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We study an enterprise software vendor’s decision on three prominent licensing models– on-premises, software as a service (SaaS), and hybrid. Our findings indicate that both the customers’ estimation of the future software quality improvement and network effects play critical roles in the software vendor’s choice of optimal licensing models. If the network effects are weak, the enterprise software vendor should choose the on-premises model when customers have a low estimation of the software quality improvement in the upgrade version. The hybrid model should be implemented if this estimation is in the mid-range, while the SaaS model generates the highest profit when customers believe that the upgrade version will have a significant improvement in software quality. As the network effects become stronger, the on-premises model will be dominated by the other two licensing models and is never optimal. In the event of a high upgrade cost and strong network effects, SaaS becomes the best licensing model due to its multitenancy nature.
Li et al. (Mon,) studied this question.