For a long time, businesses have been using enterprise OEM software licensing to sell their products faster, as well as to enhance the features and functionalities of their solutions. These solutions empower companies to provide more value to their customers without bringing in significant investments. And they present a huge portion of the global software market.
In the age of the digital workplace, it's advantageous to have a full understanding of how these software agreements work. It may even aid in your software asset management strategy. So what exactly is an OEM license? How does an enterprise OEM software licensing work? Let’s explore.
What is OEM licensing?
In very simple terms, OEM licensing is when a company (the OEM or the Original Equipment Manufacturer) provides licenses to another company to use their product within the latter company’s product.
This is very common in the smartphone industry, where smartphone manufacturers get licenses from chip manufacturers like Snapdragon to use their chips in the final product (the smartphone). Enterprise OEM software works exactly like this in the software industry and is in fact a major part of it.
How? Let's say a software company is developing an accounting, and to do so it needs some visualization tools. They could either develop their solution or simply use a third-party tool already developed, and save the development cost. If they decide to go with the latter, the two companies would come to an OEM software licensing agreement. With this, the company developing the accounting software integrates the visualizing solution within their product.
With an OEM license, the end-user gets more features, while the OEM is able to reach more customers and the licensee is able to add more value to their product.
Many software companies use enterprise OEM licenses to add machine learning, NLP, and AI capabilities to their product. It is particularly common in the analytics solutions industry.
Nevertheless, it's important to keep in mind that enterprise OEM software licensing is different from when companies purchase software for their own use. It also differs from a reseller agreement, where the licensee sells another company’s product as is or within a bundle of other products and services.
History of OEM licensing
OEM licenses began in the automotive industry, where companies would make components and sell them to different car manufacturers who would in turn add these components before selling to the final customer.
In the case of the IT industry, the OEM licensing trends first came to computer hardware around the 1970s, before it made its way into computer software. In 1985, the first Dell computer, the Turbo PC, had an intel 8088 microprocessor. And even before this, Dell computers used stock components to build custom PCs.
Enterprise OEM software had its beginning when PC manufacturers started using third-party software and operating systems in the systems they sold to the end-user. For example, in the 80s, IBM started shipping computers with the early versions of Microsoft OS. Even now, most PCs and laptops ship with Windows instead of operating systems developed by the manufacturer.
In recent times, as mobile apps and enterprise SaaS solutions have become mainstream, enterprise OEM licensing is commonly used by companies to add more features and functionality to their offerings. With APIs, companies can now add payments, analytics, and more third-party functionality to their software and offer a complete solution to their customers.
Pros of OEM licensing
As far as the licensee is concerned, OEM licensing lets them offer additional functionality to their customers without having to invest more in their product.
If a company wants to offer AI or ML features to their customers, they’ll need a dedicated team for that — with additional resources and development time. Instead, they can simply get it from another company that has already developed what they need.
The licensee can also attract a wide customer base with the added functionality. Depending on the specific terms of licensing, they may even be able to create an additional revenue stream. Licensees can also gain an additional advantage over their competitors both through the additional functionality of their product as well as through specific clauses in the licensing agreement.
As for the licensor (the party that is selling the license), they can get their product into a whole new customer base with minimal cost of customer acquisition. Through their licensees, they are able to target new markets and verticals. For instance, a software developer that had traction for their analytics solution in the fintech market hadn’t had much luck in the healthcare sector. But by offering their solution through enterprise OEM licenses, they could reach a whole range of healthcare providers.
Vendors are also able to sell volumes of their solutions in a single go-through enterprise OEM software licenses. Plus, if they’re a small company or a new startup, they can also benefit from the exposure. Working with globally known brands can help them showcase the value of their product and bring them more credibility.
Cons of OEM licensing
From the point of view of the licensor, the major drawback of OEM licensing is that, in most cases, they’re effectively surrendering a large customer base. This would depend on the particular licensing agreement, but if a specific functionality is already a part of the software they’re using, the end-user is not likely to buy another software.
Another drawback is that while you’ll be selling large volumes, you’ll also have to sell them at a lower cost.
As for the licensee, they are essentially taking on the risk of taking the product to the end-users. Since they’re buying the licenses in bulk, they stand to make a bigger loss if the product fails.
Lastly, compared to building your solution, the profit margins may be lower for the licensee when they are going the OEM route. The OEM route may also be more complicated; you’ll have to work with a third party to integrate the product and market it.
Different types of OEM software license models
The nature of enterprise OEM licensing models is more diverse than what the end-user gets. The pricing — or rather the revenue sharing — may vary based on many factors. Let’s start from the basics.
- Who hosts the combined solution — The combined solution may be hosted by the licensee or the licensor. Of course, the most obvious solution is for the licensee to completely integrate the solutions and host it. In some cases such as in healthcare or fintech where security is paramount, it may even be hosted on-premises by the user. The revenue share may depend on who hosts the solution and who handles the maintenance and the DevOps.
- How the solution is sold — When we hear enterprise OEM software licensing, we think of a company getting another software, combining it with theirs, and selling it as one single solution. But in some cases, only a small segment of the customer base would need the added functionality. And the rest may prefer a lower cost instead of additional features. In such cases, the additional features may be sold as an add-on or as part of a premium version.
- Branding and marketing — Sometimes, the end-user may be unaware that what they’re using is a combined solution. This is the white-labeled version, where the licensee may tweak the look, feel, color schemes, and other branding elements as if no other party was involved in the development. They are many reasons they may go for this. In other cases, the licensor's brand will be clearly showcased; it will be apparent that two (or more) parties were involved in the development. This may give added publicity to the OEM or may add more credibility to the final software. Either way, this presents another factor in the pricing negotiations.
- Exclusivity — In some license agreements, there may be some exclusivity clauses that prevent the OEM from selling their products to a list of competitors for a defined period. This can of course drives up the price.
- Customization — Some level of customization from the side of the OEM may be needed to integrate the two solutions since the solution might need to be supported on a different set of hardware, or the UI may have to be tweaked. The cost for customization can be added to the price of the license.
- Support — The support will be different for OEM licensing unlike that for an end-user. And the level and nature of support may vary with vendors. Some vendors may even charge you for support.
4 types of pricing models for OEM software licensing
Based on the above factors, there are different types of OEM software licensing pricing models. These are the most common ones, but the exact specifics vary from vendor to vendor.
- Flat fee: This model is pretty straightforward. The licensee purchases the right to use the OEM software for a certain period of time. The sales volume or the usage doesn’t matter since the licensor gets a fixed amount for their product. Here, the licensee takes on all the market risks; if the product doesn’t succeed or enough sales volumes are not reached, it won’t affect the licensor.
- Price per usage: This is similar to the pay-as-you-go model often provided by cloud vendors. This model may be useful for SaaS vendors where the subscriptions may go up and down over a year, or when some features may not be used. In this case, the licensee pays the OEM based on how much the end-user uses the OEM software. This could be based on data used, the number of processes performed or the number of API calls, or some other metric both parties have agreed on. Here the licensee doesn’t have many risks or overheads.
- A share of the revenue or royalty-based revenue sharing: The licensee may agree to share a percentage of the total revenue gained from the software. This can typically be anywhere between 2% and 8% of the revenue. In this case, it doesn’t matter how the final software is sold; as a subscription or a one-off sale. Here, the licensor is essentially a stakeholder in the business, and may even assist with other aspects such as sales, marketing, branding, etc.
- Price per customer: At a glance, this appears similar to the royalty, but here, a fixed price is determined per customer. The licensee can sell the software at a price they decide and can increase or decrease their profits according to the market demands, but the licensor gets a fixed amount.