Can traditional software companies embrace SaaS without Disruption?

Bob Warfield is amongst those reopening the self-inflicted wounds of European software behemoth SAP AG with his latest post on the SmoothSpan blog this week. The central question, though, isn’t whether they messed up; but whether what they’re attempting is even possible.

Facing the real prospect of significant disruption to the mid-range part of their business from the lower costs of relative newcomers Salesforce, NetSuite and others, it certainly made sense for SAP to ape Salesforce’s success and pursue a strategy that would see the German company able to offer their smaller customers a cheaper hosted solution, rather than continuing to rely exclusively upon the expensive purchase, installation and upkeep of hardware at customer sites.

However, as ZDNet’s Larry Dignan reported back in April, the company was forced to slow the roll-out of their Business ByDesign solution, and Phil Wainewright was quick to spot the opportunity that the company had handed to its competitors;

“By announcing its own SaaS product for the midmarket late last year, SAP put its stamp of approval on the on-demand model. Now that it has said customers will have to wait another year or more before they can buy it (due to scaling problems, no less), the company has created the worst of all worlds: it has validated a market and then vacated it, giving competitors a free run.”

So what went wrong, and are there broader lessons to learn from SAP’s mis-steps? As Vinnie Mirchandani notes, both Salesforce and NetSuite have been characteristically swift in publicly rubbing salt into wounds, and most companies would naturally be keen to avoid handing the competition such an easy target.

In a tightening economic climate, and with Dennis Howlett reporting customer disquiet at rising maintenance costs for SAP’s existing installed product base, the company must surely regret not having a good news story to tell about a product that requires no hardware or upgrade investment on the part of their customers. Zoli Erdos at CloudAve reports that NetSuite has jumped on this opportunity too, claiming a total cost of ownership comparable to 50% of just the annual maintenance component of SAP ownership. It’s worth noting that Dennis responds to Zoli’s post in the comments, describing the premise as;

“pure hubris and you know it.”

Unfortunately, and as SAP are discovering to their cost, moving an existing deployed software solution toward on-demand hosting is not simply a matter of moving the application from one data centre to another. Costs rise rapidly at the provider’s end, too, as they take on previously delegated costs for networking, power, maintenance and more. Software designed for single tenancy installation is either expensive in wasteful under-utilisation of numerous single tenancy servers, or technologically inefficient in the way that it operates across multiple tenancies and virtual machines. In either case, these new – and rising with every ‘successful’ sale – costs must be borne by the provider rather than the customer. Whilst SAP’s incremental costs in shipping each new software package to a customer site are very close to zero, every new SaaS tenancy brings costs that SAP must plan for and bear; space in a data centre, hardware, power, cooling, bandwidth, etc.  All too soon costs begin to spiral out of control, and if the economics are not carefully optimised ‘success’ runs the risk of very quickly becoming self-defeating.

Purely in terms of the corporate balance sheet, the shift from installing software to deploying it can be too painful to endure. Rather than a sizeable up-front license payment supplemented each and every year by an up-front annual maintenance charge and intermittently by hefty upgrade fees, software companies transitioning to provision of SaaS face the prospect of no more than a monthly or quarterly subscription payment. The ‘upgrade’ gravy train makes little sense in a SaaS environment, where customers have been led to expect continual incremental improvement. Even where customers could be persuaded of the value in some notional upgrade, the economics again become self-defeating as the software vendor rapidly finds themselves maintaining a plethora of legacy versions to their software and absorbing the resulting overheads in support, equipment partitioning and the rest.

That secret money machine of the enterprise software business – consultancy around implementation and customisation – is undermined by the Model T Ford plainness of much SaaS too, adding significantly to the woes of CFOs at traditional software companies who are trying to balance the books on a move to the Cloud. SaaS products today tend to target the low end, rather than competing head-to-head with the feature-bloated behemoths at the top of the software foodchain. The nature of SaaS products means that ‘trials’ are a couple of mouse clicks away. Even signing up to take the full product tends to be quick, painless, and priced at a point well within the budgets of middle managers and even individual professionals. Salesforce was one company to make significant headway in this fashion, infiltrating the enterprise via individuals with just enough budgetary authority to close the contract without having to negotiate the complexities of an ‘enterprise sale’ or compete directly with the incumbent system or the biases and politics of the C-suite.

Whilst perfectly capable of matching or exceeding the value of license and maintenance components over the long term, especially when the savings inherent in running a single version of the core software package in a controlled and manageable environment are taken into account, this retrospective trickle of utility rental funds requires a significant realignment of a company’s finances and metrics. All of an organisation’s carefully optimised profit and loss models need to be completely rethought, and tenets at the heart of the corporate DNA stand every chance of directly impeding any serious move toward a utility computing model where individual short-term margins will tend to be far tighter than before.

Although not directly addressing the utility computing market by name, the lessons in Clayton Christensen‘s The Innovator’s Dilemma and Innovator’s Solution are writ large here for all to see. What traditional provider of locally installed software can successfully cannibalise their own business and reimagine themselves fundamentally enough to succeed in the Cloud? SAP are certainly trying, but it’s not clear that they’re even close to succeeding.

The SaaS success stories tend to be SaaS from their foundation. Marc Benniof could not have produced Salesforce whilst at Oracle, and even Larry Ellison had to facilitate NetSuite at arm’s length to his main business.

Can traditional software providers ever make the transition, and are the major obstacles standing in their way technological or financial?