Selling or Subscribing Software under Quality Uncertainty and Network Externality Effect

Abstract

We examine the optimal way for a software vendor to license software: perpetual license at a posted price, subscription contract that subscribers receive automatic updates for periodic payment, or a hybrid approach that involves both. By addressing such specific issues in the software market as network effects, quality uncertainty, upgrade compatibility, and the vendor's ability to commit to future prices in a dynamic environment, we demonstrate how a software vendor can manage the trade-offs of perpetual licensing and subscription to optimize profit, as well as the corresponding welfare effect on consumers. Though the subscription model helps the vendor lock in consumers so as to increase profit when there is a great uncertainty associated with the next version software, it destroys the path dependence in creating network externalities.Therefore, when the network effect is sufficiently large, it is more profitable for a software vendor to provide both perpetual licensing and subscription.