- Perception 1: Cloud software costs less than traditional software
- Perception 2: Cloud software is only for small businesses
- Perception 3: The Cloud and hosted ERP are the same

Perception 1: Cloud software is less expensive

In the technology world, people are conditioned to think in terms of Moore’s Law. If I paid $X for ‘it’ 2 years ago, I should be able to pay $X for ‘it’ this year and get twice as much. Moore’s Law applies to things like memory sticks, computing power, and silicon chips … and it also applies to software perceptions.

With ERP software, the Cloud represents the latest, greatest, and most influential change in years. Since people associate the Cloud with technology, customers expect to get double the features and software the same price that they paid 2 years ago.

While the cloud can reduce upfront costs (see article on customer pricing models), it may not offer the degree of savings associated with Moore’s Law.

Cloud cost savings are primarily derived from:

• Reduction in IT staff – this is a valid source of savings, be careful not to overlook the overhead associated with Internet access, user management, user training, and data management.
• Reduced server costs – server virtualization allows datacenters with multiple servers to share workloads and increase overall server utilization. Remote access can be managed without additional servers and costly software.
• Economies of scale – outsourced datacenter management (backup, replication, operations, etc.) can lower computing costs, just like buying power from a power company can lower energy costs.

Despite the fact that these savings are real, there are many other ERP costs in areas such as requirements gathering, software configuration, training, data migration, and customization. Unfortunately, the Cloud doesn’t significantly reduce costs in these areas. Since these areas can represent a significant part of ERP expenses, the cloud may not live up to expectations when it comes to savings.

Conclusion 1: Somewhat true, but not for everybody in all situations

Perception 2: Cloud ERP software is only for small businesses

Cloud software solutions are appropriate for all customers – from small shops to Fortune 500. Here are a few reasons why the Cloud is good for enterprise businesses:

• Scalable. Cloud software and cloud datacenters are scalable so the solution can grow rapidly to serve large customers with significant processing requirements. The cloud can also shrink in periods of lower demand.
• Multi-National. The Cloud is everywhere so it can span continents for a multi-national business. Cloud software can serve remote offices without requiring additional servers and IT staff to manage the applications.
• Advanced Security. Cloud software has strong user and group security settings so specific data and capabilities can be limited to specific individuals.
• Choice of Device. Web-based software works with browsers, so users can access the system with their choice of device regardless of operating system, hardware platform, or form factor. This is useful in companies with multiple subsidiaries that cannot mandate a standard platform across all users.

Even though Cloud software is appropriate for large businesses, Cloud adoption started with small and mid-sized companies. This is because SMBs are more nimble. In a small business there are fewer committees and organizations that need to be convinced of the value and included in implementation, so decisions get made faster, deployment starts sooner, and training finishes faster.

A small business environment has more flexible processes than most enterprises. Years ago, when cloud software had fewer features than the ERP client-server incumbents, businesses with rigid processes were not willing to make the switch. These customers postponed their buying decision until all features were ready and tested. Most medium sized businesses have the same needs as larger businesses, but the benefits of automating may not justify the cost of waiting for the feature while utilizing outdated technology. A manual process performed once per week is acceptable. A manual process preformed once every 5 minutes would benefit from automation.

Conclusion 2: The cloud can serve all size businesses, but market adoption initially favored SMBs

Perception 3: The Cloud is nothing more than hosted ERP

We have argued that a hosted deployment is different from a Cloud deployment. With the help of NetSuite and several IT analysts, the concept of the Fake Cloud is being exposed as a poor substitute for a web-based system that requires no client software. More on this perception.

A cloud based application is different from client-server on many levels. The obvious difference is that customers do not install or maintain client software. Several less obvious differences involve statelessness, network traffic, and security.

The stateless nature of cloud applications ensures that they continue to work if there is a temporary break in internet connectivity. Client-server applications were designed to utilize a steady network connection. Think of cloud communications as exchanging postcards (that are instantly delivered without stamps), while client-server communications are more like cell phone calls (when your connection drops you have to “rewind” your conversation).

Cloud applications are built to minimize network communications. Going back to our postcard analogy … the goal of a cloud application is to get each instruction on a postcard. Most client-server applications are designed with the idea that there is a fast ethernet connection between the client and the server. Therefore the design didn’t worry about the amount of data being passed back and forth. When client-server applications are hosted – this is why the client’s remote desktop applications are usually co-located with the server.

Cloud application design involves different security considerations than client-server applications. Communications between the browser and the server are always untrusted. The underlying assumption is that the browser could be compromised or the connection between the browser and the server could be tapped. This means that all business data is verified by the server before being moved to the database. It also means that the transmission path is encrypted by design. Finally, each instant-postcard sent to the client will only contain data that is allowed by the security model. Each request received at the server will only be processed if allowed by the security model.

Conclusion 3: False – as explained above, the two architectures are very different

Summary and Outlook

The cloud will continue to grow and perceptions will continue to change. Fortunately, the three perceptions above are changing in a positive way … towards the truth. As adoption continues and education expands, false perceptions are gradually weeded out. In some cases vendor marketing can slow the process (as with perception 3 above), but the truth about cloud software progresses with time.

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.

Lost in Translation

An Information Passing Exercise

In school we performed an exercise where an instructor told a story to a student who then repeated what he could remember to the next student. After 4-5 students, the last person would retell the story. Not surprisingly, the story was a lot different than the initial one told by the instructor.

In the Cloud computing world, the above exercise is complicated by the fact that ‘technical instructors’ are frequently passing information along to ‘non-technical users’. As you can imagine, the story will change substantially.

Cloud Computing in the Classroom

The good news is that in the article “Cloud’s Clear Benefits“, Eric Butterman correctly identified several Cloud benefits: scalability, lower hardware costs, fewer IT headaches, pay as you go. He also mentions 24/7 access from anywhere (more a web-based software application benefit than a cloud benefit) as well as avoiding long-term costs (in fact you will have continual recurring charges in many cloud computing environments).

But, a highlight box labeled “9 Terms Demystified”, provides the following definitions.

Private Cloud: Just like cloud computing (Internet-based computing, where the applications and data are stored off-site and accessed as needed), data and services are accessed through the Internet. In this case, however, the information is only available to registered users.

This definition might be a bit over-simplified. It’s important to point out that business or school district can setup a private cloud on internal assets and facilities. This means that clients can access data without going through the public Internet. In addition, it’s important to differentiate the Cloud from the applications that run on it. An application running on a public Cloud such as Windows Azure or Amazon EC2 can restrict access to data. For example, email, ERP, and other applications are run on a public cloud, but that doesn’t mean people can access your email or financial data. In many cases, the application, not the cloud, restricts access to data.

The simplest way to think about a cloud is as a collection of resources (hardware, bandwidth, software, applications, data) that can be accessed to do work as needed. A public cloud can be accessed via the Internet and is always off-site. A private cloud can be accessed via the Internet or an intranet and may be on-site or off-site.

Another definition:

Hosted Services: An Internet-based application accessed via a PC.

This is certainly true, but the definition should be expanded because a hosted service can be accessed by a thin client or a mobile device as well as a PC. Such is the case when somebody deploys an application to a dedicated server that is maintained by a hosting company.

The Cloud Prophet’s Responsibilities

As the Cloud is evangelized to the masses, the technical folks (prophets) have the responsibility to take the time to tell the story consistently and in simple terminology so everybody can understand. This involves extra work, including asking questions to make sure the ‘students’ of your teachings are understanding the story correctly.

“Fake” ERP Clouds

As noted in our prior article, there are on-demand solutions and on-premise solutions. Some providers are using hosting services to create on-demand solutions from on-premise software. Here is how that happens:

1. A hosting provider using virtualization software declares that it is a “cloud provider” of services
2. Said ‘cloud provider’ deploys on-premise software on a hosted server
3. The ‘cloud provider’ deploys remote access software so users can access the hosted on-premise software
4. The ‘cloud provider’ sells an all-inclusive package with bandwidth, storage, backup, updates, upgrades, monitoring, and disaster recovery as cloud-based solution

In a recent CRN interview with Zack Nelson, the CEO of NetSuite is quoted as saying “There are real clouds and fake clouds. The fake clouds are people who are taking existing technology and saying, ‘We can host it for you and that’s the cloud’.”

So what differentiates a fake cloud from a real cloud? Nelson goes on to say …

“If the application is not web-native it’s not going to give you any of the benefits of the cloud. You’re not going to get any of this cost reduction, customization migration, or anytime, anywhere access because you are still using intermediary technology to access a hosted application.

The key point here is that native web-based technology differentiates true cloud offerings from hosted offerings.

Name calling or true ERP differentiation?

There is a difference between a hosted software application that is bundled with services and a web-based software application run on a cloud infrastructure. The real question is whether or not this difference impacts users of the service.

To answer this, let’s look at features supported by web-based software, that are not supported by a hosted application. These include:

• Rapid deployment – if you have to deploy client software, it’s not rapid, so hosted ERP software will not be as efficient as web-based software
• Optimal remote access – the amount of network traffic generated by a well formed web-application passing bits of data will be much less than the traffic passed by a client-server application over terminal emulation or VPN software
• Easy to maintain – a web-application will be much easier to maintain because there is no software to update or upgrade, this is especially true in deployments with multiple users

The benefits covered above include both cost savings and operational benefits. Thus, even if hosted ERP software is offered for a lower price (which would be doubtful due to the inefficiencies), users will not see the same performance.

Despite the inefficiencies, you might consider deploying non-web-based ERP software in a hosted model if your business requires features that not available in a web-based solution. In this case, you can gain some of the benefits our IT outsourcing.

Web-based ERP software on-premise

Web-based applications developed for the cloud are more efficient, but as we mentioned in our April article, there are some advantages to an on-premise deployment. These include integration with other on-premise systems and the fact that you can still work when your internet access fails. When hosted on-premise, the benefits of outsourced IT are lost, but depending on your business, it might be more important to have your data stored locally.

Cloud Infrastructure and it’s impact on Hosting and SaaS

Cloud technology enables SaaS and powerful new forms of hosting that can reduce the cost of service delivery. Note that cloud does not equal SaaS and cloud is not mutually exclusive from hosting.

How much cloud do you need?

Customers can purchase services with different amounts of “cloud” in the service delivery stack. Assume that we have four distinct layers of delivery: cloud infrastructure (hardware resources for the cloud), cloud platform (operating system resources for the cloud), cloud applications (application resources built for the cloud), and client resources (user interface to the cloud). This distinction helps us illustrate the way cloud services are offered in the diagram below.

Cloud Delivery Options

In this simplified diagram, we show three types of cloud services:

• Cloud Infrastructure (for example: Amazon, GoGrid) delivers an cloud infrastructure where you install and maintain a platform and an application.
• Cloud Platform (for example: Windows Azure) delivers a cloud platform where you install and maintain your applications without worrying about the operating environment.
• Cloud Application (for example: Salesforce.com) delivers a complete application, all you maintain is your client access program which is frequently a browser.

SaaS ERP and Cloud Models

Even legacy ERP vendors are moving to cloud technologies to offer software as a service to their customers. When vendors offer SaaS, the customer is only responsible for maintaining their client device (usually just a browser).

Vendors can offer SaaS utilizing all three cloud infrastructures above. Some vendors such as Acumatica offer all three types of services.

• Offering SaaS using a cloud application is straightforward. In this case the vendor builds an application which is tightly integrated with infrastructure and hardware so that the three components cannot be separated.
• Offering SaaS using a cloud platform means that the vendor must manage the application layer separately from the platform layer. This architecture gives the vendor the flexibility to move the application to a separate cloud platform provider.
• Offering SaaS using a cloud infrastructure is similar to a managed hosting scenario. In this case the vendor installs and manages both an operating system and their application on top of a multi-tenant hardware infrastructure. This technique provides maximum flexibility, but may increase overhead slightly.

Comparing SaaS Offering Options

Multi-tenant applications

Multi-tenant applications can be deployed in any scenario to reduce overhead associated with upgrading multiple customers and maintaining different versions of software. This implies that multi-tenancy reduces the flexibility to run an old version of software and limits customization and integration potential. Multi-tenant options should be priced lower to offset the loss of flexibility.

** Recommendation **

For a complex application such as enterprise resource planning (ERP), we advise selecting a vendor that can provide flexibility. ERP systems are not like CRM, email, or other cookie-cutter applications. Your ERP application needs to grow and change as your business changes.

Key questions that you need to ask:
1. Do you need significant customizations and interfaces with on-premise systems?
2. Will you need to move your ERP architecture on-premise in the future?
3. Do you need to own your operating environment and the location of your data?
4. Do you prefer to own software instead of renting it?

If you answered “yes” or “maybe” to any of these questions, you should consider the Cloud Platform or Cloud Infrastructure options. These options provide maximum flexibility as well as the option to own your software.

If you answered “no” to these questions, then a cloud application may provide price benefits that offset the vendor lock-in issues. Be careful that the price that the vendor quotes in year 1 is not going to change significantly in the future when it may be difficult to leave the platform.
 

Statistics we pulled from the article:

• IDC projected a 36% worldwide growth in 2009. The number was revised upward to 40.5% as a result of the recession.
• Gartner expects SaaS revenue to total $7.5B in 2009, nearly 18% higher than 2008. By 2013, SaaS spending will hit $14B.
• Computerworld study reported that 42% of survey respondents reported using SaaS in their organizations.

Impressive growth forecasts, but we need to be clear what is being forecast. The definition of SaaS means different things to different people. For example, the article describes several SaaS applications, then adds “even Schumcher’s PeopleSoft applications, including all financial software, run as a managed set of services.”

Is (PeopleSoft running in a managed environment) = (SaaS application)? In our opinion, no.

What is a Hosted Application versus a SaaS application?

The table below describes some of the characteristics which differentiate a SaaS offering from a hosted offerings.

Many other characteristics are the same. Both require Internet access. Both can be web-based or require client software. Many SaaS applications can now be customized to nearly the same extent as licensed applications.