Wednesday, May 27th 2020

Licenses in a Subscription World

Most new startups default to a subscription model for their software. Should they consider selling licenses instead?

Subscriptions Aren't Free

The SaaS subscription model is the de facto standard for business-to-business startups and the unspoken expectation of venture capitalists.

Superficially, a subscription model makes sense for early stage companies. By definition, it provides consistent revenue for an otherwise volatile business, even if no new customers are acquired (or if net churn is zero). And, a more approachable cost increases conversion and can help boost lifetime value. As businesses grow, subscriptions are also an excellent test of how well their product serves customers.

However, a subscription model comes with hidden risks for new companies at a time when developing a deep understanding of their customers is vastly more important than quick revenue. This risk can be separated into two buckets: the business and its customer relationships.

Subscription Business Risks:
  • Optimization around fear of churn
  • Increased difficulty justifying evolutionary changes due to fear of churn
  • Decision-making bias toward short-term outcomes
  • Landing on a comfortable local maxima with a 'good-enough' product
Subscription Customer Relationships:
  • Provisional by nature
  • Product feedback bias toward short-term, granular features
  • Customers are less likely to help guide overall product direction
  • If product does not meet customer needs, negative feedback is limited to churn

Licenses Support Optimization

Mature businesses and startups alike have embraced the software-as-a-service model. Widespread adoption of subscriptions makes it easy to assume that licenses are inherently inferior; their pricing is less approachable and they require consistent sales for sustainable revenue.

However, these perceived drawbacks are exactly why a license model is an extremely valuable tool for early stage companies. During the product optimization phase, licenses are an excellent way to quickly hone a product to effectively meet customer needs. They increase feedback volume and quality, support greater executional freedom, and closely align business and customer incentives.

Startups will have to think carefully about unit economics when pricing licenses, but declining infrastructure costs mean they can still maintain significant margins over the license term (I should know, I sell licenses to cloud storage). Thoughtful pricing can even make licenses a very attractive investment.

License Business Benefits:
  • Capital up front accelerates iteration and supports significant product evolution without fear of losing subscribers
  • Closing higher-priced sales requires deep understanding of customer need and provides greater product validatation
  • Immediate understanding of customer LTV
  • SaaS infrastructure costs decrease predictably year-over-year
  • Foundation for upsell opportunities in the future
License Customer Relationships:
  • License investment aligns customers with long-term objectives of the business
  • Builds product-focused customer relationship instead of a price-focused one
  • Easy to build a community of customers for product feedback and requests
  • Customers who disagree with product changes are quick to explain why instead of simply cancelling a subscription
  • Data from license customers helps inform future subscription pricing

Ultimately, most B2B startups will adopt a subscription model as their product matures. Increased conversion and recurring revenue are significant benefits for businesses that can reliably predict their current CAC and LTV. However, for pre- product-market fit startups with no historical data, rapid iteration and strong customer relationships are much more important as they develop the best possible product for their market.

Silicon Valley is over-indexing on recurring revenue. Far too many founders and investors assume that the standard revenue model for large software businesses will translate well to small ones. Selling licenses early on helps new companies focus on long-term optimization for millions of users instead short-term optimization for a few thousand dollars in recurring revenue.