In-Depth

Pros and Cons: Software As A Service

IT can eliminate costly upgrades and reduce installation problems by running hosted applications instead of licensing them. But there are pitfalls.

• By Vincent J. Ferravanti
• 05/25/2004

The ubiquity of personal computers, the Internet, and Web-based applications is having a fundamental impact on the way business applications are being sold. The development of Web-based applications has decoupled the user interface from the business application as well as its software and hardware. As a result, a user working at a personal computer with a Web browser can access a variety of business applications running on any number of different hardware platforms in any number of different locations for the cost of an Internet connection. This decoupling is allowing application software companies to change their business model from sales to service.

Currently, business application software companies generate the bulk of their revenue by selling their software. As a result, the current software business model is cyclical. Software application companies sell their products into a market, then sell upgrades. Sales revenue peaks after each upgrade, then lags until the next upgrade, creating a cyclical revenue stream, which, in turn, create cyclical stock prices and other business complications.

To level out their revenue stream, application software companies have been looking for a different business model. Companies such as Microsoft have been switching to a licensing business model in which customers pay a yearly licensing fee to use Microsoft products and are guaranteed upgrades during the licensing period.

While licensing can level out a software company’s revenue stream, it does little to break the upgrade cycle, and the postponement of an upgrade can put an upgrade outside of a license period and change the upgrade from free to fee. Microsoft is facing this problem with its delay of “Longhorn,” the next version of its Windows operating system.

Licensing’s only benefit to the customer is free upgrades. Since implementing upgrades costs customers money, an upgrade must have enough added value to justify its implementation costs. The new features introduced in an upgrade may be of little or no value to some customers, causing them not to upgrade even if the upgrade is free, in which case a license has no value.

Unhappy with licensing, some software companies are adopting a new business model, enabled by the Internet, in which software is sold as a service. In the software service business model, the application software company hosts its software application and each customer pays a per user fee, usually monthly, to use the software application. Access to the software application is provided over the Internet through a Web browser.

Like licensing, the software service business model provides a steady stream of revenue in the form of monthly payments. Unlike licensing, the software service business model requires the software company to take on the cost of hosting the application.

The software service business model offers several advantages to both the customer and the software company that offset the higher costs of this model. By purchasing a software service (as apposed to licensing or purchasing software), the customer has no up-front acquisition costs, no hardware or software to buy, and no support staff to hire and train. The cost of acquisition is reduced to the cost of training employees on the application and converting existing data. The reduction in these costs allows the software company to charge more for a software service then a license.

The low acquisition cost of software services also makes the services affordable to a broader range of customers. This affordability gives small companies the opportunity to use the same feature-rich software solutions as those of larger companies, and allows software companies to sell their service to a greater number of customers.

Because the software application company is hosting the application, in a software service there is only one instance of the software. In a licensing or sales model the software is distributed to the customer and is installed on the customers’ computers in a variety of environments, out of the control of the software company.

The existence of only one instance of the software application in the software service business model has several advantages. There is only one hardware and software platform for the software company to support. This greatly reduces development costs. A single instance also means that the software company can introduce software enhancements one at a time, breaking the upgrade cycle and eliminating the cost that cycle generates. These cost savings help to offset the cost of hosting the application.

The single software instance of the software service business model also makes application integration difficult. With the sales and licensing business models, customers can modify their local instance of the software application to interface with other legacy applications. This is not possible with the single instance software service.

However with the development of Web-based applications has come a push to develop standard Web-based interfaces for applications. The development of technologies (such as Web services and XML transactions standards) is making trans-vendor application interfacing more commonplace. Software service companies will be able to develop standard application interfaces for application integration. For now, the software service business model applies best to applications that can be run in isolation or with limited interfaces.

Using a software service prompts several other customer concerns about integration. According to the Aberdeen Group, the chief concern is data security. This stems from an uneasiness people still have about sending confidential data across the Internet, though this concern is starting to wane. As evidence: H&R block filed more tax returns through their Internet site this year then through their storefronts.

The other concerns surrounding software services are: system security, back up and recovery, and disaster recovery. Software companies are addressing these concerns in the same way that application service providers addressed them: with robust equipment, policies, and procedures.

In addition to these concerns, a company looking at a software service should also ask: "What would I do if the software company went out of business? Will I be able to retrieve my data, and how long will it take me to get that data back up and into a new system where I can access it?" The software service is providing both software and hosting, so the loss of the provider means the loss of both services. This creates a single point of failure, a considerable risk.

Despite these concerns, the low implementation and support costs of software services makes them very attractive to customers. The benefits of a reliable revenue stream, single instance implementation, and end of the upgrade cycle make the software service business model very attractive to software companies. This win-win combination has attracted at least one company to the software service business model.

SalesForce.com claims to have over 130,000 subscribers and 9,000 companies signed up to use its customer relationship management (CRM) software service. Companies pay SalesForce.com a monthly per user fee to access its Web-based CRM application. SalesForce.com claims that it can accommodate customer specific configurations and that it interfaces to most major Enterprise Resource Planning systems. SalesForce.com also claims to be servicing companies with as few as two users up to Fortune 500 companies with hundreds of users. The question is, is the software service business model appropriate for business applications other then CRM?

I believe it is. As issues of Internet security and trans-vendor interfaces are addressed, the number of software companies adopting the software service business model will grow. While I do not consider software services appropriate for all of a company’s application software needs, they can fill many of those needs. The benefits to both customers and software companies are just to great for the software service business model not to be successful.