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TCO of SaaS: Is on-premise software a better deal over the long run?

SaaS may not necessarily be cheaper than on-premise software over the long term, but experts say that ease of use outweighs long-term SaaS TCO concerns for many.

Asahi Kasei Spandex America ripped out an SAP R/3 ERP system that was more than three years old and implemented NetSuite in early 2007. So far, a year's subscription of NetSuite is equivalent to what the wholly owned U.S. operation of the Japanese chemical company Asahi Kasei was spending every month on SAP, according to CFO David Stover.

For many companies like Asahi Kasei Spandex, which has 180 employees and 35 NetSuite seats, cost is the major factor that makes Software as a Service (SaaS) a compelling proposition. Launching something as complex as a new ERP system without new hardware or new people or living through a costly implementation project is an easier sell, especially in this recession.

But down the road, will the choice actually prove cheaper? While the upfront costs of SaaS application deployments are typically cheaper than on-premise, analysts debate whether the perpetual subscription cost, integration concerns and gaps in functionality may make them more expensive in the long run.

"I think this is very much up in the air," said Joshua Greenbaum of Berkeley, Calif.-based Enterprise Applications Consulting. "There's a high probability that the long-term costs are going to be comparable to on-premise."

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None of the customers using SaaS who were interviewed thought a product like NetSuite was sophisticated enough, for instance, to run a large, complex manufacturing business. It's not capable of handling hundreds of thousands of part numbers or running batch jobs overnight, according to Gerry Sylvia, whose company runs NetSuite. He worked with SAP at a previous employer -- a large contract manufacturing company.

And there are clear differences in complexity between applications like CRM and HCM, and ERP. SAP currently sells e-sourcing, carbon management and CRM applications via the on-demand model. But SAP's on-demand ERP for small and medium-sized businesses, Business ByDesign, was debuted two years ago but hasn't yet been fully released to the market. SAP is working on it to make it profitable and ensure end-to-end process functionality. The vendor is also developing on-demand, line-of-business applications for its enterprise customers.

That said, for smaller companies, or smaller divisions of larger companies like Asahi Kasei, a product such as SAP ERP, with its intense data requirements, can be too robust. Asahi Kasei Spandex America was running SAP because its former parent company had SAP, Stover said.

"I know SAP's a great system for a very big company," he said. "Truly, for us, I don't need a big old nuclear bomb when a hand grenade will work."

For the right type of company, aside from a low-cost implementation enabled by not building or deploying anything physically on-site, SaaS has pluses in its corner.

The IT skills needed to implement and manage on-premise applications aren't getting any cheaper, Greenbaum pointed out.

In turn, with SaaS, the ERP upgrade process, which is propagated automatically several times a year across the customer base, clearly favors the on-demand model, he said.

For instance, compared with undergoing one major upgrade in a five to 10 year period in an on-premise world, customers of Workday -- a company that sells SaaS HR applications and is a little more than four and a half years old -- are already on their eighth upgrade, according to Workday CTO Stan Swete.

SaaS applications also tend to be easier to use and quicker to deploy than many on-premise applications, and they leave customers with fewer support problems, according to a recent Forrester Research report, "The ROI of Software as a Service." Firms that Forrester interviewed said they saw a "significant" reduction in support needs when moving to SaaS.

However, the cost of hardware is going down all the time, Greenbaum said, making hardware considerations more manageable when deploying on-premise.

Also, moving to SaaS doesn't guarantee that a company will be able to retire hardware or people because many are keeping on-premise software to fills gaps in the SaaS deployment, according to the Forrester report. Some companies find they're spending more money on change management and integration than they did with on-premise software.

In turn, from a purely technical perspective, a SaaS implementation is cheaper. But it's easy to underestimate the cost of gathering requirements and setting up the process workflows needed for the software to do its job, according to Eric Kimberling, president of Panorama Consulting, a Denver-based ERP consulting group.

But these factors haven't weighed on some longtime users of SaaS, who said they didn't think it would be more expensive than an on-premise deployment over the long term. All agreed that the costs of not having to hire new people to run the software or buy and implement new hardware on which to run it made SaaS the better choice for them.

For instance, at GestureTek, a company that makes motion-sensing technology, the annual renewal rate for NetSuite is equal to what the company would be spending on hiring one IT person to manage an on-premise system, according to Gerry Sylvia, production and logistics director. The company, based in Sunnyvale, Calif., has 55 employees.

"If you talked to me four years ago, I would have said, 'Well, we're so scared.' You invest so much time, labor into the system, and all of a sudden, they jack up the prices on you," Sylvia said. "Every year, we go through the renewal dance; it does go up a little, but it's all reasonable. The peace of mind alone is huge."

It's GLI Pool Products' expectation that competition in the SaaS market will keep subscription costs low, according to sales and IT administrator Jerome Foskey. They expect their NetSuite contract costs to remain even year over year, or even slightly lower. GLI, which has 125 employees, is based in Youngstown, Ohio, and manufactures custom vinyl pool liners and safety covers.

In the end, running plain vanilla, pipeline software may be cheaper with SaaS, according to Greenbaum. But, with a robust, complex CRM deployment -- one that is integrated with order management for instance -- the five-year cost of on-premise may be comparable. Microsoft prices its CRM product so that after five years, customers wind up paying less by owning it on-premise.

Vetting the SaaS TCO will come down to what the customer wants, analysts agree.

"I feel like the prices are going to be in the same ballpark and the question is going to be time-to-benefit, ease of management and ease of use," said Warren Wilson, research director at Ovum Research. "And those characteristics will continue to make SaaS a very popular option, even if it is a little more expensive over the long term."

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