SaaS Surfs the Cash Conservation Wave

June 21, 2010 Dan Burger

Sure, the software as a service (SaaS) sales model makes a lot of sense if you’re talking about simple and quick to implement applications like Salesforce.com. But how does it look when it’s a complex set of ERP applications that a manufacturer might find useful? More often than not, a SaaS deal like this would be considered by an SMB with a sharp financial eye and an awareness of industry-specific apps running on an IBM Power System i.

Smaller companies are always more creative when it comes to doing more with less, a lesson that was learned like never before during the economic downturn over the past two years. To compete with the biggest and richest competitors, they have to hammer out their own advantages. On the IT side that might include SaaS, the monthly, subscription-based alternative to software licensing.

There are a number of reasons SaaS is getting more attention in the SMB space, and the big one is money. The little guys can’t afford what the big guys have in the way of software, hardware, and staff.

One of the trends picked out by Ralph Rio, a research director at ARC Advisory Group, is what he refers to as “cash conservation.” There’s nothing like a recession to make a CEO realize debt is an expense the company can’t afford. Cost-cutting and creating cash flow fit right into the SaaS benefits agenda.

“The recent economic difficulty and desire to preserve cash made SaaS a choice for cash conservation reasons,” Rio says. The SaaS model avoids the high initial costs associated with license fees and IT infrastructure. A company could spend a million dollars on licensing an ERP application compared to $200,000 a year acquiring the application using the software as a service model. That’s cash conservation.”

Manufacturing is not often thought of as leading the way in information technology innovation. However, Rio points out, the cash conservation pain point might be higher in manufacturing, causing SaaS considerations to be a higher priority than in other market segments.

Some of the software vendors have positioned themselves to quench a rising thirst for SaaS.

“Based on conversations I’ve had with 50 or so software companies of various sizes, the smaller software companies are providing SaaS as an option to their traditional software licensing at a much higher rate than the established vendors,” Rio says. “There’s probably 25 percent of existing ERP customers in a place where they need to replace an aging ERP system. My sense is that many will go to hosted or to SaaS.”

More of the software vendors in the manufacturing segment are offering hosted solutions rather than SaaS solutions, Rio says. The hosted option still requires a software license be purchased, but the vendor (or a business partner of the vendor) runs the software at its data center rather than in the customer’s data center. The customer savings comes from not buying additional hardware or hardware upgrades to run the software and not devoting staff to manage it. The hosting model is what many remember as an application service provider (ASP), an alternative dating to the late 1990s, which was not widely accepted.

Although SaaS is a good option for certain companies, it’s not a likely candidate for widespread replacement for on-premise IT.

“It’s situational,” says Kevin Beasley, the CIO at VAI, an ERP application vendor with strong ties to the IBM midrange market. “SaaS could become very prominent in certain types of applications, but I expect companies are going to have a mix,” Beasley adds, referring to SaaS and on-premise IT.

VAI has a SaaS version of its i/OS-based ERP software for manufacturing, retail, and distribution companies. The company has been involved in the IBM SaaS Specialty Program, a marketing and technical initiative, since 2008.

In his interaction with companies that are considering software as a service rather than purchasing a license, Beasley has seen financial considerations play an important role.

“There are a lot of different reasons,” Beasley says. “One customer told us his company preferred to do everything with SaaS (contracts) because it is backed by a venture capital firm and SaaS does not show up as long-term debt on the books. Therefore, the company looks more profitable.”

Some companies, Beasley says, are looking to avoid the long-term debt associated with making major purchases. “We saw a lot of that last year,” he says, referring to the economic crisis that he believes has cleared.

However, there are some companies focused on cleaning up debt in order to obtain better financing rates. Other organizations are choosing SaaS because they don’t want to tie up their credit buying software. “Companies want credit available for inventory,” Beasley says. “SaaS doesn’t tie up capital. It provides more purchasing power.”

Rio says the ARC Advisory Group has identified a SaaS trend related to security concerns expressed by small to midsize companies that can’t afford to secure their IT infrastructures. The theft of intellectual property rights and customer data is particularly worrisome, as is the dependence on e-commerce.

“Five or 10 years ago, there was more concern about a virus on an individual PC. Now it’s much more intense with attacks and concerns at a higher level. Intellectual property is the competitive advantage for a company. Revenue is, of course, vital to profitability and stock prices. The risks are much higher,” he says.

“The pain point for the IT people has shifted a lot in the past five to seven years. It went from an IT manager concern–How do I service my user base?–to an executive suite concern. It’s gone from losing a half-day productivity, which is not a threat to corporate viability, to the point where the Internet is used for running businesses. When servers are compromised, a good portion of the revenue stream stops.

“The SMB companies cannot afford the expertise to secure their systems. They are going to third parties in cloud computing to get the level of needed security.”

Beasley adds a word of caution to companies that use SaaS as a strategic approach to solving security issues.

“There are three security components that don’t go away,” Beasley says. “Companies still have on-site network infrastructure that needs to be maintained–things like routers, firewalls, and so on. Security at the network level is still the weak point. You might have everything in SaaS and the greatest data center in the world, but the local network is the entry point of the data. There’s also the issue of compliance for many companies. Even though there’s SaaS in place, compliance regulations always rest on the shoulders of the company, not the software provider. A company can’t claim it is compliant because it has SaaS. You have to have internal compliance. A lot of attacks are hitting through the browser. If you hit through the browser and get on the LAN, you can get to the SaaS environment. There still needs to be strong security.”

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