Maybe software should be packaged like this?  Photo: Tetra Pak Package Portfolio, by Tetra Pak, CC license

A “packaged application” is software already built, coded, tested, used by other enterprises in your industry, and hopefully a solution that will meet most of your needs.  In general I recommend using packaged applications (why re-invent something?)

But a packaged application is not ready-to-use, in any sense of the word. The word “packaged” is kind of a misnomer. You won’t find a warehouse management system in a shrink-wrapped box on the shelf at Best Buy. A packaged application is simply one whose features and functions match in general terms what you want the software to do, but which still needs to be configured for your business. Configuration (also called setup) involves a lot of work and expense.

Much of the time involved in configuration is not in setting up all the data and parameters, but in deciding what data and parameters to set up. What data do you want to/have to set up for each customer? Should employees be “suppliers,” so that you can reimburse them for travel expenses? Do you want to manage your inventory levels according to min/max parameters or days on hand, or some other way? In most enterprises, decisions like these aren’t made by one person – groups of people get involved, and all those meetings and explanations have to be scheduled, and someone has to herd everyone into a decision. Not a quick process.

Packaged software is an annuity business. A software company survives in the long run because it is able to collect annual maintenance and support fees from its customers while providing custom development services and a stream of version upgrades. The support fees can be 20% to 25% of the original cost of the software license, so to the software firm, it’s like selling a new system to the same customer every four or five years. In exchange for the fees, the customer gets access to support desks, can have the software firm make modifications to the system usually on a time-and-materials basis, and automatically gets some upgrades and patches (or fixes) as well as user guides and maybe some technical documentation.

Recurring support revenue is highly profitable for vendors selling packaged applications. It is not unusual for big packaged software vendors like SAP, Oracle, and JDA to have this type of revenue represent 60+% of its sales while incurring only 5% or 10% of its operating expenses.

If you are selecting a packaged application, understand that your vendor will try to sell you the traditional on-premise solution, in which you will own and host the software while paying the vendor for additional licenses, upgrades and custom developments, plus the annual maintenance fees of 20% to 25% of the original license cost, which, on a license costing $500,000, for example, would be $100,000 to $125,000 per year.

And therein lies one of the most debated and disruptive topics in the software market today: the move away from the traditional on-premise (also referred to as perpetual license) model to a service or subscription-based model.  It is not exaggerating to say that the perpetual license model has in a way been the drug, the stream of highly profitable revenue, sustaining the software industry the past two decades.  Stay tuned.