”. You’d have to build this into the license key which is incremental work (but trivial on a SaaS deployment), but I think you could simulate the same affect. However, I doubt this will be anywhere as easy or logical as in a SaaS model.

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  • http://intensedebate.com/people/martin_edi18731 martin_edi18731

    The IT comment was really more about their insistence on 'owning' the data which isn't an option in our case. Fortunately we sell to marketing people…;-)

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