September 30, 1994

Fred Greguras: Law Firm of Fenwick & West, Two Palo Alto Square, Suite 800, Palo Alto, CA 94306; Telephone (650) 494-0600; FAX (650) 494-0674; InterNet: fgreguras@fenwick.com

Sandy J. Wong, M.P.A., Oikoumene On-Line Marketing, 164 Everson Street, San Francisco, CA 94131; Telephone (415) 334-6066; InterNet: sandy@oikoumene.com

Copyright (C) 1994 Fenwick & West and Sandy J. Wong. Permission is granted to distribute this article freely for educational and non-commercial purposes, provided that this copyright notice appears on all such copies distributed. 

SOFTWARE LICENSING FLEXIBILITY
COMPLEMENTS THE DIGITAL AGE

CONTENTS

• ABSTRACT  
• INTRODUCTION 
  • OBSERVATIONS 
    • Network Licensing 
    • Distributed-Processing Licensing 
    • Evolving Pricing Models 
    • Object-Level Licensing 
    • Shrinkwrap Licensing 
    • Sales Not Licenses 
    • Intellectual Property Protection 
    • Software Performance Risks 
    • Volume Licenses 
    • Signed Licenses 
    • Patent Infringement Risks 
    • Specific License Agreements 
    • Damage Limitations 
    • Performance-Warranty Disclaimers 
    • Virus Protection 
    • Open Systems Issues 
    • Shareware and Freeware Licensing 
    • International Transactions 
    • Electronic Delivery 
• CONCLUSION

--------------------------ABSTRACT

(back)

This paper summarizes our observations on current and future trends in software licensing practices. While U.S. issues are emphasized, some global issues are also addressed because of the trend toward global computing environments and the importance of international reve nues to the U.S. software industry.

Our observations reflect the changes in computing environments, particularly the on-going transition to client/server computing which will ultimately move toward enterprise-wide computing environments. Distributed processing may ultimately create a seamless virtual global computing environment in which new licensing approaches will be needed. The U.S. software industry is evolving toward more flexible licensing practices and pricing methods that reflect the overall business value of software to users. At the same time, vendors must be able to implement a reasonable degree of protection for their intellectual property and produce enough revenue to fund the next generation of products to sustain its global lead in information technology. Because of the growing use of mass market methods for software distribution, statutory intellectual property protection such as copyright and patent protection is extremely impor tant since no agreement is needed for implementation. While statutory intellectual property protection provides proprietary protection for software assets, insurance is the possible safety net for potential liability for mass-market software when no contractual lim itations on liability and warranty disclaimers can be implemented.

Other observations include that licensing approaches must accommodate the emerging market requirement for electronic delivery of software. The paper concludes with discussion of a number of other licensing issues, including licensing beyond the application level to the object level, the use and enforcement of shrinkwrap licenses and a proposal for establishing standard licensing practices for shareware and freeware.

INTRODUCTION

(back)

The U.S. software industry is facing the challenges of more sophisticated network environments, greater competition, increasingly dominant players and, at least in the PC segment, substantial price cuts, with resulting lower margins. More software than ever before must be distributed on a high volume, mass-marketed basis. High-end commercial software has been the most resistant to price cuts while workstation and PC software prices continue to trend down ward. Other important challenges which impact the foreseeable future include the evolution of distributed processing aspects of today's client/server computing to more complicated global enterprise-wide distributed computing.

At the same time, the scope and nature of available software products are ever expanding. They range from graphical user interfaces familiar to PC users to applications programs like mass-market spreadsheets, to more sophisticated software used to design integrated circuits. Less obvious is embedded software, critical to equipment in locations as disparate as the factory floor and a doctor's office. In fact, instruments and devices of all types depend more and more on software because software provides the flexibility to meet the needs of a variety of users.

These changing business conditions continue to impact on the direction of the software industry and software licensing practices. The result is more flexible license arrangements for all types of software. Licensing practices must be constantly monitored so they fit this real world business environment. In particular, licensing approaches must match changing network usage and evolve toward the vision of the virtual corporation in the information infrastructure.

Vendor and user consortiums, such as Open Users Recommended Solutions (OURS) in New York and MIDI Manufacturer's Association (MMA), are addressing software licensing issues. Both groups have prepared papers to educate vendor and user communities on such issues. There have been many stories in the media about user/vendor licensing issues. A recent proposed Information Week survey identified product pricing, scope of permitted use limitations and the impact of the following licensee business changes as having the greatest potential for user/vendor disagreements: acquisition of a licensee, outsourcing of a licensee's computing facility and hardware platform changes.

OBSERVATIONS

(back)

Following are our observations on current and future trends in software licensing practices, particularly in the U.S. Certain international issues are also addressed because of the trend toward global computing environments and the importance of overseas revenues to the U.S. software industry.

Network Licensing

(back)

License agreements and related pricing must be consistent with current network environments. The proliferation of networks is causing licensing practices to evolve even faster to accommodate both users' and vendors' needs. Current primary network licenses are concurrent use, site, enterprise, and node. Concurrent use licenses authorize a specified number of users to access and execute licensed software at any time. Site licenses authorize use at a single site but are losing favor to enterprise licenses that cover all sites within a corporation because of more vitual computing environments. Node licenses are becoming less appropriate in the client/server environment, since the licensed software may be used only on a specified workstation which a user must log on to in order to access and execute the application.

Use measurement software (``license manager'') is allowing vendors to be more flexible in licensing arrangements. This management software monitors and restricts the number of users or clients who may access and execute the application software at any one time. This is important so a user pays only for needed use and a vendor can monitor such use to protect intellectual property.

License manager software can generate reports covering such items as the number of users waiting to use an application at a given time, the number of users accessing an application at a given time, the client they are accessing them from, and the dollar cost of software in use at a given time. These reports can help identify changes needed in software procurement approaches. Asset-management software, which helps track the inventory of software used in a business , has also become an important tool. The software inventory identified in an audit can be reconciled with purchasing records and illegal copies removed.

Other innovative, use-related approaches have also been welcomed by users, such as currency-based licenses. Currency-based licensing provides a user with a specified monetary amount of software licenses, i.e., licenses for different business application software, so long as the total value in use at a given time is less than X dollars. Users would also like platform-independent licensing under which one license permits software to be used on a variety of different computer systems within a business, instead of buying a different license for each version of the same software used by different systems.

Distributed-Processing Licensing

(back)

Licensing for client/server and distributed processing environments must become even more flexible. Distributed processing may ultimately create a seamless virtual global computing environment in which new licensing approaches will be needed. More flexible licensing schemes that are easier to administer will be needed for the growing client/server and distributed processing environments. Keeping track of which software is licensed for use by ``X'' number of users can be a full time job. The shift to client/server computing is the most significant trend in the software industry today. This shift will ultimately move toward enterprise wide, peer-to-peer, distributed processing environments. Eventually, any platform may be able to function as a client or server.

Microsoft recently announced a new pricing policy for Back Office, a suite of integrated network, e-mail and database applications, in which servers and clients are licensed independently. Customers obtain a single server license for each server and a single license for each client. Most current licensing practices assume that a client needs access to only one server and, therefore, client and server pricing is bundled together. This requires a user to pay extra when a client may access more than one server. The new pricing model is intended to reflect the move to more distributed computing environments by separating client access from the server so a user pays only for additions, either more clients or more servers. In addition, the availability of such a suite provides the benefit of buying an integrated set of applications from a single vendor.

At present, vendors try to be very specific about the number of users per server because that is the price measurement mechanism generally available today. Users seek actual usage pricing within a distributed network rather than hardware-dependent pricing schemes. Many users want pricing to be on the basis of a software product's overall business value, i.e., actual usage levels, not the number of servers, concurrent users or size of the CPU on which it runs.

Other than, perhaps the act of access and time of use, there is no standard definition of ``usage'' nor the means to measure such usage on a real-time basis in a network environment. There also are no pricing models. For example, current license managers monitor and restrict how many users may have access to and execute an application at any one time. Elements of value beyond mere access would have to be defined to measure usage for billing purposes. Different applications would likely have both common elements and distinct elements of value. Common elements could be frequency of access and time of use. Distinct elements, on the other hand, could be the frequency of the execution of an algorithm (in a design application, for example) or a module and would differ from product to product. The billing formula would likely be a combination of such value factors, probably with different weights. Global enterprise-wide software access and use requirements may make such technical capability a necessity. One approach is to incorporate management capabilities directly into the network operating system. Such functions must be invisible to the user and not cause any delay in application performance. Novell has announced software metering as part of its NetWare strategy.

Evolving Pricing Models

( back)

License pricing models are evolving at the same time as computing environments are changing. User and vendor pricing requirements must be balanced so that new, as well as existing licensing approaches result in enough working capital for R&D for the development of new and enhanced software products. Flexible software licensing pricing needs to develop in ways that optimize bottom-line profitability for both vendors and users. From a vendor's viewpoint, the business issue is whether the pricing models result in enough revenue to fund the next generation of products. Revenue and profit estimates are more difficult to project in the changing computing environments. Revenue pressure is also causing some vendors to consider shifting from the present widely-used model of a perpetual license fee with about fifteen percent recurring maintenance revenues to other models with greater recurring revenues.

Object-Level Licensing

(back)

Licensing must go beyond the application level to the object level for business and multimedia applications. License managers to monitor and restrict use will be needed which permit licensing at the object or module level rather than at the entire application level. This is particularly important for objects which can be used for multimedia content.

Shrinkwrap Licensing

(back)

The use of shrinkwrap licenses is growing. Software vendors are increasing the use of shrinkwrap licenses (as opposed to a signed agreement) on PC and other mass-market platforms. The concept is that the license terms are deemed accepted once the user breaks a shrinkwrap seal or opens a sealed envelope containing the software. As explained below, this probably does not establish an enforceable agreement in most cases. Competitors' actions, the computing platform, the nature of licensed use and price are key factors in this consideration. Users' procurement policies may create an upper dollar limit for shrinkwrap transactions as opposed to signed agreements. From the vendor's side, we have observed the use of the shrinkwrap approach up to a $50,000 price point.

Sales Not Licenses

(back)

Many shrinkwrap transactions are sales not licenses. More software transactions are intended to be sales. The basic legal concept is that any purported license agreement which is introduced after the sale has been consummated is not enforceable. No major mass-market software vendor appears to have a shrinkwrap license visible on the outside of its packaging. Some have a 1 or 2 line license notice on the outside of the package while others have nothing visible on the outside but do have a license inside the box. Due to the multiple ways that such software can be ordered (retail store, catalog, telemarketing, preinstalled, etc.), there is a high likelihood that a court would treat many of these transactions as sales rather than ``licenses.'' Video game companies pioneered the sale of units of their software products. Many lower-priced application software packages are also distributed without any attempt to implement a license agreement. The consequence of the transaction being a sale is that the scope of use and other customer restrictions in shrinkwrap licenses are not enforceable, and attempts to limit warranties and liabilities are probably not effective.

Intellectual Property Protection

( back)

Statutory intellectual property protection is extremely important. Only statutory intellectual property protection (patent, copyright, trademark) is possible when software is sold rather than licensed since no agreement is needed to implement such protection. Trade secret protection is not feasible for software in the increasingly larger mass market because there is no enforceable confidentiality contractual provision and, in some cases, the sheer number of copies distributed. In other markets, the trade secret provision is often negotiated when a signed license is employed, which slows down the sales cycle. Therefore, vendors more critically evaluate whether to try to implement trade secret protection. Patent and copyright protection are often acceptable alternatives.

Software Performance Risks

(back)

While statutory intellectual property protection provides proprietary protection, insurance is the possible safety net for potential liability for mass market software. Errors and omissions (``E&O'') insurance for performance risks is the only certain safety net available for mass- market software, since either no signed agreement is possible or a shrinkwrap license containing a limitation of liability may not be enforceable. Insurance is growing in importance as more complex software products are distri buted by mass-market methods. For example, consider the risk level of a word processing package as compared to a computer-aided design package.

Volume Licenses

(back)

Corporate customers want some type of volume licenses for widely-used PC applications. Corporate and other major software users want volume licenses of some type (including enterprise and site licenses) for widely-used PC application software such as word processing and spreadsheets. They also desire value-added services in such arrangements. These multi-copy arrangements help reduce the incidence of piracy of such applications. Vendors continue to make application suites (discounted bundles of applications) attractive with volume licensing programs. Flexible licensing of software suites is also providing users a choice of which applications in the suite to deploy from a CD-ROM.

Signed Licenses

(back)

Signed license agreements are generally more user friendly. Even when a signed license agreement is employed, such agreements tend to be more readable, user friendly and balanced in risk allocation between the vendor and user than ever before. Reductions in software prices and competition in most software industry segments have created the need for simplification. The business goal is to reduce the cost and time of the negotiation phase of the sales cycle. While some negotiation may always be required, the strategy is to minimize it by improving the chances of receiving a customers' positive response to a standard agreement.

Patent Infringement Risks

(back)

The patent infringement risk is generally allocated to the vendor who puts software into distribution channels. Major software vendors are building patent portfolios of software related inventions for both offensive and defensive pur poses. A portfolio can be used defensively for cross- licensing and to otherwise fend off or reduce the impact of infringement claims. While vendors carefully craft and qualify intellectual property indemnities in most license agreements, particularly with respect to patents, the bottom-line commercial reality is that users will force vendors to provide a reasonable degree of protection against patent, copyright, and trade secret claims in the geographical territory where the software will be used or distributed.

Specific License Agreements

(back)

Major U.S. companies are leveraging their software purchasing power more effectively. Some Fortune 500 U.S. companies insist on using their own end use software license agreement forms if a vendor wants to do business with them. This business practice is also being imposed by some big European companies but (as yet) not by Japanese companies.

Damage Limitations

back

Users are negotiating proposed damage limitation caps more aggressively. Vendors try to limit possible damages through two types of contractual provisions; a disclaimer of certain types of damages (such as consequential damages) and a maximum dollar amount limit on liability (a ``cap''). A disclaimer of consequential damages is still acceptable in a negotiated license agreement in almost all instances. On the other hand, a cap on the vendor's total liability in the amount of the license fee is more difficult to implement, that is, ``Licensor's total liability under this Agreement will be limited to the license fee.'' Some multiple of the fee is often the compromise reached. Even when a cap is negotiated, most discerning licensees will not agree to apply it to intellectual property infringement indemnities.

Performance-Warranty Disclaimers

back

``AS IS''transactions, that is, without any performance warranty, are the exception in commercial transactions. Users want vendors to stand behind their product performance representations. Vendors usually offer a limited software performance warranty for a specified period with reference to user documentation or specifications. For example, compare the following two licenses:

``THE SOFTWARE IS PROVIDED `AS IS' WITHOUT WARRANTY OF ANY KIND, EXPRESS, IMPLIED OR OTHERWISE.'' ``Licensor warrants that during the ninety (90) days following delivery to Licensee: (i) the Software will perform in accordance with its then current User Manual in all material respects; and (ii) the storage media containing the Software will be free from defects in materials and workmanship.''

Virus Protection

(back)

More customers are asking software vendors for a warranty of ``virus free'' software. For example:

``Vendor warrants that the Software contains no computer viruses or other contaminants, including but not limited to any code or instructions that may be used to modify, damage or disable Licensee's computer system.''

While there is more antivirus software available, this risk is more difficult for vendors to manage than performance risk because of the difficulty in detecting viruses.

Open Systems Issues

(back)

Open system issues are much more important in the work station and mainframe markets. Compatibility, portability and migration paths may be important factors in a buy decision for software. The license agreement may have to address these issues, including pricing implications.

Shareware and Freeware Licensing

(back)

Standard license rights provisions should be established for shareware and freeware to provide more certainty about deployment rights and obligations. Simplicity is not always helpful. Industry groups should establish a set of routine licensing rights and obligations for low or no cost software. The simplicity in how rights are presently granted results in too much uncertainty because any rights not expressly granted by a licensor are reserved. For example: ``Permission to use, copy, modify, distribute, and sell this software and its documentation for any purpose is hereby granted without any fee, provided that the above copyright notices and this permission notice appear in all copies of the software and related documentation.'' This language is clearer than most but since the right to terminate the grant may be a reserved right, continuing use is unpredictable. A business cannot deploy such software in important applications either internally or in a commercial product under such circumstances. Two sets of licensing practices could be established; one for internal use only and the other for commercial distribution. The routine practices would cover copying, modification, network rights and permitted distribution. There would be no performance or no noninfringement warranty or indemnity because of the low or no cost aspect of the transaction. A user can test performance but would remain at risk on infringement issues. No termination of rights would be permitted so long as the activities were within those authorized. Once such practices are established, the software owner could keep the grant simple: ``This software may be used for internal purposes as specified in the X Association licensing prac tices.'' The owner could also specify exceptions to the set of rights and obligations.

International Transactions

(back)

International transactions are an essential source of revenue. Greater percentages of vendor revenue are coming from international sales as opposed to domestic transactions. The U.S. is the world's largest software exporter. Overseas sales of PC software totaled about $2.5 billion in 1993, according to the Software Publisher's Association. International transactions require vendors to have more knowledge of local licensing legal requirements such as the EC direc- tive on copyright protection for software and of international payment mechanisms such as letters of credit. The EC interpretation of copyright law's ``first sale doctrine'' may cause a shift from perpetual licenses to annual licenses to prevent a ``license' from becoming a sale. Some vendors differentiate between U.S. and foreign markets by continuing to obtain signed licenses in foreign markets for enforceability reasons even when a shrinkwrap is used in the U.S.

Electronic Delivery

(back)

Licensing approaches must accommodate the emerging market requirement for electronic delivery of software. Current practices of distributing software must change as the economic need for conducting business in cyberspace enfolds. The software industry may shift to commercial distribution systems in which networks link software vendors and users to distribute all types of software. Software delivery and licensing will increasingly be implemented through networks including the Internet. Networks are already being used for the delivery and licensing of demonstration copies of software, and some vendors are delivering actual release copies. IBM, for example, reportedly is planning a service that would allow customers to order, receive and distribute software over its IBM Global Network and through online services such as Prodigy and the Internet. E-mail has become a widely-used means of software maintenance communications. Electronic delivery and licensing are components of a future integrated license and asset management tool. That software tool will be the enabling utility for distributing software, monitoring and billing for software use charges and for preventing piracy. It will provide more use flexibility and management capability for users while helping vendors protect their intellectual property.

CONCLUSION

(back)

In summary, both users and vendors must make adjustments as computing environments evolve. Vendors need to offer more flexible licensing options that fit the evolving environments and also protect their intellectual property. On the other hand, pricing for such options must be balanced in a way that the U.S. software industry continues to generate the revenues needed to fund R&D and to retain its advantage over foreign competition. America's edge in software and overseas sales of information technology, a key factor in its recent replacement of Japan as the world's most competitive economy, is critical to economic viability in the future.