SaaS or On-Premises? The Price Competition Between Two Software Vendors

Abstract

This research studies the price competition between a Software as a Service (SaaS) vendor, who adopts a subscription-based pricing scheme, and an on-premises vendor, who uses a perpetual license scheme. The SaaS vendor decides its subscription price, and the on-premises software vendor decides its initial-version price in the first period, as well as the upgrade price in the second period. We find that firms’ pricing strategy largely depends on the differences in the customizability and implementation costs between the two vendors. In a complex software market where the customizability of the SaaS software is minor, an entry of a SaaS vendor into the market decreases the profit of the on-premises vendor. The on-premises vendor should reduce its initial price, but increase its upgrade price to compete with the SaaS vendor. Moreover, it is better for SaaS vendor to adopt a pay-per-use pricing mode rather than a subscription pricing mode, when the customizability of the SaaS software is minor and the on-premises software is not costly to implement. The SaaS vendor has an opportunity to become a monopolist when the customizability of the SaaS software gets higher, and the on-premises software is sufficiently costly to implement. But if the customizability is too high and the on-premises software is not costly to implement, the SaaS vendor should not continue to improve its software customizability.

Keywords: SaaS, on-premises software, software upgrade, price competition