Software as a Service (SaaS)

Why does Software as a Service (SaaS) make sense?

When the economy takes a downward turn, corporate IT budgets are usually one of the first casualties.  This is the case with the current recession, as evidenced by an October 2008 CIO Magazine survey in which 40 percent of 234 IT chiefs surveyed said they are cutting spending, essentially freezing new IT initiatives, if not scrapping them altogether.

However, technology is a critical element of business, and despite the current economic climate, the need for reliable IT remains the same—especially when it comes to fundamental business applications such as email or customer relationship management (CRM). As companies across all industries face tough decisions about where to put their limited dollars, here are three key reasons why the hosted or “software as a service” (SaaS) model makes a great deal of sense.

Financing

Most companies rely on some form of financing for technology purchases (hardware or software), either through a vendor-sponsored payment plan, a specialty leasing agent or a straight bank loan. When credit markets are tight, it’s difficult for many organizations, particularly smaller ones, to secure tech financing. And tight credit markets go hand in hand with a precarious economy.

On October 27, 2008 The Wall Street Journal reported a jump in defaults on tech financing loans, coming after “years in which such loans flowed freely.” During this period, lenders regularly offered tech financing for 0 percent interest or no money down to businesses with limited liquid assets—mirroring the risky (if not reckless) approach that led to the meltdown of the subprime mortgage market. And the results have been similarly disastrous. According to the Equipment Leasing and Finance Association, which represents 700 lenders, the number of equipment loans written off as losses jumped from .48 percent in September 2007 to .86 percent in 2008, a leap of nearly 80 percent. And Baytree Leasing Company LLC, which specializes in tech financings, confirmed in October 2008 that its default rate for commercial businesses is now between 1 and 1.5 percent. To give some perspective to those figures, research firm Aite Group has predicted that in Q3 2008 the percentage of real estate loans being written off as losses by the top 100 U.S. commercial banks will be around 1 percent.

As a result of the spike in defaults, specialty lenders and banks, on which companies once relied to fund their IT initiatives, are now charging higher interest rates and requiring more money down, making it much more difficult to secure financing. Long gone is the zero-interest loan. Today a standard interest rate for small businesses is hovering around 8.25 percent.

Joining banks and tech-financing businesses, hardware and software vendors that lend money directly to customers are also toughening their terms. Many now require a significant upfront payment—often up to 50 percent for software—to offset the risk of default. (Software vendors suffer more from defaults because reselling used software is illegal. Reselling used hardware is not.)

The impact of the financing crunch on smaller businesses is twofold. First, it is simply harder to secure loans. In October 2008 the CIO Executive Council reported that nearly 20 percent of 31 CIOs surveyed postponed or canceled purchases specifically because of unfavorable credit terms, demonstrating how difficult, if not impossible, it now is for many companies to implement on-premise IT deployments—and foster growth—because they just can’t afford them. And in a down economy, while overall costs are important, day-to-day cash flow is vital. That means that even when financing is available, the jump in upfront payments can be a deal breaker for many smaller companies.

Second, when money is tight, few companies want to—or can afford to—take on unnecessary risk. And for IT executives, risk comes in the form of long-term commitment to a particular hardware or software purchase. If a company is able to secure tech financing in a difficult credit market, the costs have increased, reducing the overall ROI of the technology acquisition. That translates into increased pressure for the investment to result in a successful IT initiative.

Flexibility

A word commonly used by the media in a down economy is “uncertainty.” Uncertainty about the markets. Uncertainty about employment. Uncertainty about the future. Despite endless analysis and predictions from expert (and highly paid) financial pundits, the truth is that no one really knows when things are going to get better. While the frenzied speculation keeps media outlets around the world in business, speculation is exactly what it is. In July 2008 the ever provocative Huffington Post featured a blog entry by Margaret Heffernan called “The Recession Narrative: Pundits Know Nothing.”

For smaller businesses, the one certainty about uncertainty is that it demands flexibility around IT infrastructure and applications. In this case, flexibility means the ability to accommodate growth and reductions. While in-house software can scale up as your company grows, it doesn’t work the other way around. The same goes for the associated hardware.

Take Microsoft Exchange for email. If a company with 500 employees uses an in-house Exchange server, in addition to buying all the hardware (primary and backup servers, networking equipment, storage), it must also buy 500 client access licenses (CALs ), plus pay for ongoing support. Each CAL costs around $70 and is non-refundable. As the company grows, it must purchase a new CAL for each employee, even if that person is a seasonal or temporary hire for the holidays, a common situation when businesses can’t afford to staff permanent positions. Most (if not all) employees need email accounts, regardless of how long they are going to be around to use them.

For on-premise deployments of CRM software, user licenses are even more expensive. For example, a single user license for Oracle’s Siebel CRM Professional for mid-sized companies costs $350 for a base application (sales option, service option or marketing automation). Add-on modules for additional functionality run from $60 up to $2500 per module per user, and support is an additional annual per-user fee.

If that same company suddenly needs to lay off 20 percent of its workforce, it now has 100 CALs that it can’t use, plus an undetermined number of Oracle/Siebel licenses it can’t use (assuming not every employee uses all elements of the company’s CRM system). That’s a lot of money down the drain for a smaller business, especially when money is already tight.

The flexible SaaS model, on the other hand, is based around scaling the software up or down with your business. Hosted solutions allow you to add users on demand and remove them on demand. You pay on a monthly basis only for active users. And in a down economy, the likelihood of having to lay off active users goes up, which is why this approach makes sense when business is slow.

A SaaS model also allows you to add and remove software, not just users, on demand. For example, you could lease SharePoint just for a special six-month project. Or you could decide that your business just can’t afford mobile connectivity for every user right now. In an on-premise solution, you have already paid for the functionality, so you’re in a “use it or lose it” situation. In the SaaS model, you can turn off mobile connectivity, and then turn it back on in three months when cash isn’t as tight.

The flexibility of a SaaS model also results in faster time to ROI. With in-house software, you have to buy everything, set it up, test it, etc. It may be a long time before your company sees any value from it. With SaaS, you see instant results, or at least much quicker results. This is always important, but it increases in importance in a down economy.

Staffing

While layoffs may be inevitable in a down economy, your customers will expect the same level of attention, service and quality they have always received. Successful companies recognize this and go above and beyond to preserve customer loyalty by showing them that it’s business as usual, even when it’s not.

Moving to a hosted or SaaS model allows you to reduce headcount without impacting the customer experience. How? Because it eliminates the need for expensive in house IT experts. Going back to the example of Microsoft Exchange, proper maintenance requires at least one full-time, trained IT professional, which can easily cost six figures in annual salary and benefits. Freeing up that money will allow you to save positions that will have a direct impact on your customers.

In October 2008 the Bureau of Labor Statistics of the U.S. Department of Labor reported 2,269 companies had cut at least 50 jobs in the previous month, the highest number since the aftermath of the Sept.  11, 2001 attacks. Many economists predict that unemployment will jump from the current 6.1 percent to near 8 or 8.5 percent by the end of 2009, resulting in the highest unemployment rate the country has seen in more than 20 years.

While the accuracy of those predictions has yet to be determined, the current reality is bleak enough.  When layoffs are unavoidable, a SaaS model can help preserve the positive experience your customers have with your company.

Conclusion

In any economy, there’s no question that SaaS solutions are a smart option for smaller companies. They can be up and running quickly. They don’t require a degree in computer science to administer. They are reliable. They can scale with your business. They even reduce your organization’s impact on the environment.