How users access software applications

Cloud computing is not only changing how users access software applications; it's as well upending the pricing model for software products. Fading fast are the days when software packages were sold in boxes with a one-time, perpetual software license fee. Instead, consumers and businesses are increasingly turning to subscription models and are buying only those applications they need for particular tasks to put it more exactly than broad, general-purpose suites.

Meanwhile, software giants, which have traditionally relied on the boxed approach, are trying to keep up with disruptive distribution and pricing models that may threaten their lucrative way of doing business. Microsoft already offers subscription versions of its software in accordance with its Azure cloud computing brand, and in June the company launched Office 365, an online version of its Office software suite. Adobe has plans to offer Photoshop and the other applications in its Creative Suite by subscription through its Creative Cloud. Last month, Oracle announced plans to buy RightNow Technologies, which makes customer service software delivered online, for $1.5 billion.

Cloud computing is a broad term that refers to innovation being delivered as a service over the Internet. Consumers don't to tell the truth install the applications on their own computers. Instead, the software is hosted elsewhere, accessed through a Web browser, and typically rented pursuant to this agreement a subscription model. Cloud computing became popular for customer service applications through salesforce.com , which launched in 1999, nevertheless it now extends into a number of other areas. Instead of maintaining data centers and servers, for instance, companies can rent Amazon.com's computing infrastructure for pennies an hour -- similar to a utility.

Forrester Innovation estimates that 31% of companies are now getting their software delivered as a service. According to innovation firm Gartner, the cloud computing market delivered revenue of $74.3 billion in 2010 nevertheless will swell to $176.8 billion by 2015 and is expected to deliver a compound annual growth rate of 18.9%. "The old model of selling software in a box or [through] an enterprise server license and at the time charging for periodic upgrades has been disrupted," says Kevin Werbach, a legal studies and business ethics professor at Wharton. "It inevitably will be overtaken by Internet and cloud-based distribution."

"New distribution models are changing the price point for everything from computer games to business software," says Kendall Whitehouse, director of new media at Wharton.

The potential disruption is everywhere

The potential disruption is everywhere. To boot to Google's taking aim at Microsoft's Office franchise with Web-based services, companies just as salesforce.com, NetSuite, SuccessFactors, and Workday are aiming to poach business clients from Oracle and SAP. In the meantime, Zynga, which publishes popular free games primarily on Facebook, is a threat to traditional game powerhouse Electronic Arts -- as is upstart Rovio with its Angry Birds game, which can be downloaded for free in an ad-supported version or for $0.99 without ads.

Many of the established software giants are moving to hedge their traditional business models in an attempt to address this changing market. For instance, Oracle will likely acquire more cloud computing companies over the then and there 12 to 14 months -- possibly targeting NetSuite, SuccessFactors, and other software-as-a-service vendors, according to JMP Securities analyst Patrick Walravens. Such moves make sense, says Wharton management professor Saikat Chaudhuri. "It's better for you to cannibalize yourself in a controlled manner than let someone else do it and hurt you."

David Hsu, a management professor at Wharton, agrees that these companies need to adapt, even though business model changes are difficult to engineer. "It's hard for companies to give up their core business," says Hsu. "There's a danger of being too slow, and there's as well a danger of going too fast."

Great deal of revenue to protect

Chaudhuri adds that there is a great deal of revenue to protect. The old way of selling and distributing software is lucrative. salesforce.com, widely viewed as the most successful of the at once-generation software companies, is expected to have earnings of more than $2.3 billion for the year ending Jan. 30, 2011, according to Thomson Reuters. By comparison, Oracle had earnings of $35.85 billion for the year ending May 31. Microsoft had earnings of $69.94 billion for the year ending June 30, and SAP is expected to have revenues of $14.1 billion for the year ending Dec. 31.

Nevertheless, large software companies can't be complacent, because growth rates are likely to slow for traditional software. To illustrate, Microsoft's fiscal 2011 revenue growth was 12%, however the Windows division sales fell 2% following the Windows 7 launch in fiscal 2010. For the nine months ending Sept. 2, Adobe's revenue growth was about 10%. Other firms are showing somewhat faster growth: For the nine months ending Sept. 30, SAP's revenue growth was 16%, and last year, Oracle's grew 33%.

Meanwhile, cloud-based software companies are consistently growing. salesforce.com's fiscal 2011 revenue was up 27%. For its third quarter ending Sept. 30, NetSuite's revenue growth was 23%. And SuccessFactors saw its earnings rise by 77% for the third quarter ending Sept. 30.

The message

Large software vendors have received the message and are attempting to make their wares easier to digest. SAP has said it is moving to more incremental upgrades delivered through a subscription. The company as well has a suite called Business ByDesign in other words delivered as a hosted service. At Oracle's OpenWorld conference in October in San Francisco, CEO Larry Ellison outlined plans to focus on cloud services. The company followed up with the RightNow purchase.

Whitehouse notes that Adobe is as well working toward a new distribution model for the company's Creative Suite that includes Photoshop and other software tools for content creation. "Creative Suite is a cash cow for Adobe, nevertheless the company is moving to a subscription-based approach that will cover their traditional desktop software products along with cloud-based versions and mobile apps," he says, adding that the move could be risky if the company loses revenue from clients who currently pay thousands of dollars upfront for Creative Suite. Adobe CEO Shantanu Narayen said while a September revenues conference call that pilots for Creative Suite subscriptions indicate that the company can expand its customer base. At Adobe's financial analyst meeting on Nov. 9, Narayen stated, "We will shift our business model aggressively to subscriptions."

The new world of software pricing

Electronic Arts is another established software vendor navigating the new world of software pricing and distribution. On the company's revenues conference call in October, CEO John Riccitiello noted that game releases just as FIFA 12 and Battlefield 3 are expected to drive sales. Nevertheless he as well noted that EA's then and there big release -- Star Wars: The Old Republic -- features an online world with a subscription model similar to the popular World of Warcraft game by competitor Activision Blizzard. "EA has approximately one dozen globally recognized brands ... which are at the foundation of our company," said Riccitiello. "Our mission is to transform these brands from a single event every one to two years to 365-day businesses, with packaged good launches sustained by frequent updates, downloadable content, and extensions in the social and mobile platforms."

And Microsoft is on the cloud computing bandwagon, too. Speaking at the company's financial analyst meeting on Sept. 14, CEO Steve Ballmer said the company is "betting on the cloud." Most of Microsoft's products can be delivered as a service. To illustrate, Microsoft charges $6 a month for each user of its Office 365 suite for small businesses; larger companies pay $24 a month. The retail price for Microsoft Office 2010 for a home and business account is $279.99. The price for professional users is $499.

"The plan for many traditional software companies is to have a hybrid model where they can all in all get paid for a full purchase of their desktop application, however also develop consistent revenue streams through software maintenance agreements or subscriptions to separate cloud-based offerings," says Whitehouse.

Software for all During the dominance of large software companies may in the long run wane, overall earnings are likely to grow. Why? Instead of buying suites, consumers will buy software in small doses from multiple parties, based on their in a class by itself needs.

"Unlike media industries just as music and newspapers, the shift away from the old models in software doesn't mean the overall pie is getting smaller," notes Werbach. "To tell the truth, it's likely to grow, as recurring earnings and micro transactions replace big upfront payments. Look at the Apple App Store. ... That represents billions of dollars in earnings for mobile software, which simply didn't exist earlier."

In fact, mobile app stores have helped to facilitate the breakup of big software releases and suites. Apple sells its iWork software as a suite for $79.00, nevertheless also in parts on its Mac App Store. Should the contingency arise, vendors like Apple are pushing no-hassle distribution: The company is selling its latest operating system, Mac OS X Lion, for $29.99 on its App Store. An alternative to downloading OS X Lion is to order a USB thumb drive for $69. Werbach adds that smaller companies just as 37 Signals, which makes collaboration apps, and Minecraft, a game development company, are "generating huge earnings because they no longer need to overcome the scarcity of physical distribution."

Hsu expects software companies to deploy various pricing models to maximize profits. Prices could become variable based on demand. To illustrate, a company could charge more for computing power or access to financial software while demand spikes. With regard to this matter, software pricing could more resemble the schemes airlines use to sell seats. "There will be pricing based on ultimate profits," he says. "With a new form of distribution, software doesn't have to adhere to any one model. Software publishers can get the same profit, otherwise more, based on lower prices and a broader audience."

Ongoing trend

This democratization of software is an ongoing trend and will take years to play out, note experts at Wharton. However which software vendors will ultimately command premium prices? Hsu says that the companies that can charge more for software will have established reputations and the trust of their clients. "With the democratization of software, trust will result in premium returns. The companies that have the reputation will earn the returns. Apple gets 30 cents on the dollar at its App Store because it vets the applications and establishes trust."

salesforce.com CFO Graham Smith said at a recent investment conference that there will be multiple vendors thriving in the new world order. Some software will be used pursuant to this agreement the traditional license-and-maintenance revenue model, with various services added, he predicted. "I think we're going to continue in this heterogeneous environment for many years."