Revenge of the Nerds: How Chip Vendors Are Changing Software Pricing

The big four processor vendors — AMD, IBM, Intel and Sun Microsystems — rely heavily on continual innovation and speed increases to fuel their businesses. At the heart of their strategies is Moore’s Law.

Simply stated, Moore’s Law says that transistor density on integrated circuits roughly doubles every two years. These chipmakers have continually rode the Moore’s Law curve for over 40 years with increasing the density of circuits and consolidating functions into increasingly powerful microprocessor designs. This product development strategy has evolved to include multiple processing units — or cores — within a single processor design. You can find an explanation of dual-core technology here.

AMD’s dual-core processor, called the Opteron, has been adopted by several systems manufacturers for low-end workstations including by IBM for their IntelliStation workstation product line. IBM also chose the Power Everywhere Show in Tokyo earlier this month to announce its own dual-core processor, the PowerPC 970MP. Sun Microsystems also has multi-core technology in its line of UltraSPARC processors.

All this power in processors has many software companies wondering how to price their applications accordingly. On the one hand, software vendors argue, this is really like having two processors in a single chip, while on the other, the argument says that there should be only a per-socket price per application. Intel and the chip vendors are coming down on the latter side of this argument for obvious reasons. This debate has been going on since last year; the shipment of the first dual-core processors this month and its implications for enterprise software vendors are making this point noteworthy now.

CRM Best-of-Breed Curiously Silent

Scouring the Siebel site for any word of their stance on pricing as it relates to dual-core processors showed what the case is for many other best-of-breed CRM vendors: no one is taking a stand on this. This is surprising, given Siebel’s latest 10-Q on file with the Securities and Exchange Commission showing a higher reliance than ever on maintenance revenue and a drop in the elephant-size deals this vendor relies on. Deals over US$1 million fell from 29 in Q1, 2004 to 22 in the Q1, 2005, a reduction of 24 percent. Total deals dropped from 306 to 244 with a corresponding drop in average deal size from US$414,000 to $307,000 from Q1, 2004 to Q1, 2005. All these financial metrics point to maintenance revenue as the lifeblood of Siebel for years to come if this trend continues — and yet nothing on dual-core or multi-core pricing.

Enterprise Vendors Seize the Opportunity

Oracle’s stance on multi-core processor pricing states that a .75 multiple will be used to equate the number of cores in a single processor to the price for an application. In the case of 11 cores in a processor for example, 8.25 will be rounded to 9, which will be the basis of pricing from Oracle. Exemptions include Oracle Standard Edition One or Standard Edition programs running on one processor that has one or two cores, one processor will be the basis of pricing. You can see the July 8, 2005, edition of the Oracle price list here, which includes their policy statement. Oracle is going in exactly the opposite direction of what so many users want in pricing strategies: simplicity. Sure, there is greater power in a multi-core processor — but Oracle’s strategy to pricing cannot scale long-term.

Microsoft’s stance has been much more straightforward — and while many analysts have long applauded it for its initial and decisive move to adopt per processor pricing since October 2004 as defined on its site here, there is much more at stake than simplicity. Longhorn’s launch and the success or failure of Microsoft to defend its most valuable customers — the IT departments and infrastructure accounts it has fought so hard to win versus open source competition — is at stake. Give Microsoft credit for realizing that early and going after the the low-end of the multi-core marketplace.

A Pricing Revolution Is at Hand

All of these dynamics are aligning to give users what they have wanted for years — a break on high maintenance fees and more understandable pricing models from vendors. CRM users in particular are finding it increasingly difficult to justify 22 percent or higher maintenance fees every year for what in some cases has been bug fixing and mild software increases in performance and functionality. Open source has become a viable alternative in several IT departments precisely for this reason; the costs of maintenance and support continue to escalate with no equivocal increase in value from larger enterprise vendors. Add to this the fact that many software companies are increasingly dependent on maintenance revenues, and it is easy to see how the balance of power in negotiating pricing is shifting back to the users. The shipment of multi-core processors by the world’s largest processor manufacturers has just given users another reason to go after the following:

• Much more simplicity in pricing models. Consider the fact that Microsoft has long had some of the most complex pricing structures there are in software and been lectured by CIOs about becoming simple to deal with. Seizing the opportunity to simplify pricing while going after the next generation of processor so critical to their growth was a good move.
• Subscription pricing is propelling OnDemand application growth. The fact that subscription pricing, aimed at Sales Force Automation and Analytics applications, is considered by many companies superior to per-seat or value-based pricing, is starting to have a reverberating effect on all OnDemand applications growth. This is evident also within Siebel’s OnDemand revenue — one of the bright spots in an otherwise ugly quarter.
• Push for per socket pricing now. The good news for many CRM users is that their vendors have been slow to define a position on the multi-core processor pricing issue.
• Consider an automated license compliance system. For many IT departments this pays off quickly, but be aware that FUD can play a role in these vendors attempting to oversell a system to you. They claim product activation is the main approach used for licensing — when per processor is by far the most dominant.

Bottom Line: Software pricing strategies are overdue for major change. Despite many companies becoming complacent in their approach to managing maintenance pricing as a competitive weapon, multi-core processors are forcing the issue of where the real value is in overly complex maintenance and upgrade pricing.