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.

{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?

Businesses 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.

The Challenge of New Technology Adoption

When the cloud and web based software provide so many advantages for ERP software buyers, why are some users reluctant to make the switch?

Sometimes switching is difficult because there are issues of data conversion and delivery of features that have been customized on a legacy solution. In other cases, legacy vendors and the entrenched community have taught customers that the way to buy software is to “follow the crowd”.

Following the Crowd

On a community forum, we noted two comments related to the ERP selection process that suggest a “follow the crowd” strategy for ERP software selection:

Comment 1: “Talk to companies similar to your own. If the ERP vendor doesn’t have any customers in your industry (and size), then what does that tell you?”

Comment 2: We use (vendor name removed) and their customer support and out of the box fit is great for us (Make-To-Order metal fabrication) I would talk to companies using the software without even involving the software vendors and consultants. Talk to single site companies that are MTO Aerospace and Machinery and 35 million in sales. Go to Google and search for “cloud erp software”. Then go to the software vendors sites and see if you can find companies referenced that are similar to you and call them up.

Contacting references is a good idea. But do not let that be the sole criteria for your decision. The follow-the-crowd strategy may not be the best for your business.

Choice of references
Companies with a large number of accounts will have some satisfied customers and some unsatisfied customers. Guess which type of customer will be listed in their references section.

Get an edge on your competition
How do you differentiate your company? Superior service, flexible pricing, unique product lines, or something else? In many cases your ERP software can give you a competitive advantage by improving service or reducing your costs. If you limit yourself to old technologies being used by competitors, then you will rise only to the level of your competition. When changing ERP software, you have the opportunity to jump ahead by providing access from anywhere, a custom portal, better teamwork, more efficient processes, etc. Purchase software that supports your company’s strengths or growth plan.

Vendor and VAR references
The opinions you obtain from references are impacted by both the software vendor and the reseller. In some cases a reseller will save an implementation that would otherwise ended poorly. In other cases a reseller may sour a deal by delivering poor support or slow response times to a customer. If you purchase from a reseller, then vendor references will only tell half of the story.

Flexible software in the hands of a knowledgeable reseller

A winning combination involves flexible software built with the latest technology in the hands of a reseller that understands the details of your business. There are several reasons to select the value added reseller (VAR) model. These include:

• Deep understanding of your business. VARs often have expertise in a particular area (manufacturing, distribution, non-profits, government, project based accounting, etc.). They can apply knowledge of past implementations to your business.
• Cross vendor knowledge. Some VARs have experience with more than one software solution. A working knowledge of different products can be very beneficial for your software selection.
• Customizations. If you have specific integration and configuration requirements, then a reseller can build and support them. Frequently resellers are more responsive to your customization needs than vendors.
• Local Support. In the era of SaaS, Cloud, and web, the benefits of local support may be dwindling, but an in town VAR is available for face to face meetings for requirements gathering and support.

A software vendor that sells directly to businesses may provide their own solution engineer that has expertise in your particular business vertical. If you go the vendor-only route, make sure that you get to meet this person who will help you before signing your contract.

Conclusion

This blog advocates the adoption of new technology. We do not want to undermine the process of getting references, but it’s more important to adopt ERP software based on your business needs, not the experiences of potential competitors that might be using 5-20 year old technology.

Just because everybody else is doing it one way does not mean that you cannot adopt somebody better. Your best bet might be a software reseller in your industry that can deploy modern technology and customize it to the needs of your business based on experienced gained implementing legacy systems.

What’s Missing – the Value Added Reseller

As an open-source company, Compiere was predisposed to work with the community including value added resellers that could profit from configuring ERP to customer needs. Consona, on the other hand, has a “services” menu on it’s web-page menu instead of a “partner” menu.

Compiere - VAR Friendly

Consona - Services not Partners

It will be interesting to see how the transition from a community of partners to a single partner unfolds. The press release did not mention how existing partners would fit into the Consona plan.

VARs do not work for Free

Today’s vendors are scrambling to enroll value added resellers. The fact that Compiere was not able to obtain a large number of paying customers may have had to do with its partner channel. While many customers were willing to download the solution (company boasts millions of downloads), few (130 customers) actually pay for it.

For VARs who receive income by receiving discounts on vendor software, Compiere offered little incentive. If VARs are operating on thin margins, they will certainly not expend the time and effort to adopt and sell a product which can be downloaded for free.

With complex software such as ERP, VARs provide business process expertise as well as accounting and industry specific expertise. Without VARs, many small and medium sized business customers probably struggled to implement the software to match their business processes. Mid-sized and larger customers that could afford consultants were probably aligned with VARs that offered other solutions.

Other Links

Certainly VARs were not the only factor in the lack of Compiere customers. Other authors have already written on the topic – including providing a good history, perspective, and other theories.

• ERP Graveyard Blog by Ned Lilly – good description of the history and theory on where things went wrong.
• The Enterprise System Speculator by Frank Scavo discusses the history, points out some counting issues, and provides opinions on what went wrong.

In Bob Scott’s Insights, we found the following blurb about Epicor:

CEO George Klaus has finally owned up to the fact that has company has a channel program, following Epicor’s Five-Star award by Epicor’s Partners for Growth Program. Now, this is very strange since Klaus has spent much of his time during Webcasts telling investors and Wall Street that the company is totally direct sales. Now, Klaus said he’s proud of the channel program.

Several publications, such as this one from ChannelWeb, have discussed the NetSuite 100% channel offer:

NetSuite’s retort comes on the heels of the company’s effort to expand its channel partner ranks by offering resellers 100 percent margins on first-year subscription revenue.

Microsoft gave it’s channel incentives to sell against NetSuite as reported in the Channel Register:

Microsoft said it was tapping its 10,000 US reseller partners to punt its Dynamics range of software through the channel.

And several other companies such as Lawson, Acumatica, Sage, and others have announced the addition of several new VARs around the world.

So all vendors seem to agree that VARs will continue to play an important role in driving ERP sales and deployments. What all vendors do not agree on is whether or not they should be 100% VAR focused or the role of VARs in supporting customers.

The results are interesting, but not surprising:

• Businesses are still clinging to top vendors (SAP, Oracle, Microsoft Dynamics)
• 30% of top vendor implementations last longer than expected (13.2 months on average)
• 53% of top vendor implementations are over budget
• most customers, 75%, are “fairly satisfied” or better with their vendor while only 23% are “fairly unsatisfied” or worse
• 69.8% of customers do not realize 50% of the benefits they are expecting from their implementation

Cloud ERP News Analysis

Top tier vendors should give their sales, service, and public relations people a very large bonus. We say this because most businesses (70%) do not get the results that they want to realize, yet say they are fairly satisfied (75%) with thier vendor. This includes both the timeframe for delivery as well as the features that are delivered.

The VAR Steps In

Maybe ERP customers are satified because the value added resellers (VARs) that deliver these solutions are able to develop a good personal relationship and fix problems as they arise. If the solution is not delivered on time, the VAR is there to pick up the pieces and explain that this is typical of all systems. Thus the customer becomes “fairly satisfied” (54%) instead of satisfied or very satisfied (21%).

A Real Alternative?

Until recently VARs have not had an alternative for distributing a solution other than the ones offered by the top vendors. VARs that want to distribute a web-based or SaaS solution have had to deal with direct competition from vendors, unfamiliar business models, and less-flexible platforms which minize the amount of customization they can provide.

Recent launches of web-based and SaaS software solutions which are tailored to VARs will improve delivery times and have the potential to improve customer satisfaction. These products give VARs the ability to offer clients an alternative to the client-server solutions which are responsible for not delivering on all customer expectations.

The 2011 Report

Once VARs have a viable alternative based on modern architectures, they will be able to speed delivery times and provide flexible solutions which will meet customer expectations. This in turn will raise customer expectations while driving higher satisfaction. The impact will not be immediate (implementations take 13 months), but improvements are on the way.

Channel Move or Publicity Stunt?

The program attempts to reward VARs (strapped for cash) in the short term, while helping NetSuite (channel problems) in the future. The question to consider is how much is the reward compared with giving up future revenue.

Customer example

Let’s assume that a customer has budgeted $100,000 to spend over 7 years for an ERP system. This money can be spent on license fees, maintenance, hardware, and ongoing customizations. The table below shows a typical schedule of payments.

SaaS versus traditional payment schedule

The net present value (NPV at 2% discount rate) of these payments favors SaaS by $3,500, but we will ignore that for now.

Focused Spending

With the traditional model, the spending is upfront and is focused on hardware, software, migration, training, customization, and integration. This is critical to mid-size businesses which require these services to match existing infrastructure and business process requirements. Many times this cost can be 3-4 times the cost of the license.

With SaaS, the majority of the $100k is spent in later years with a focus on eliminating the cost of maintaining software and paying IT personnel. Customization, implementation, and training may only be 1 time the cost of an annual payment. This model is best suited for companies which can utilize off the shelf solutions that require little integration with existing systems.

VAR Payment Schedule

Assuming that VARs earn a 30% margin on training, implementation, and integration tasks, the payment schedule for VARs under the various plans is listed below.

VAR payment for SaaS and traditional licenses

So VARs earn about the same amount of money across the different plans over a 7-year period when the customer pays $100,000.

Our Take

NetSuite is beginning to focus on the VAR channel to help get higher end customers. This is good for the VAR industry. However, the 100% year one commission program awards smaller VARs that sign up customers without adding a significant amount of value. NetSuite will end up with many low end VARs that have little incentive to maintain a relationship with their clients. More importantly, VAR programs suffer when the vendor’s main strategy is direct sales.

We doubt that this program will tempt VARs that are currently aligned with a channel focused vendor and drive value from customization and integration work.

Don’t get stuck in the past

We agree with Nelson that cloud computing is the future of ERP (disclosure: ERP Cloud News is the URL of this blog). There are many mid-sized business customers without IT expertise that need to access an ERP solution from different offices and geographies. These customers will be well served by a cloud solution.

Don’t bet too heavily on the future

The Sage reseller also makes many valid points. First, a company with only 20% channel sales does not have a great channel program. This is because NetSuite aims to replace the training and support services that VARs provide with it’s own. In addition he makes the point that many SaaS solutions do not offer the customization capabilities which are critical to the VAR business model.

Just like there are customers that will benefit from SaaS, there are customers who will benefit from a highly-customized on-premise solution.

Focus on the “Value Add” in VAR

As the Sage reseller pointed out, “VARs must add their own special sauce to the mix”. If this special sauce is a add-on module, then find a cloud solution that allows you to use your existing development skills to port your application to the cloud. If the special sauce is customizing the application, then find a cloud solution which supports robust customizations. If your special sauce is customer support and training, then find a cloud solution with a business model that provides customer ownership.

Most importantly, realize that your customers may want to switch to SaaS and back to on-premise depending on their changing business needs. A VAR which understands how to help customers through this transition will be the most valuable of all.

Most [SaaS companies] are going it alone rather than investing in traditional channel activities. However, it seems to me that if they are to safeguard their future, then capturing the hearts and minds of the many thousands of channel VARs is going to be critical.

Many value added resellers (VARs) read our blog, so we wanted to publically thank Dennis for the insight.

Varying VAR roles in different market sizes

• Enterprise customers: Nearly 100% of all enterprise sales are accomplished through VARs or with the help of a VAR. Software complexities, legal requirements, unique process flows, tax requirements, and much more require expertise.
• Upper-mid market and mid-market customers: VARs are particularly important for clients who need customized workflows, customized reports, and integration with other systems. VARs with a detailed knowledge of accounting and business processes can provide ERP setup and configuration advice which saves clients a lot of money down the road.
• Lower-mid market customers: Generic workflows and non-integrated SaaS solutions might work for companies which do not require extensive automation. But, we would caution that even smaller companies need the accounting and reporting advice that VARs provide and that we chronicled in an earlier post describing an implementation.
• Low end markets: Clients with sub-$1,000 budgets for software and implementation will not be able to afford a VAR, even though they may benefit from a VAR’s services.

Direct sales versus channel focused

Vendors select different channel strategies depending on the customers they target. Customers who use QuickBooks can purchase directly from Intuit, while high end customers rely on consulting services and reseller advice when buying an Oracle or SAP solution.

Few vendors are able to create a VAR program which can co-exist with direct sales. Most attempts to do so result in channel conflict and non-strategic channel programs. It will be interesting to see if NetSuite can overcome a statement that is highlighted in their financial reports: “we generate sales directly through our sales team and, to a lesser extent, indirectly through channel partners”.

In our opinion, the partner models proposed by Microsoft, Acumatica, and Sage seems to be more in line with upper tier markets.

An ERP Installation Example

Earlier this week, I participated as an observer during an ERP installation. The conversation between the value added reseller (VAR) and the customer was very typical. The discussion included topics such as why a 13th accounting period is important, the benefits of implementing accounts receivable versus manually using the general ledger, how and when to setup sub-account codes, how taxes need to be implemented, how to customize reports … and on-and-on for a few hours. The VAR also showed the client how to perform these processes using the software.

This installation was very typical, so why am I writing about it? Answer: This was a SaaS ERP implementation on a cloud platform. Note that the conversation didn’t change because the implementation was SaaS, and although the software installation was very different (it was done on Microsoft Azure), the business conversation was identical to an on-premise deployment.

In the case of ERP, the business discussion is much more meaningful and important than the deployment conversation.

More Evidence

Articles from Bob Scott’s Insights cover various aspects of the mid-sized ERP and accounting market. By just reviewing the titles of recent posts, it’s apparent that partner programs are not going away.

• AccountMate signs VARs: “AccountMate doesn’t sign a lot of new resellers and CEO David Dierke says that’s one of the hazards of being a source-code software company. But it enlisted 10 new dealers this year and that’s double the amount for 2008.”
• Intacct Growing Channel Program: “Intacct, which markets Web-based financial software, is beefing up its channel program.”
• SaaS is the Future, But: “Acumatica continues to recruit VARs with the idea that SaaS remains the way of future.”

Why VARs will Continue to be Important

1. VAR Sources of Revenue.
Nelson predicts that most VARs are going to lose a lot of revenue because they will no longer be required to install and maintain systems. The problem with this argument is that VARs get an extremely small percentage of their revenue from managing systems. Most accounting and ERP VARs help businesses build customized workflows, migrate data from legacy systems, build interfaces to existing systems, customize reports, and customize business processes. The cost and need of these services dwarfs the cost of maintaining an operating environment.

2. Subscription Based Billing.
Nelson says that most VARs will have to switch to subscription based billing because that is how cloud-based software is sold. First, most “subscriptions” require a 1 year pre-payment that is equal to over 50% of a traditional license. Second, most businesses will not want to pay a subscription for migration, customization, configuration, and business process services.

New Partnerships

VARs will continue to be relevant in the SaaS world, just as they are in today’s hosted world. Several VARs are working with hosting providers (as well as cloud providers) to outsource server operations. They realize that datacenter operators are experts at buying, powering, and backing-up servers. Partnerships between software vendors and cloud providers have the potential to create a turn-key offering that VARs can offer clients without changing their existing business model.