An economic model to compare the profitability of pay-per-use and fixed-fee licensing

This paper develops an economic model to compare the profitability of two strategies for the pricing of packaged software: fixed-fee and pay-per-use licensing. It is assumed that the market consists of a monopoly software vendor who is selling packaged software to customers who are homogeneous in marginal value of software use but heterogeneous in level of use. In addition to obtaining the software package from the market, customers can develop the required software in-house. When in-house development costs are constant across customers, the results show that the software vendor prefers pay-per-use licensing over fixed-fee licensing if in-house development is relatively expensive, whereas fixed-fee licensing is optimal if the cost of in-house development drops below a certain threshold value. When the assumption of a constant in-house development cost is relaxed by letting it vary among customers, it still holds that pay-per-use licensing is optimal if its average is relatively large. For low and medium values of the average cost of in-house development, however, fixed-fee licensing may no longer be optimal as the relative attractiveness of the two licensing strategies now depends on how dispersed the in-house development costs of individual customers are.