Here's how the 2008 financial crisis led to the dominance of subscriptions in the software industry, and why they're here to stay in the cloud era
- Over the last two decades, software has slowly shifted from a traditional licensing model to a cloud-based subscription model.
- Cloud companies like Salesforce pioneered the model, but experts say the 2008 financial crisis was the inflection point - as companies cut costs, the pay-as-you-go model became very attractive.
- Companies like Adobe and Microsoft made the switch to focus on a subscription model and have reaped the rewards, as their businesses boom.
- Subscription software companies say that the model is actually better for users - the software gets more features, more often, and customers don't have to pay a high sticker price up front to get started.
- However, critics note that over the course of the lifetime of a subscription, users will often pay more than they would have if they bought the software outright.
- Experts say the model is here to stay: It makes it easy for corporate customers to sign on small teams to use specialized, industry-specific tools, just for starters. But they say that privacy and security are going to be big shadows over the market, especially thanks to laws like the EU's GDPR.
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Subscriptions aren't just everywhere - they feel inevitable.
Everybody from Apple to Disney is pursuing a subscription-based billing model, joining mainstay digital media companies like Netflix and Spotify. Out goes the old way of buying goods and services a la carte; in with paying a monthly or yearly fee for all-you-can-eat consumption.
This shift, however, is nothing new in the world of software. Over the last two decades, the software world has slowly shifted from the traditional licensing model to a cloud based subscription model.
The subscription model was pioneered by early cloud companies including Salesforce and NetSuite (now a part of Oracle).
Those companies rejected the traditional model, where software vendors would lock customers in to long-term contracts. Their innovation: Customers get billed per user, per month, with no contracts or commitment - just log on and punch in a credit card to get started using software delivered from the internet. This model is often called "software as a service," or "SaaS."
That model wasn't an immediate smash, experts tell Business Insider. Rather, the inflection point was the 2008 financial crisis, which sparked a reckoning in accounting departments all over the United States that made the pay-as-you-go approach far more attractive.
Nowadays, subscriptions are just about standard all over the industry. Major companies like Microsoft and Adobe have made tremendous pivots towards subscriptions: Microsoft now claims 200 million commercial Office 365 subscribers, while Adobe made $2.7 billion in revenue from its subscription services last quarter. Companies like Slack and Zoom rely on subscription revenue, as does just about every new SaaS startup out there.
It's no wonder why, either: Subscription businesses grew revenues about 5 times faster than S&P 500 company revenues, 18.2 percent versus 3.6 percent, according to an October 2019 report from Zuora, a company that helps companies manage all their software subscriptions. At the same time, software as a service business are growing 200 percent faster than than perpetual license software, the report states.
"These are applications that make workers more productive. Being hosted from the cloud is a big piece of that," Edward Parker, a data and cloud infrastructure analyst at BTIG, told Business Insider.
Business Insider spoke with experts about how the 2008 financial crisis set the stage for the current era of cloud subscriptions, why companies like Adobe and Microsoft have bet their business on them, and what about this whole revolution makes IT departments (and some users) a little frustrated.
A financial crisis triggers a move to the cloud
The shift towards the subscription economy had a surprising catalyst: The 2008 financial crisis.
In an environment of such uncertainty, companies were unenthused at the thought of spending a lot of money upfront to license software for use by a predetermined number of employees. Cloud software, which allows customers to pay as they go based on the number of users they need, provided a compelling alternative.
"Fortune 500 companies are saying we're not sure if we're gonna have cash, so why would we go buy expensive software?" Tien Tzuo, the CEO of subscription management company Zuora, said. "Why not just try this software as a service thing?"
Tzuo says that Salesforce, founded in 1999, really hit its inflection point around 2008, amid this shift. Salesforce, and companies like it, presented a way for companies to allow business to continue as usual, without having to make a commitment to legacy vendors like Oracle or Microsoft - or to maintaining their own servers.
"Nobody knew what's going to happen. So, okay, we're not going to do any major spending but operations go on," said Laurie Wurster, a research director at Gartner who follows the software space. "They tried to do cost containment, costs savings...so we saw a move to the cloud because people still have to get work done whether the economy is sluggish or not, they have to get work done."
Wurster says that within the tech industry itself, companies that mastered the subscription model weathered the recession. She notes that CA Technologies, which Broadcom acquired for $18.9 billion in July 2018, weathered the downturn better than many of its peers, thanks to a subscription model it had adopted in the early 2000s.
"They had all these multi-year contracts and so they continued to see that same revenue stream coming in from people's operating expense for enough of their customers that had that model that it was positive. It had a very positive impact on their bottom line during that financial crisis period," Wurster said.
A lower barrier to entry
Software providers like Microsoft, Adobe and Salesforce say the main benefit of cloud based software is that it allows them to have a more direct relationship with their customers. When software can literally be updated several times per day, it gets a lot easier to add new features that solve real problems.
"The single biggest transformation that it has enabled us to do is have a much more direct relationship with our customers," Adobe CTO Abhay Parasnis told Business Insider. "If it's good for your customers and if you continue to innovate, it's not surprising that as a net result your revenue, your business growth continues to be very healthy."
Parasnis also said it has lowered the barrier to entry for people who want to use Adobe's software. Software like Photoshop and Illustrator is expensive, sometimes prohibitively so, and subscriptions bring the price down to get started.
In 2011, a perpetual license for Adobe Photoshop was $699, and an upgrade cost $199. Now a subscription for Adobe Photoshop ranges from $9.99/month to $20.99 per month, depending on if users want the Lightroom app bundled in. A full Creative Cloud subscription costs $52.99 per month and includes all of Adobe's apps. For business users, it's $79.99 per month. Either way, that's cheaper than the upfront price in 2011.
"Our net business has grown many, many-fold since we have transformed. But it actually has lowered the price point," Parasnis said.
Microsoft has seen a similar trend. An Office Home and Business 2019 one-time purchase - that includes Word, Excel, PowerPoint, and Outlook - is $249.99. Meanwhile, an Office 365 subscription for personal use has a lower upfront cost - it ranges from $69.99 to $99.99 per year depending on how many devices you want to use the software on. For enterprise users, an Office 365 subscription ranges from $8 to $35 per user per month.
A more flexible approach
Analysts say that companies often favor this approach: While they may shell out more cash in the long run for a subscription service, the advantages of not having to manage, maintain, or update the apps themselves is worth it - plus the flexibility of being able to add (or subtract) users at will.
"Rather than hire a bunch of IT people and then buy a bunch of Dell servers and buy a bunch of Cisco switches that buy the software and then have full staff owning and operating all that stuff. For me, I'll just write a check to Salesforce.com per user per month. It's just delivered to you. So it is much easier," said Parker, an analyst at BTIG.
Brian Goode, general manager for Microsoft's software as a service products like Microsoft 365, Dynamics 365 and Power Platform, said the main challenge he faces is helping customers see the value of a subscription, versus the more traditional way of doing business.
"Not all customers moved at the same time and frankly some customers were faster than others. But I think just helping customers understand the benefits of both the business model and the product value they get from a cloud based service really was kinda the big thing we needed to focus on," Goode told Business Insider.
Not everybody loves it
Still, that higher lifetime cost doesn't sit right with everybody. When in 2013, Adobe dropped the option to buy traditional boxed copies of software like Photoshop, and instead required a subscription to its Creative Cloud service, a vocal group of users rioted, going so far as to create a Change.org petition urging the company to roll it back.
While the one-time license for Photoshop and other apps was expensive, an Adobe Creative cloud subscription costs the same over 2 to 3 years.
For business customers, there are other drawbacks. Under the more traditional legacy model, software would be installed on their own servers, in their own offices or data centers. That approach, while less flexible than the cloud, has certain other benefits: It's often easier to customize, given that it's installed on your local hardware, and it gives users some degree of reassurance over where their data is being kept.
That last point is an especially large concern with cloud-hosted software - particularly when it comes to Europe's GDPR laws and California's new data privacy regulations, Parker said.
"Privacy is probably the biggest concern, especially in areas for instance like Europe where there are regulations that mandate that data needs to be on specific locations," Parker said. "You may be obligated by not only law, but from a business practice standpoint of not having your data leave your own four walls, you're going to want to put that behind your own firewall."
Another challenge for enterprises is simply managing the amount of software subscriptions they use. With the rise of the cloud, employees no longer need the blessing of the IT department to try and buy new software. The result is that companies can end up with hundreds of cloud-based software subscriptions, with little oversight or governance.
Jody Shapiro, CEO and founder of Productiv, a company that helps enterprises manage the number of subscriptions they have, said software as a service has had a disruptive impact for enterprise companies.
"There were literally hundreds of applications in use at any given enterprise and real struggle by CIOs to understand what they had...but also to really understand the value they delivered," Shapiro told Business Insider.
Not slowing down
Despite those headaches, Parker said that he doesn't expect the adoption of cloud software to slow down any time soon. Software is only getting more important in the average worker's everyday life, opening the door for more and more specialized tools.
"There's a big overarching trend here, it's cliche but true, data is the new oil and software is eating the world. So companies have a very urgent mandate to better use software to make their businesses, not only more efficient but look for areas of competitive advantage in their industry," Parker said.
Still, at least one expert we spoke with thinks that subscriptions aren't inevitable, and there may be another thing coming down the pipeline.
Frank Slootman, CEO of data warehousing startup Snowflake and the former CEO of cloud software giant ServiceNow, says that the idea of charging a flat rate per-user for unlimited usage of a product is unsustainable, and advocates for a business model that bills customers for actual usage of the product.
"I have misgivings about [subscriptions]. I felt that the way we charge for software wasn't as customer friendly or as equitable as a usage model. That's how it is in our consumer lives. When you buy gas for the car, you consume it. You buy cell phone minutes, you use them. You pay for what you use. I think that the SaaS companies represent enormous profit sanctuaries and I think there's a risk to those sanctuaries over time," Slootman told Business Insider.
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