Software For Hire

"I was up late programming, when I saw Bill Gates and Larry Ellison being interviewed," said Ragsdale, president of TPO1 (formerly The Power Of One), a CRM-focused solution provider in Palisades Park, N.J. "When they got through, I woke up my wife and told her everything had just changed."

Ragsdale's seismic shift was caused by more than just the sight of Gates and Ellison apparently sharing the same TV studio. For him, it was the fact that both software titans had a vision for how the Internet would enable the development of more powerful, easier to use and more efficient software that could be bought and metered as needed, like electricity. "I'm ready for this," said Ragsdale.

The "this" he's talking about is software as a service (SaaS), characterized most often by the offerings of companies such as Salesforce.com, Salesnet, Intacct and NetSuite, which are delivered over the Web. Such offerings are also referred to as on-demand software and application service provider (ASP) software—partially because analysts have yet to agree on a standard nomenclature. But the bottom line is that these Net-native applications were written from the ground up to support multiple customers with a single database instance. It's this so-called multitenancy capability that gives the SaaS delivery model dramatic economies of scale over traditional application deployment models. This is software for hire, paid for on a subscription basis.

Two studies released last month illustrate rising vendor interest in rentable software. First, consider "Key Trends in Software Pricing and Licensing," published by the Software and Information Industry Association (SIIA) in conjunction with asset management vendor Macrovision. According to this study of 396 software executives and 100 enterprise customers, one-third of ISVs already offer subscription-based pricing. Moreover, within the next two years, 52 percent expect to offer subscription pricing as their primary sales model.

Then there's Summit Strategies' third in a series of SaaS reports, "From Myth to Reality," which charts the model's growing traction among traditional ISVs. "This will become the predominant business model for ISVs," predicts the report's author, Phil Wainewright. "It's far more disruptive than a lot of people had credited. This business model will truly shake up the software landscape. Probably only one or two of the names that dominate the market today will still exist in 10 to 15 years' time. The rest will have either failed outright or been taken over."

As for customers, it's clear that opinions vary depending on the size of the company. The SIIA study found that 64 percent of enterprises currently prefer the perpetual licensing model over subscription-based options. And a research report from Summit Strategies indicates that smaller companies with 100 or fewer employees were more likely than larger companies to be currently using or evaluating SaaS applications.

The implications for business models are profound. Software vendors must rethink the kinds of functions they provide, how best to deliver those capabilities and their approaches to and through the channel. Solution providers face potentially higher hurdles as they learn to work with bite-size chunks of income—rather than the big gulps they're used to—and a waning reliance on the margins from the technology-related services that have traditionally made up their repertoire.

Just because embracing the new model could be painful doesn't mean it can be ignored. "Either embrace this kind of software now, or it will be thrust upon you," advised Nat Bartholomew, a partner in charge of management and technology consulting services at Langan Associates, an Intacct solution provider in Arlington, Va. "I believe there will be no server-based systems in a few years. None."

Now For Something Completely Different Bartholomew may be overstating the demise of applications installed on customer premises. But many observers do believe the SaaS model will eventually dominate the applications industry. "I think it's still a decade or more before this fully plays out, which means for the next five years value-added resellers can have a safe business with on-premise software and ignoring SaaS," Wainewright said. "So the question is, do you want to play it safe or strike out as an innovator in this new space? Because the companies that will be successful will be the ones that learn the new trades."

Ragsdale, who began offering ASP software three years ago, illustrates the value that comes from mastering new tricks. "Right now, the hosted solutions we are selling are resonating the most with our customers," said Ragsdale, who sells a mix of licensed software—including Act, Saleslogix and Microsoft CRM—and hosted software such as Accpac, Salesnet and Entellium to the up-to-Fortune 500 space. "This is where our real growth is now. A good, solid 70 percent of new sales is in [SaaS]. For years I had no guaranteed income coming in the door. Now I have income guaranteed every month, and I couldn't be happier."

But that ensured revenue requires a fair amount of business model adjustment, and not just because the dollar amounts that VARs take in can be decidedly smaller than what they and their sales reps have grown accustomed to with licensed software. Some vendors, like NetSuite—which disclosed last week it had signed another 50 resellers worldwide—give partners large up-front fees when their clients buy multiyear subscriptions, which provides a nice combination with those monthly fees. Intacct lets its partners charge whatever they want. Salesnet is similar to NetSuite. Clearly, it's up to VARs to mix the two payment schemes. VARs also have to consider their talent mix. Some are hiring more salespeople to handle the large volumes of leads pouring in from the SaaS vendors. Others have trimmed their sales force. And depending on the customization capabilities of the software, some VARs are also adding technical people to deal with the different APIs for integration.

"My counterparts must be very good businessmen," said Mick Gallagher, CEO of LS Technologies, Fallbrook, Calif., which provides both NetSuite and Oracle database implementations. "They have to run their [general and administrative] expenses correctly, they have to know and plan in advance when to add implementation power. But most important, an ASP partner has to realize that because there's no long implementation cycle of billable hours, he has to deploy that software rapidly. It's down to volume and velocity. You can still hit those dollar numbers, but you do it with more transactions. It's a complete change."

Accent on that word "complete." That's because VARs must also reconsider the issue of expertise, as in what additional value does a solution provider offer when there's less emphasis on technical services? "I'm an accountant again. I'm not a technologist anymore," said Langan Associates' Bartholomew. "And because of that, we are looking at larger and larger clients with bigger and bigger solutions."

Steve Nelson, partner of the two-man CPA firm Nelson and Pickens, Dallas, agreed: "Getting rid of that IT part was huge for us. Our expertise is accounting. Now that we're selling NetSuite, we can get into larger customers than we could if we'd had to deal with the software, too."

Accentuate the Positive
Granted, neither Bartholomew nor Nelson are technologists by trade. But their experiences raise a key issue about the kinds of partners who should, and should not, decide to take on the task of representing SaaS. "The higher the level of business value-add that resellers can provide a client, the more likely they could find SaaS a model that makes sense to them," said Tom Kucharvy, president of Summit Strategies. "As you move from the packaged software model to software services, you reduce the number of technology services that have to be implemented. Since most resellers depend on those services revenues for their margins, that's bad," said Kucharvy. "The good part is that it gives those resellers who can a way to stop diverting their resources to solving yesterday's problems around integration and customization and move up to business processes. For the resellers who can do it, it's a huge opportunity. For those who can't, it's a tremendous challenge."

In other words, the solutions that providers bring to customers now revolve around their acumen in automating and streamlining business processes, rather than in packaging technology. "Should you look into selling SaaS, either instead or in place of on-premise [solutions]? That's the first question you have to ask yourself," Kucharvy said. "The second is which provider do you work with."

Partner Play
That voyage of discovery for the right vendor can be especially problematic. Many of the best-known players in the SaaS movement are only now breaking out of a purely direct sales model. Salesforce.com, for example, doesn't work with reseller partners other than paying a onetime 10 percent referral fee. Others, such as NetSuite and Salesnet, have channel programs that are more fully baked. There are also issues of the vendor's commitment to the channel, to the ASP model and to industry verticalization—itself a sign of the software's maturity and an additional revenue avenue for partners.

Even the more mature channel efforts can be subject to channel conflict. Take NetSuite, which receives 30 percent of its revenue through the channel. "The executive staff doesn't have a true understanding of what a partner program is," Gallagher said. "A pro-partner vendor in a pro-partner market can generate 60 percent or better revenue from the channel. NetSuite does not recognize that the customer is only using the software, and that the partner owns the customer relationship. That creates channel conflict. It doesn't help that NetSuite hasn't segmented part of the market for partners to play in."

While NetSuite CEO Zach Nelson acknowledges instances of channel conflict, he claims the situation is improving. "You don't want zero conflict because that means you aren't being aggressive enough. No friction, no fire. When you have the potential of 7 million customers, you don't see that much conflict anyway. If there's ever any question about whose deal it is, we pay everyone the full commission rate. While I'm sure it causes some psychological pain, there's no financial pain at the end of the day. Today we're experiencing two conflicts a month, max, out of 300 deals."

To help sweeten the taste in partners' mouths, NetSuite has developed a way to compensate for those smaller bites of the commission apple that are typical with the recurring revenue model. That's because customers wanting to lock in rates can purchase multiyear contracts, paid for at the onset. "If we sell a three-year license, we're selling a $45,000 subscription," said Rufus Lohmueller, CEO of Lohmueller Associates, Raleigh, N.C. "When they pay 100 percent of that up front, we get all of our revenue up front. So it's a fallacy to say you can't make the same kind of money up front as you did with licensed sales."

Movin' on Up?
The dozen or more solution providers interviewed for this story that focus mainly on the SMB market universally derided the vendor-propagated notion that customers will eventually outgrow ASP software and migrate to a licensed version. "Vendors are telling you that there will come a point when customers outgrow the hosted capability and need to be on-premise. What are they, nuts?" asked Ragsdale. "The whole reason hosted is so appealing is just the opposite. [Customers] are tired of the fact that every time they turn around they've outgrown their on-premise systems."

But that's for the SMB market, with an emphasis on the "S." At the upper end, where companies trying the SaaS approach tend to rent more traditional applications such as those from SAP and PeopleSoft, companies like IBM are finding that spiraling usage costs could eventually swamp any savings advantages over licensed software. That's when a licensed version could make sense, although Kucharvy urged VARs to carefully weigh vendors offering both strategies. "View with caution the attitude that the software is an upsale," he said. "If the vendor offers it both as packaged and hosted, you really have to watch to see that the software company has a long-term commitment to the service and the channel."

One clear sign of that commitment, say observers, is the effort vendors make to enable channel-delivered vertical domain expertise. Salesnet, NetSuite and Intacct encourage customization by their partners. Intacct went even further by building a coalition of nearly 20 on-demand software vendors, enabling its partners to craft the right best-of-breed combination. "When we looked at Intacct, we found they were integrating with other business packages—and that would help set us apart," Bartholomew said. "When we saw that, we jumped in with both feet, and have transitioned completely out of licensed software. More people will migrate to hosted systems. It's only a matter of time."