Software licensing: Pay-per-use versus perpetual. Working Paper. Available at SSRN: http://ssrn.com/abstract=1088570

Piracy has been a major problem for perpetually licensed software. Usage-based licensing architecture such as pay-per-use or software-as-a-service can offer technology-based protection against piracy. We provide an analytical framework to examine the economic implications of pay-per-use versus perpetual licensing in a market with potential piracy, network effect, and heterogeneous consumers in terms of marginal usage benefit and acquisition costs for pirated software. We show that the potential piracy rate, the user inconvenience cost of pay-per-use licensing, consumer heterogeneity, and the network strength are important factors determining a vendor’s optimal choice of licensing architecture. While perpetual licensing tends to be optimal when consumers have homogeneous valuations, pay-per-use is more profitable than perpetual licensing or mixed licensing in markets with heterogeneous consumers and low user inconvenience costs. If the inconvenience cost is low enough, pay-per-use will be more profitable than perpetual licensing even if the market has no potential piracy. The presence of network effect also favors pay-per-use over perpetual licensing; if the network effect is strong, pay-per