Custom Software Development Costs vs. Proprietary Licensing Fees

It’s become conventional wisdom that custom software development is more expensive than simply buying and installing a proprietary software package off the shelf.  It makes perfect sense, right? 

There are millions of software packages available from the enterprise to the desktop to mobile devices – and allegedly cheap SaaS/subscription pricing has taken over the world. So one might assume…

Surely you can find off-the-shelf software that meets the needs of your business at an affordable monthly fee, right? Well, not so fast…

When it Comes to Software, Conventional Wisdom Can be Dead Wrong

When it comes to the costs of custom vs. packaged software, conventional wisdom is often just plain wrong. The perception that licensing proprietary software is inherently cheaper than developing and owning a custom solution ignores Total Cost of Ownership (TCO), Return on Investment (ROI) and typical accounting and procurement practices.

And this perception doesn’t take into account that the costs (especially ongoing costs) of proprietary SaaS subscriptions can be easily buried in a company’s operating budget.

Custom software is often considered a capital expense that may require multi-level approvals. Subscription software licenses, on the other hand, often get pushed unobtrusively through standard procurement channels.

A Brief History of Proprietary Software

Proprietary, off-the shelf software has been considered a panacea by many for at least a couple of decades now. 

In enterprise computing, Enterprise Resource Planning (ERP) applications exploded in popularity around the turn of the 21st century as a supposedly quick fix for the impending Y2K disaster. And leading proprietary vendors built monopolies in the process.

On the desktop, software suites like Microsoft Office combined word processing, spreadsheets, presentation programs, email management and even a simple DBMS into one relatively inexpensive offering. And Microsoft leveraged this into a monopoly.

For mobile devices, the Apple and Android app stores built a broad channel for packaged application vendors worldwide. And created yet another monopoly in the process.

Well you see where this is going. Proprietary software is built on monopoly power. Monopolies exert control over their customers, and almost always raise prices over time.

Fundamental Differences Between Custom and Proprietary Software

Apart from the discrepancies in hard costs between the two primary software development/ownership models. It’s important to define each and call out some fundamental differences. For our purposes, we’ll lay-out a couple of definitions:

Custom Software

Custom software includes purpose-built applications, middleware and integrations designed to meet the precise needs of your business. Development roadmaps, timelines, and specs are constructed specifically to meet your current and future business objectives. You own and control the software IP.

Proprietary Software

Packaged or proprietary software is developed and sold by a third party vendor. The vendor owns and controls the IP and customers license a defined set of usage rights under an End User License Agreement (EULA). User needs are secondary to vendor profit margins. 

The proprietary software model depends upon constantly matching the least functionality — and lowest R&D costs — with the highest number of customers that will accept and purchase the software.

Software Pricing 101

Generally speaking, software pricing follows one of three basic models: Development for hire (custom software), perpetual licensing, and subscription licensing. Perpetual licensing was long the go-to model but has become much less common as subscription licensing has grown in favor.

Each type has variations (often industry-specific) and there are hybrid models, of course.  For instance, perpetual licensing may include mandatory maintenance or updates & upgrades or a SaaS software package may add transaction fees.

Custom Software Pricing

Custom software pricing is relatively straightforward. Typically detailed in a Statement of Work (SoW) and software development agreement, the project pricing is agreed upon before work begins. As a result, hidden or unexpected costs are minimized or eliminated.

The SoW can be based on hours required to complete the work or a fixed project price. Payment terms may call for partial payments attached to milestones or dates. It’s also common for payments to be spread over the length of the project starting with an initial payment due at SoW signing along with some number of interim payments and a final payment due upon project acceptance.

Change orders can increase total project cost, and additional services like technical support, maintenance or updates may be called out separately. IP ownership transfers to the customer and ongoing costs are often completely eliminated outside of a potential support contract.

While the initial costs of custom can be higher – or at least appear to be – custom software TCO over time is usually much lower than proprietary software.

Proprietary Software Pricing

Proprietary software pricing comes in two flavors, perpetual and subscription. Subscription or Software as a Service (SaaS) is the dominant model today, whereas perpetual licenses were the most common for decades.

Perpetual License Model

While overshadowed by SaaS today, but perpetual licensing is still present in some legacy systems, and a on-prem vendors still offer it on new implementations. This model frontloads your software licensing costs, and it’s paid for upfront. It’s typically installed on-premise, and once implemented and paid for, your vendor can’t “shut it off” or deny access. It does not confer ownership – that remains with the vendor, and ongoing fees like maintenance, updates, and upgrades can still pile up.

SaaS/Subscription Model

The SaaS model avoids the high upfront costs of the perpetual model – in practice, it breaks the initial bump into monthly subscription payments. Detailed analysis will reveal that within a number of months or years, the aggregated subscription payments will meet and exceed the amount of most upfront perpetual license payments.

It’s also worth noting that if you stop paying your monthly subscription fee, you’ve breached the terms of your license, and can be locked out. Proprietary vendors often dangle a deceptively low base subscription fee to make it appear that their software is more affordable than it actually is.  

Some variations on the subscription model can add some additional charges to the base subscription fee, like transaction charges or usage fees. While these may sometime appear trivial, they should be included in your cost analysis.

For instance, if your vendor charges $0.20 per transaction, you may say, so what? But if you are running 1 million transactions per month, you’ll get hit with an extra charge of $200,000 per month.

Proprietary vendors are notorious for presenting a low monthly subscription fee without being completely upfront on other mandatory costs like training, implementation fees, maintenance agreements, upgrade fees, and customization charges. So your monthly cost can quickly balloon, and your TCO gets trashed.

It’s also critical to get a thorough understanding of exactly what modules your base subscription price covers. You may find that you need one or more “optional modules” to actually use the software. It’s a common trick that can increase your total costs dramatically.

The monthly subscription fee is just the start of SaaS license costs. Adding the “optional” modules you need, plus training, support, maintenance, updates, and upgrades, can quickly multiply what you actually pay.  And, of course, ongoing costs never go away.

Perception vs. Costs: TCO and ROI are the Key Metrics to Measure

A common mistake when comparing the costs of custom vs. proprietary software is to approach the process too narrowly. For example, focusing solely on the initial development cost of a custom solution vs. the “teaser” monthly subscription fee of a proprietary package, is deceptive.

An in-depth analysis of ongoing costs and other key considerations often leads to the conclusion that custom software is just a better deal for most companies. To get a more accurate picture of the comparative costs, it’s beneficial to consider the Total Cost of Ownership (TCO), Return on Investment (ROI), and soft costs like opportunity costs, and the cost of inefficiency.

Total Cost of Ownership (TCO):

Arguably the most important metric to consider when comparing custom to proprietary costs, TCO takes a long-term view. While you may recoil at the upfront cost of custom development, projecting the costs of proprietary software over a 5-year period is even more shocking.  

Proprietary software tends to pile on multiple costs beyond a monthly “teaser” subscription fee – even at the time of implementation. Over time, ongoing costs invariably overtake and exceed any perceived cost advantage. To estimate the TCO of a proprietary software package, it pays to consult a well-designed Software TCO Calculator.

Return on Investment (ROI):

The easiest way to conceptualize software ROI is to compare it to buying a house vs. renting. A mortgage payment may be higher than a rental payment, but it yields a valued asset. Custom software is owned, and proprietary software is rented.

IP Ownership:

On a related note, custom software confers IP ownership. It may not show up as a ledger entry, but IP ownership gives you control over costs now and in the future. For more on the benefits of IP ownership, check out: What does it mean to own your own software IP.

Opportunity Cost:

Opportunity cost may be hard to quantify, but it’s real. Because licensing proprietary software can hold you back from seizing an opportunity, it can cost a great deal of money. It goes back to a lack of control – if you’re waiting on your proprietary vendor to deliver the functionality needed to introduce a new product or service, your business loses out.

Inefficiency Costs:

The costs of inefficiency can be hidden and hard to precisely measure, but that doesn’t mean they are not there. Businesses almost always have to compromise and adjust to proprietary software to some degree. This can hurt efficiency by imposing bad or redundant processes and adding unnecessary operational costs. It may be a soft cost, but it adds up over time.

Hidden Software and/or Service Costs:

For complex applications, vendors may not be totally transparent on all modules and service that you’ll need or be required to buy to use their software effectively. So you should thoroughly investigate potential hidden charges beyond the monthly subscription fee.

On top of basic licensing costs, you may encounter charges for implementation, SLAs, user onboarding, customization, and integrations – even data storage.

The Bottom Line on Custom vs. Proprietary Software Costs

While initial custom development costs may be higher than proprietary software upon installation, the superior TCO of custom software makes it a better deal from a pure cost standpoint. When you consider the added benefits of IP ownership, more efficient operations, competitive advantages, and more, it’s clear that the advantages of custom software outweigh potentially higher upfront costs.

Pell Software Solutions Deliver Higher Value at a Lower TCO Than Proprietary Software

Pell Software is a premier custom software developer with broad and deep expertise in creating purpose-built software solutions that deliver more value at a lower TCO than possible with proprietary solutions. With years of successful engagements with businesses like yours, we know what works and what doesn’t. 

We’ve worked with companies ranging from startups to SMBs to national companies in a range of industries. And while our technical skills are world-class, our primary focus is partnering with you to solve your business problems and get a leg up on your competition.

We will work closely with you to develop a “perfect-fit” solution that meets your business goals while always keeping an eye on costs. Bottom line, our solutions meet – or exceed – your objectives and deliver a superior ROI over proprietary alternatives.

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