Challenges

By CIOinsight  |  Posted 05-05-2005

Customized Outsourcing: The Latest on Rentable Software

Opportunity
Software as a service can take some pressure off the IT department.

At one time or another, we've all been presented with the confounding choice of whether we should rent or buy. Whether it's a home, a car, or even a tuxedo, the questions remain pretty much the same. Can I afford to buy it? How much will I use it? What kind of financing is available?

The idea of renting software has been alternately embraced and reviled for decades. Most recently, the hype around application service providers, or ASPs, proved to be built largely on empty promises.

Alas, stymied by unreliable service, confusing price structures, and applications that weren't easily configurable, companies struggled to make hosted software fit their needs in the late 1990s.

But now a new age of outsourced everything—along with better bandwidth and a more mature market—is making software by subscription, or software as a service (SaaS), a viable option. In fact, Gartner Inc. predicts that renting will be the software model of choice by 2008, with more than 50 percent of all software purchases being made on a subscription rather than license basis.

"The reality is, it's becoming a standard way of how people are doing business," says Gartner Vice President Joanne Correia.

For small companies, software by subscription is a no-brainer, says Dana Stiffler, a senior analyst with AMR Research Inc. "It's ideal for companies that don't have the staff or the up-front investment, so you can let your people focus on your business instead of running the applications." This was the case for Platform Learning, a small New York City-based firm that provides tutoring services for school-age children throughout the U.S. Platform needed to overhaul its paper-based order-fulfillment system in order to get educational materials to its 50,000 students more quickly, but it lacked the capital and in-house resources to buy the necessary software, says CIO Joe Sorisi.

Renting the software gave the company a no-hassle solution to its problem, and shortened the fulfillment process by three days. "Now we can get curriculum expedited to meet demand," he says. "That increases customer satisfaction, which will help us get new business." Gartner's Correia agrees, adding that firms don't want to pay up-front costs with no guarantee of success. "Companies are no longer saying, 'Here's a million dollars for a license, and I am going to absorb all the risk,'" she says.

But it's not just the up-front costs that are driving people to rent. Stiffler says that companies are fed up with paying maintenance fees. According to an AMR survey of several hundred executives, nearly one-quarter feel their vendor's upgrades for traditional software licenses don't deliver enough value to justify the costs, which have risen as much as 25 percent in the past year.

But there are still hurdles for software as a service. For example, it could end up costing you more money in the long run if you don't do a thorough cost analysis and project it out over several years.

And while the challenges of customization have largely been addressed, there are still major difficulties in integrating hosted applications, both with each other and with in-house software.

Ask your finance department:
  • What is our total cost of ownership over time for our various applications?

    Ask your human resources department:
  • Can we afford to hire more staff to maintain our software?

    Ask your CTO:
  • What upcoming software purchases would lend themselves to the rental model?

    Value

    Value
    Consider all the costs before you commit to software as a service.

    Holden Humphrey Co. is a small, Chicopee, Mass.-based wholesale lumber distribution company with 24 employees—none of whom work in IT.

    In conjunction with its preparations for Y2K, the company decided it needed an upgrade of its computer systems, but it didn't want to hire IT personnel. "I realized that we are not in the computer business, nor do we want to be," says Lance Humphrey, the company's president. "We need to focus on what we do best, so we opted to pay someone else to do that for us." Holden Humphrey put virtually all its systems on a hosted model. Now, the company pays roughly $1,000 a month to give nine employees remote access to its inventory management, accounting and CRM systems.

    While Humphrey says the renting option isn't inexpensive, he says he couldn't even begin to estimate the costs of handling the systems in-house. "We would have had to hire some computer guys, and a manager to look over their shoulders—when you're done paying for all of that, it makes the subscription model seem really affordable," he says.

    It often seems that way at first. However, the cost of renting the software could surpass the cost of buying the license outright over time, something you may want to consider if you plan on being in business for a while.

    "Since a lot of these pricing models are volume based, charging per transaction, it means the cost of the software rises with usage," says Andrew Bartels, an analyst with Forrester Research Inc. "It's not a fixed-cost environment, as is the case when you buy software."

    Michael Lubanski admits this is a possibility. Lubanski is director of enterprise monitoring for Towers Perrin, a global management consulting firm that subscribes to Mercury Interactive Inc.'s software to monitor the uptime of 200 external client-facing Web-based applications. "I am sure there is a point in the future," he says, "where the line will cross and the cost of the subscription will be more. But I think that point is pretty far away." For now, he adds, the value of subscribing is clear.

    "It would have been very expensive to purchase a software license, and a high investment is always going to be tough to get through management," he says. Plus, "a subscription makes it easier to show ROI" because of the small monthly cost.

    But companies should never base the decision to rent rather than buy software purely on cost, says Sheryl Kingstone, a Yankee Group analyst. "If it's a money issue, you can do financing plans. You don't buy a car up front for $30,000; you finance it." There are other balance-sheet issues to consider before choosing a subscription service over buying a license.

    "If you buy a subscription, it can only hit your expense line," says Gartner's Correia. If you buy the license, on the other hand, it becomes a corporate asset, and you can deduct the depreciation. "One of the reasons some enterprise software won't move to the subscription model is because companies put a lot of resources into developing their programs, and they are assets," she says.

    Ask your HR department:
  • How quickly do we plan on growing headcount throughout the company?

    Ask your finance department:
  • How does amortizing software compare to rental prices?

    Ask your accounting department:
  • What are the tax implications of owning versus renting?

    Challenges

    Challenges
    Software can be configured, but integrating it with other programs remains difficult.

    The single biggest obstacle to renting software is the basic inability to integrate different applications. Sharing data between a CRM program and billing software can be a challenge, especially if some of your applications are hosted while others are kept in-house.

    Analysts say these issues will wane as IT departments move toward service-oriented architecture (which allows users to access specific software components and tools regardless of their operating systems), but for now, "integration issues are big," says Gartner's Correia.

    "The subscription model doesn't lend itself to applications that need to be highly integrated with each other internally; they are set up for very core business process functions, like e-mail." And while most companies haven't even begun to think about integrating their subscription apps with other systems, it's important to consider how programs will mesh as the technology evolves, says Yankee Group's Kingstone. "You want to have a five-year roadmap so you don't end up with siloed applications. If you only look at one at a time, you won't be happy with the implementation in the long run."

    That was the approach Joe Lindsay, president and CTO of QS Labs Inc., in Irvine, Calif., took when he decided to move some of his company's software to a subscription model. QS Labs, which develops compliance software for healthcare and life-sciences companies, uses Salesforce.com for its sales automation and CollabNet for some of its software development needs.

    Although the systems at QS Labs aren't integrated yet, Lindsay says the company "chose vendors that would make it easy for us because they have open standards." And, he adds, "The rise of standards-based integration around Web services will eventually make integration easier, and cost effective." Gerry Hurley, director of IT for Washington, D.C.-based College Summit, a nonprofit organization that helps disadvantaged teenagers get into college, agrees. College Summit uses Salesforce.com for its fund-raising efforts, which provides an easily accessible CRM program to employees, most of whom travel regularly.

    The Salesforce.com software is integrated with the organization's internal workflow software called CSNet, and Hurley is working to add College Summit's accounting software as well.

    Decisions, Decisions
    Here is a look at the four most popular ways to buy software.

    Perpetual License The customer pays an initial license fee and may use the software in perpetuity. However, customers sign an update contract, and must pay additional fees for updates. This type of license is the most popular with users, and makes up over 90 percent of the software licenses sold.

    Term License The customer pays an initial fee for the license and may use the software for an established term. Often, the fee is paid in a lump sum up front. Once the term ends, the customer must again pay a fee for a new license. The customer also generally has a maintenance contract of the same duration as the term-license contract.

    Subscription License The customer has the right to use the software developed by the vendor for a contractually specified time, as in a term license. But unlike a term license, the customer has the right to subsequent updated versions of the software as well as a certain amount of technical support. There are two types of subscription licenses: The customer buys and runs the subscription in-house, or the customer buys the subscription that is hosted by the same software vendor.

    Appliance License The software program is sold on a hardware device branded by the same vendor as a package of hardware and software. Most commonly, the software is available only on the vendor's appliance (board or blade) and is not for installation on a general-purpose computer. Other times, the software is configured so that it will work fully only in conjunction with the purchase of the hardware.

    Source: Gartner Inc.

    But feeding corporate data into the new system can also be a challenge, Hurley says. While there were very few hiccups in getting up and running with Salesforce.com, "the most difficult aspect of this was moving from a large number of disparate Excel spreadsheets to one system," he says.

    In addition, because College Summit is a nonprofit organization and Salesforce.com's product was designed for business use, some of the organization's taxonomies had to be changed to fit the software program.

    "In the nonprofit world we talk of the development group, the people who work on getting grants," Hurley says. "In the corporate world, they would be considered salespeople. But because they aren't salespeople, they don't have the same language or do the same reporting. So we needed a new naming convention." Salesforce.com recommended an outside consultant to help the organization with data conversion and preparation.

    Control of applications can also be an issue. While it's true that a benefit of software as a service is that vendors handle upgrades, keep in mind that maintenance schedules may not conform to your business needs. "When they do their upgrades, we typically have to work on their schedule, and if it doesn't match ours, we have to make accommodations," says Towers Perrin's Lubanski. "There's not a whole lot we can do about it."

    Analysts agree that for now, the best way to approach software as a service is to consider all the options. "Evaluate all the pricing models out there," says Correia. "Right now things are very muddy because we are in the middle of this shift. You have to start understanding all the models."

    Ask your line of business heads:
  • Which software systems will need to interact?

    Ask your CTO:
  • How long would it take and how much would it cost to migrate to a subscription service?

    Ask potential vendors:
  • How do you handle system upgrades and downtime?

    To download the a Fact Sheet, click here.