SaaS is a risky business

Turning to subscription-based software isn't right for everyone, so tread carefully.

Manufacturing Business Technology - August 2005

By Erik Keller

A popular way to sell enterprise software is via a licensing model called software as a service (SaaS), which turns the traditional licensing model—as well as the risk—of enterprise software on its head.

Traditional models for buying software require that a buyer sign a contract stipulating an up-front payment to buy the solution, with annual maintenance payments ranging from 18 percent to 28 percent. In addition, this involves lots of "-ations"—e.g., customizations, configurations, integrations, or modifications—typically needed to get the software working.

At some point, the mythical "big switch" is thrown and everything works. Ta-da! Or not. SaaS is different. Rather than paying a lot of money and hoping everything works, subscriptions are collected over an extended period of time based upon how much the solution is used.

As you might imagine, there is plenty of controversy regarding these models and which is most expensive long-term. However, few have looked at the difference from a risk perspective. When you do, it creates an entirely different picture for both buyers and sellers.

Traditional licensing mechanisms put all the short-term risk on the buyer and little on the seller. Once the seller has the check in hand, it's on the backs of the buyers to ensure the solution works. This is far from a sure thing, however, as the ERP blowups of the past— as well as the present—have taught us. Firms ranging from the Chasm Group to Gartner have statistics stating that between 40 percent and 70 percent of all enterprise software projects—depending upon the type of solution—fail to meet business and budget objectives.

The risk equation is flipped under the SaaS model. If sellers don't get the solution up—and widely used—they don't get paid. For their revenues to increase, the seller needs to ensure high utilization that increases over time. In this case, seller risk is high; buyer risk is low.

However, longer-term, the risk equation for both of these models flips. Traditional licensing becomes risky for sellers because once the software has been successfully installed, the clients now own the software and don't have to pay the seller for its continued use. For the longest time it was seen as inevitable that maintenance would always be paid, and at list price. Not anymore. Maintenance has become an option that the buyer chooses to continue paying.

Conversely, over the long haul, SaaS decreases risk for sellers and increases it for buyers. It decreases seller risk because once a manufacturer becomes dependent and builds business processes around the software, it's very difficult and costly to rip it out. Thus, after awhile, a smart seller can selectively hang tough and increase price. Users can always threaten to find another vendor, but the leverage of software ownership is no longer in their court.

So when you consider risk in your enterprise software selection process, bear in mind the following: if you have a great IT department that never—or hardly ever—has expensive blowups, go with traditional licensing. But if you're like everyone else, you may want to consider SaaS as a way to manage your short-term risk and then decide if the long-term commitment is worth it.