Software companies have historically understood their business as essentially an exchange of code for dollars. The idea was that if you wrote good code, you could make money selling it.

This model worked pretty well for a while. Customers could benefit substantially from software that did the things they needed it to do. And, to get the benefit of this software, they had to install it on their own CPUs. So they were quite willing to shoulder the cost of licensing, installing and managing installed software.

No More Cash for Code?
But a major shift is taking place. For one thing, with the emergence of viable cloud architectures, code can run anywhere. It is no longer always necessary to license code and install it on your own machines. In fact, because growing software complexity is making the ongoing ownership of installed code a costly hassle, buyers have a strong incentive not to buy more of it.

For another, software is increasingly commoditized. Just about anything you can write into your code can be duplicated by someone else. So it’s harder to compete on software features alone.

And buyers don’t want to buy more features anyway. Most of them only use a small percentage of the features in the software they’ve already bought. So spending more money on more features they may never use doesn’t make any sense.

The Consumption Alternative
Given these conditions, a new model for the software value exchange is emerging. Described in the book “Consumption Economics” by J.B. Wood, Todd Hewlin and Thomas Lah, this model entails the transfer of risk from buyers to vendors. Rather than making large capital outlays for on-premise software deployments that may or may not deliver expected value, buyers are now pushing risk onto vendors—who can no longer count on starting their buyer engagements with high-margin up-front cash payments.

Under this new model, vendors can monetize their code only insofar as buyers use it. That usage can be measured by a variety of parameters: number of users, hours of use, number and type of features activated, volume of data, etc. But the key is that vendors no longer get upfront cash for code. Instead, they get compensated over time based on their ability to continuously deliver value to buyers.

What’s a Vendor To Do?
This shift to consumption economics obviously poses serious challenges to software vendors. But it also presents major opportunities to those who understand it, transform their companies and products to accommodate it and— most of all—prove themselves capable of delivering real value to customers.

Software still delivers tremendous economic value. In fact, it is only a slight exaggeration to say that the world runs on software. So there is plenty of money to be made writing good code. But the way software markets operate is changing rapidly. It will be interesting to see who successfully capitalizes on those market changes and who is left behind by them.