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`OPINION
`The Pros and Cons of Software as a Service
`
`By Dale Troppito, The Gantry Group
`Computerworld | Jun 14, 2004 1:00 AM PT
`
`The software industry is in a critical state of metamorphosis. Much like a butterfly emerging
`from its cocoon, software is spreading new wings as a service. The trend began to take hold
`back in the mid-1990s with the introduction of the application service provider. ASPs were
`the first to capitalize on the Internet as an interactive delivery channel for application
`software and data exchange. But the ASP fell victim to the dot-com bust and became a
`pariah of the investment sector.
`
`Today, we don't often mention the ASP acronym; instead, we speak of "hosted" or "managed"
`services and "outsourcers." But the underlying premise is the same: Software is being
`delivered as a shared service.
`
`The Downside of Perpetual Licensing
`
`For decades, the prevailing purchase model for software has been the perpetual, on-premise
`license, priced by the total number of enterprise user seats or by the site as a whole. For
`software vendors, this meant that the initial sale was the big revenue opportunity.
`Aftermarket revenue came from the sale of annual maintenance contracts, software
`upgrades and, possibly, add-on capabilities. But perpetual licenses have brought vendors
`perpetual heartburn because they fail to accommodate a desire for recurring revenue
`streams. The sales force must constantly forage for new customers in order to sustain
`revenue growth. Software vendors have longed for a model that would allow the business to
`flourish from an established, loyal customer base.
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`Buyers of software applications, on the other hand, were faced with making a large upfront
`investment -- and taking a large upfront risk -- with the perpetual license model. Unsure of
`the delivered business value, concerned about the software's ability to meet enterprise
`expectations and worried about cash-flow impact, buyers often refrained from signing
`contracts. Prohibitively costly license fees made enterprise systems inaccessible to many
`small and midsize companies. The perpetual license is now recognized as an inhibitor to
`software sales.
`
`The Downside of On-premise Software
`
`Buyers drove the requirement to have both the software and the associated corporate data
`on-premise. The prevailing concerns over enterprise control of the software and corporate
`data security made it impossible for buyers to consider any other licensing or delivery model.
`This meant that software vendors -- and buyers -- were condemned to continuous
`maintenance, software update and asset management activities. Software license
`management proved to be highly complex, and enforcement of companywide compliance
`was difficult.
`
`As the effects of the stalled economy swept over enterprises at the beginning of this decade,
`resource-challenged IT departments, out of necessity, creatively looked for new models to
`reduce the internal work docket. IT departments began thinking pragmatically in terms of
`business processes and workflow that needed to be accomplished and not of the purchase of
`discrete applications. As a result, enterprises became receptive to business models that
`would reduce software maintenance costs and move not only applications and transactions
`but also complete business processes outside of the enterprise to increase efficiency and
`lower costs.
`
`The Upside of Software as a Service
`
`The Internet is the enabling technology that has transformed software into a delivered
`service. Indeed, the Internet makes it possible for enterprises to responsively access the latest
`version of software through a familiar browser interface on a transparently shared basis.
`Hosted services deliver the same level of software capability and performance as on-premise
`applications, but with centralized off-site management of application maintenance, upgrade
`management and infrastructure provisioning. Pricing is modeled as a subscription based on a
`metric reflecting usage. Relieved of the large upfront capital outlay and the ongoing drain of
`dedicating IT resources to software life-cycle management and customization, enterprises
`are gravitating toward this new view of software as a service.
`
`Software vendors see great opportunity in adopting this outsourcing and subscription model.
`Not only does the subscription model bring vendors a recurring revenue stream, but it also
`typically bundles rights to software use, automatic updates, maintenance and technical
`support into one annual fixed fee. This tidy service package is a breath of fresh air for
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`software vendors and enterprises alike. And the fact that vendors can meet revenue goals by
`farming the installed base, instead of hunting feverishly for new customers, infers that
`customer service just got better for enterprises.
`
`Enterprises also see a number of advantages to this new service model. Their concern over
`managing cash flow is eased by the elimination of upfront costs for the applications and a
`predictable software life-cycle cost structure. In addition, corporations are less risk-averse in
`a software-subscription model because there is less at stake financially; they feel they have
`the option to re-evaluate their application choices at any time. Finally, outsourced services
`relieve enterprises of the often painful software installation and maintenance process,
`allowing them to focus on their core business.
`
`No software sector is immune to this business model shift. Even ERP vendors are taking the
`plunge into the world of outsourcing their software as a hosted solution. Leading ERP
`vendors, such as SAP, PeopleSoft and Oracle, have established partnerships with providers to
`host their offerings. This will inevitably enable ERP vendors to move their businesses
`downmarket.
`
`Once a software vendor crosses the threshold into the service world, a palette of opportunity
`presents itself. Vendors are naturally extending their offerings to include outsourced
`managed infrastructure services and data center services. The secondary leap into
`nontechnical administration and professional services becomes just a small step on the
`continuum. The net result is that the distinction between software vendors, hosted services
`providers and business process outsourcers is blurring.
`
`The Implications of Software as a Service
`
`The acceptance of software as a service by the enterprise community has overcome the
`objections and risks surrounding the concept of application outsourcing. Formerly,
`enterprises' concern over information security, integrity and availability alone would have
`scuttled any hope of entering into an off-premise relationship. However, the struggle to
`survive in a lagging economy over the past four years has tempered these concerns, putting
`cost reduction at the top of the corporate priority list. More than ever, enterprises are
`focused on business process efficiency and establishing performance metrics to benchmark
`and track against. This shift has dramatically changed the dynamic of the software selling
`process. Companies seek solutions that will have a nearly immediate, measurable positive
`effect on operating costs and business performance. The best software delivery model is one
`that achieves this primary goal, while assuring secure, always-available access to the
`applications with minimal need for IT resources.
`
`Subscription-based pricing offers enterprises a "pay as you go" plan, requiring far less of an
`upfront investment. While the upfront lump-sum revenue afforded by a perpetual license
`sale is forfeited, software vendors usually gain in the long run through a long-term recurring
`revenue relationship.
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`The downside for vendors is that enterprises are less invested -- both monetarily and
`emotionally -- in their software, making a review of their buying decisions more likely after
`deployment. Switching applications is far more economically feasible for a company in the
`subscription scenario. Even though the subscription model involves some implementation,
`the software is less entrenched within the enterprise's infrastructure than the installation of
`an on-premise application. Software vendors are trying to manage this trend by entering into
`multiyear service contracts with their customers. But the bottom line is that vendors that
`offer a hosted service have a customer base that's far less captive than in the past. To counter
`customer churn, the software vendor must continually resell the customer at subscription
`review time and make customer service a top business priority.
`
`Dale Troppito is a managing partner and founder of The Gantry Group LLC in Concord, Mass.
`The Gantry Group, which specializes in technology return on investment, has established best
`practices for ROI assessments that rely on primary market research to validate accurate
`capture of the real value drivers and costs delivered by technology. You can reach Troppito at
`dtroppito@gantrygroup.com.
`
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