ERP Software Cost Comparison: On-Premise, SaaS, and Hosted

March 30, 2011
By djohnson

Overview

This article presents costs associated with different ERP software deployment scenarios. The numbers presented in this article have been gathered by averaging quotes provided by 2-3 different ERP and hosting service providers.

ERP Software Purchasing and Deployment Options

The Cloud has inspired a new way of thinking about ERP software deployments. Companies have the option to purchase a license or purchase a SaaS solution. When purchasing a license you own the software and have the ability to deploy it in your datacenter (on-premise) or outsource operations to an external provider (hosting). When you purchase a SaaS solution (sometimes called an on-demand solution), you rent a complete turnkey package that includes software and the entire delivery mechanism.

This article will examine the financial ramifications of these three models on your business.

Small Customer Licensing

With a very small deployment scenario, the cost of licensing the software is $20,000 and the cost of one year of SaaS is $16,000. The resulting chart (on the left below) shows that a SaaS deployment can provide lower costs in year one, but after 2-3 years of service, the hosted model can be less expensive in terms of total out-of-pocket money.

By looking at the graph, you would conclude that you should never purchase a software license and try to build your own infrastructure. However, in some scenarios (for example you are are running a point-of-sale terminal that needs to connect to your server) an on-premise deployment makes sense because you may not want to rely on an external Internet connection.

ERP Software Cost - Small BusinessERP Software Costs - Mid-Sized





{click graphs to enlarge}






Mid-Sized Customer Licensing

For mid-sized businesses, we increased the cost of the license to $50,000 and the cost of SaaS to $40,000 per year. The resulting chart (above on the left) shows that the break even point for SaaS versus hosting occurs sooner (around year 2). In year 5 the cost of SaaS approaches the cost of a license plus internal infrastructure. These changes occured because the cost of the fixed license and recurring SaaS payments increased proportionately while the infrastructure cost remained relatively fixed. We observed a proportionate increase in SaaS and license pricing by comparing specific customer proposals from SaaS and license vendors.

Even though we increased the cost of hosting to $500/month, the cost of paying for 1/5 of an IT person to maintain the server, operating system, and software application caused the on-premise deployment to be more expensive than hosting over the long run.

Review of Assumptions

Cloud-based and Web-based Software

As previously reported, there has been significant discussion judging the merits of hosted ERP versus SaaS. In this comparison, we assume that the same software can be run as SaaS or deployed on-premise. This means that we are not considering the scenario where legacy client-server software is being hosted on the web along with VPN software, hosted desktops, etc.

We assumed that the software was web-based so client upgrades are not required.

Relationship between SaaS and License Pricing

The cost of the SaaS annual fee compared to the cost of the software license is critical to the analysis. For this analysis we used the following rule-of-thumb:

SaaS annual price = (2/3) x (Cost of license + One year maintenance)

This approximation accurately represents actual market data provided by SaaS providers and on-premise license providers. In both cases, the cost per user (when applicable) is reduced as more users are added at approximately the same rate. Also in both cases, the addition of modules increases the cost.

Other Assumptions

  • Calculations did not include NPV calculations.
  • Hardware and software costs for an on-premise deployment are similar for small and mid-sized customers. This equals approximately $15,000 for the deployments shown. This does not include off-site backup storage.
  • Maintenance fees are 20% per year of the license costs. In the hosting scenario, maintenance covers only the application, in the on-premise scenario the maintenance costs cover the application, OS, and database software.
  • Configuration, training, and data migration fees are equal across all three deployment models. We used a 1:1 ratio of license cost to consulting fees for this analysis.
  • Customization fees are not included, but would be equal across all models.
  • Application support is not included, but would be equal across all models.
  • For an on-premise deployment, power and replacement server parts were assumed to cost $1,000/year.

When is SaaS Better?

ERP Software Costs - SaaS benefitBusinesses benefit from SaaS when they do not have IT resources to dedicate to installing and managing applications. Even in the hosted scenario, some level of IT expertise is required to install application upgrades. We assumed upgrades occur two times per year and require approximately 5 hours to install. As a result of this assumption, we budgeted $1,000/year for application upgrades in the hosting scenario. In all cases we assumed that the application was web-based so no client software upgrades were required.

Break Even for Mid-Sized Businesses

By lowering the SaaS cost by changing the SaaS rule of thumb (discussed earlier), we computed a break even point over a seven year deployment. Holding other assumptions steady, the break-even occurred when the cost of the SaaS annual fee is approximately 1/3 of the cost of the license plus one year of annual maintenance. So, if your only concern is out-of-pocket expenses, the option to purchase a $50,000 license + hosting + maintenance is roughly equivalent to a $20,000/year SaaS license.

Adding Cost of Capital

** section added May 2 **
After publishing this article, I received several requests to include the cost of capital in my calculations. Adding a cost of capital has the following impact on the different models:

  • SaaS – expenses are deferred, so the model becomes more attractive as the cost of capital goes up.
  • Hosted – the license cost is paid upfront, but some costs are deferred, so the benefits are less than with SaaS
  • On-Premise – the on premise model contains the most upfront expenses as well as significant ongoing IT expenses that paid over time. As the cost of capital increases, the upfront costs are not impacted, but the impact of the ongoing IT costs is reduced so that the overall benefit is higher than hosted but less than SaaS.

Cost of Capital Impact on ERP Analysis

With ERP software there is a significant amount of upfront analysis, consulting, configuration, testing, and training, so the impact of the cost of capital is less than it would be for simple software applications. The graphs below show the impact of making adding a 3% and a 15% cost of capital to the analysis. This was done by discounting the future payments to reflect the time value of money.

  

The analysis doesn’t change dramatically for the 3% case, but when the cost of capital is assumed to be 15% and higher, the SaaS solution will always be less expensive than an on-premise solution. At 15%, the breakeven between SaaS and hosted shifts by a few months in favor of SaaS.
** end of May 2 section **

Conclusion

This article addressed costs, but costs are only one part of the deployment equation. Your deployment model should be based on your level of IT expertise, your comfort level with outsourcing, the strength of your Internet connection and tolerance for downtime, and the timing of expenses.

As your business changes, your business requirements change. Company size, IT expertise, legislation, risk, programming requirements, and other factors will influence your SaaS versus on-premise deployment over time. You should partner with a provider that offers a choice of license and SaaS deployments so you can switch your deployment as your requirements change.

Contact us if you would like to receive a copy of the spreadsheet used to generate these graphs.


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12 Responses to “ ERP Software Cost Comparison: On-Premise, SaaS, and Hosted ”

  1. Neill Austin on March 30, 2011 at 11:43 am

    I think it’s also important to factor in the capital outlay for a standard software licence as well. This can be a huge resource drain in the year of purchase.

    For example if you have to buy a system for a specific business function, your going to look at its life cycle being up to 5 years due to the initial cost of purchase. That means for 5 years you’re tied into that product regardless of what else is out there. I think SAAS offerings give users the chance to get a new solution when they arrive without having to write off their previous investment.

    Over the course of 5 or more years SAAS will provide greater flexibility, but may have a slightly higher cost in the long run.

  2. François Eric on April 2, 2011 at 12:49 pm

    Very interesting. I agree with your theory but I must say that I find ERPs must almost always be customized to user needs. Therefore a SAAS solution is interesting but I find rarely meets the small business needs.

    I know such solutions often allow you to add or remove modules but they still add a level of complexity that the users might not appreciate. I find these solutions often ask the client to adapt their processes to the software rather than the contrary.

    This can obviously be the case with out-of-the-box on premise solutions but I believe that the ERP is so important and so core to the business that it must be taylored to the needs of the enterprise.

    My 2 cents but, this being said, I really enjoy your posts.

  3. Ankur on May 2, 2011 at 7:50 am

    Thanks for the article on cost comparison between SaaS and non-SaaS options on ERP software. I would be interested in understanding the details behind the data used to analyze and conclude the results your team has presented. Some of my thoughts after reading the article are:
    1. Whether the cost of money (borrowing money, interest etc) for the non-SaaS option has been considered?
    2. The cost regarding support/IT resources should be considered as an important one since there are significant cost saving in using hosted or SaaS model vs an onsite model.

    • djohnson on May 2, 2011 at 9:23 am

      Ankur – thank you for your questions. I received a few requests to add the cost of capital to the initial analysis, so I added a new section to the post describing the impact. The cost of IT/support is indeed important. These costs are included and drive the higher costs of the on-premise solution in our model.

  4. lorand on May 4, 2011 at 9:47 am

    I am making my disertation paper on the theme SaaS ERP vs ERP traditional. Could someone offer me some useful links, documents etc. on this theme( the costs, the benefits, examples on how should be implemented etc). thanks

  5. Simon Hopkins on July 25, 2011 at 3:35 pm

    Interesting article and a good read. Having worked in ERP for over 20years I know how opaque the license pricing can be. I am hopeful that one of the benefits that SaaS will bring is a clarity on pricing (which should have an overall lowering of per seat license fees). I looked at this in my blog a few weeks ago.

  6. R Bagman on December 30, 2011 at 1:23 pm

    If anyone is planning on replacing their ERP solution within 5 years, then they should NOT be buying it in the first place. If flexibility (especially in functionality) is key to the buyer, the SAAS offering will be the most restrictive.

  7. Mike Stroven on January 30, 2012 at 9:30 am

    So, if I’m paying the same amount to customize any of the options, “Cloud-hosted”, “On-premises”, or “SaaS”, my best initial move would be to choose a powerful open-source product with $0 license costs, and save my money to pay consultants 12-24 months down the line to upgrade as necessary…

  8. ERP Cloud Borker on February 15, 2013 at 4:43 am

    Hosted ERP and SaaS ERP are combined to created so called Cloud ERP also we can refer to SaaS ERP as an hosted ERP since the CTO is based on renting services of using services on demand.
    Nowadays researchers talk about either Cloud ERP or ERP on-premises.

  9. Rene Brandon on April 4, 2013 at 1:40 pm

    The article says:”Relationship between SaaS and License Pricing

    The cost of the SaaS annual fee compared to the cost of the software license is critical to the analysis. For this analysis we used the following rule-of-thumb:

    SaaS annual price = (2/3) x (Cost of license + One year maintenance)”.

    Using a $50,000 license cost, what does your research show the Saas price to be, per year, if it was a 3 or 5 year subscription contract?

    Thank you, Rene

    • djohnson on April 4, 2013 at 4:43 pm

      SaaS providers typically discount long term contracts and different vendors offer different options. For a 2-3 year commitment many offer 10% off their one year SaaS price. Using our rule of thumb, this would yield $36k/year. Within the industry, we don’t see many customers willing to sign up for a 5 year commitment. For this arrangement there would have to be substantial discounts and very low cancellation fees.

  10. Hijaaz on April 15, 2013 at 12:40 am

    Hi

    Really useful article, Can you tell me the approximated no. of users for the above mentioned costs. And how much would be the total cost of ownership for On-Premise, SaaS, and Hosted

    Thanks
    Hijaaz

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