Nonlinear Thinking

Getting Religion? Microsoft Embraces SaaS (Sort of)

There are probably bell-weather events for every movement, market evolution or technological advance.  For the Software-as-a-Service (SaaS) market, this is probably one of them.  With its Office suite continuing to face challenges from competitors, such as Google, offering free software, Microsoft applies a tourniquet by offering a subscription pricing model for the software.  InformationWeek has the story.

Microsoft said Wednesday that it will give consumers the option of buying an annual license for Office and its Windows Live OneCare security package for $69.99 per year under a program called Equipt. The license covers use of the software on up to three computers and includes access to all future product upgrades.

More than anything else, Microsoft is counting on Equipt's convenience factor to help it fend off competitive threats from Google, IBM, and other vendors that are offering free and open source desktop productivity suites that can be downloaded over the Internet and provide capabilities similar to Office.

Microsoft is hoping that's enough to prevent consumers from migrating to free software. Google recently introduced its Google Docs package, which features functional equivalents of Office's main applications and costs nothing.

The emergence of free software could be hurting Microsoft's bottom line. The company said that sales of its Office products among consumers dropped 39% in the most recent quarter. The company blamed most of the decline on the fact that the previous year's third quarter results were significantly boosted by revenues that had been deferred under an Office 2007 upgrade program.

Still, consumer sales of Office have shown no growth over the past three quarters, Microsoft said. 

Confirmation Bias

Change is hard.  Too much experience with enterprises both large and small has confirmed this to me in spades.  But experience has also shown that maintaining enterprise stasis, when external market drivers suggest a different path, is incredibly dangerous, if not outright fatal.  Such is the place that we seem to find the majority of the global IT service providers with respect to the very large, and growing, externality known as Software-as-a-Service (SaaS).  There appears to be an almost collective confirmation bias among the service providers in viewing SaaS as, at best, a minimal threat to their business model.  They shouldn’t have to be reminded that five years ago, they didn’t view the India pure play service providers as game changing competition either.

  

Confirmation bias refers to a type of selective thinking whereby one tends to notice and to look for what confirms one's beliefs, and to ignore or undervalue the relevance of what contradicts one's beliefs. For example, if you believe that during a full moon there is an increase in admissions to the emergency room where you work, you will take notice of admissions during a full moon, but be inattentive to the moon when admissions occur during other nights of the month. A tendency to do this over time unjustifiably strengthens your belief in the relationship between the full moon and accidents and other lunar effects.

IT service providers are struggling with understanding how their application management delivery models will be impacted when/if they integrate SaaS into the service mix.  How are margins impacted? How is systems integration revenue impacted? If they don’t have intellectual property, in the form of proprietary applications, to deliver in a SaaS model, do they become expensive middlemen in the delivery model?  And if they are just middlemen, do they have a future in a SaaS world?  Hence, the search for validation that SaaS will not become much more than a niche service, albeit an important one.

This tendency to give more attention and weight to data that support our beliefs than we do to contrary data is especially pernicious when our beliefs are little more than prejudices. If our beliefs are firmly established on solid evidence and valid confirmatory experiments, the tendency to give more attention and weight to data that fit with our beliefs should not lead us astray as a rule. Of course, if we become blinded to evidence truly refuting a favored hypothesis, we have crossed the line from reasonableness to closed-mindedness.

As Bob Dylan sang so many years ago, “You don’t need a weather man to know which way the wind blows”.  Service providers must begin to embrace SaaS as a key element of their service delivery models and their business models or prepare end up on the wrong side of a very strong, and sustained, gale.

A Guide to the Cloud Computing/SaaS/PaaS Environment

BEA Systems has put together a really nice visual rendering of the nascent world of on-demand technology services.  The on-demand environment currently includes the distinct service lines of cloud computing, software-as-a-service (SaaS) and platform-as-a-service (PaaS).

Peter Laird also provides these concise definitions of the key service lines.

Cloud Computing

Cloud computing refers to the virtualization of the data center, such that server machines are not thought of individually but as just a commodity in a greater collection of server machines. Cloud computing solutions in general strive to eliminate the need for an application deployer to be aware of the actual physical machines that are used to host the application. Some have called this idea “hardware as a service”.

Software as a Service (SaaS)

An application that is delivered through the SaaS model typically is done so:

• Over the internet,
• Remotely by a third party, with little/no opportunity to bring that application in-house
• With a usage-based pricing model

Platform as a Service (PaaS)

When a vendor offers a Platform as a Service, they are offering an integrated platform to build, test, and deploy custom applications. The PaaS is offered to you in a SaaS model (remote, usage-based). 

Core Cloud Services

After defining the 3 markets, there remains a set of solutions that contribute to all as fundamental building blocks. In other words, these solutions address cross cutting concerns.

You can read more on the industry player's map at Peter's blog here.

More on The Road Not Taken

Thursday's Wall Street Journal has a column by Bob Guth that discusses the long friendship between Steve Ballmer and Bill Gates and analyzes the dynamics surrounding transfer of CEO power from Gates to Ballmer back in 2000. Among the many issues between the two, one key casualty was NetDocs, which Guth describes as " a promising effort to offer software programs such as word processing over the Internet. The issue: Because NetDocs risked cannibalizing sales of Microsoft's cash-cow Office programs, some executives wanted NetDocs killed."

Gates and Ballmer were never able to settle on a plan, with the NetDocs initiative ballooning to a 400-person staff and then, finally, getting folded into the Office group in early 2001, where it died.

One has to wonder where the SaaS world, and Microsoft, might be if they had followed through on the development of NetDocs. It would have put itself in a strong position to compete with Google Apps.

Instead it was Google that developed and released an online application suite that includes word processing, spread sheets, presentations, and email. Google Apps can be accessed online for free and is the key element in the challenge to Microsoft's business model of selling software.

Google delivered another salvo to Microsoft's software dominance by partnering with Salesforce.com, which makes applications used by sales representatives available online by subscription. As a discrete offering, Google Apps are a threat to Microsoft's consumer business, but bundled with Salesforce's offerings, they become a real threat to Microsoft's corporate business.

The folks in Redmond must be praying that Google doesn’t buy Salesforce.com in the near future.

Profiting with SaaS

A topic that is sure to surface more and more as SaaS becomes mainstream is whether the Software-as-a-Service model is financially viable.  Bruce Richardson of AMR Research recently weighed in with a commentary entitled, “SaaS and the Elusive Path to Profitability” that reignited the debate. 

Richardson made the case that most SaaS companies are losing money acquiring new business while focusing on the long-term profitability of the customer during the life of the relationship. Not surprising since that has been the go-to-market strategy for almost all SaaS providers in this emerging market phase of the technology.  New companies attempting to establish their presence and positioning in any market, but particularly in an emerging market, are almost always going to have high sales and marketing, general and administrative and R & D costs.  It sort of comes with the territory.

Jeff Kaplan, of THINKstrategies, who has written frequently on the growth of SaaS, provided a rebuttal of sorts to Richardson’s thesis.

What his analysis fails to do is fully recognize the trends lines, acknowledge the growing success rates and admit that many of his points simply reflect the stage of life of the SaaS movement.

What Kaplan correctly points out is that over the past year, as the fundamental economies of scale have begun to kick in, the publicly traded SaaS providers (salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo) are all showing reductions in their relative sales and marketing, R&D and G&A costs. This is leading to lower customer acquisition costs for each of the companies.

Not only are companies of all sizes increasingly interested in SaaS alternatives, but they are accelerating their customer decision-making processes and reducing the salescycles for SaaS vendors. They are also signing bigger deals which promise greater margins for the SaaS providers.

For instance, salesforce.com has seen a steady rise in its average contract size and recently won a 55,000-user deal with Misys, a financial software provider. And, this deal pales in comparison to Workday’s announcement last week of a 200,000-user deal with global electronic components manufacturer Flextronics.

What is now materializing for the SaaS marketplace is a level of maturity that allows the early providers to begin realizing returns from the capital intensive work they put in to not only establish their own unique positioning but also in creating acceptance of the SaaS delivery model.

For the past 5-10 years, salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo have been burdened with the responsibility of educating the market about the viability and business benefits of SaaS. This evangelistic work required a significant investment in sales and marketing, R&D and G&A costs.

SaaS is entering a new stage in which the same level of evangelism and market education is no longer necessary. Instead, as SaaS gains mainstream acceptance and experiences broad-based adoption, SaaS companies must content with escalating competitive pressures created by the ‘gold-rush’ effect overtaking the SaaS industry.

However, the SaaS executives I’m talking to prefer this problem and are pleased to report that their cost of customer acquisition is dropping and account penetration is rising along with their profitability.

There are learning curve effects for both the marketplace and the SaaS service providers that are beginning to have a positive impact for the market overall but there is still a ways to go.  I continue to believe that SaaS will be a huge discontinuous change for the broader service provider market.

Enterprise Software 2008

McKinsey & Co. and the SandHill Group recently released their 2008 customer survey of enterprise software. The key finding:

Innovation in the software industry is on the upswing,with Software as a Service (SaaS) being a key driver. The SaaS model is becoming mainstream and this has led to the rise of a new generation of SaaS platforms (also referred to in the industry as Platform-as-a-Service – PaaS).

The survey showed increasing acceptance of subscription and on-demand models but more surprisingly, a high portion (74 percent) of enterprise customers favorably disposed to adopting SaaS platforms.

Though the accepted wisdom has been that SaaS delivery would appeal primarily to the SMB market due to their willingness to accept greater standardization of enterprise applications in exchange for a more robust set of features, the McKinsey/SandHill study presents a broader set of potential customers.

The momentum behind adoption of subscription and on-demand purchasing models is clearly being driven by SMB customers, for whom the pricing models have the greatest initial appeal. While the faster adoption in SMB is no real surprise, what is interesting is that there are some large enterprises that are converting to the models that underpin SaaS offerings.

The study found that the momentum towards adoption of SaaS platforms was “surprising”.

In short, nearly every company – or division of a larger enterprise – is a customer or a prospect for SaaS platforms.

Saas Apostolic

There continue to be profound polarities of thinking in the market regarding the eventual impact of software-as-a-service. Many subscribe to the notion of that SaaS will never be ready-for-prime-time in the Global 1000 world, that its impact will be relegated to the SMB market. Others view its dominion as a fait accompli. And then there are the myriad in-between permutations of those two schools of thought.

Having embraced the concept of ASPs and application hosting in the mid 90s, I find myself lining up solidly with those supporting the eventual pervasiveness of the delivery model. In a world where maintaining any kind of competitive parity requires core competences in adaptability and flexibility, the idea that a plurality of enterprise applications will need to be customized to fit business processes that are believed to be unique is just a bit provincial for my taste.

A traditional argument against SaaS making inroads into large enterprises has been the reluctance of the Big 3 enterprise application providers -- Microsoft, SAP and Oracle -- to cannibalize their traditional license fee business. But, at the end of the day, the savings that can be realized utilizing SaaS and other utility models by even the largest enterprises will be too compelling for vendors to ignore.

As an example, EMC is stepping forward to target larger enterprises with a SaaS platform called EMC Fortress

While I believe utility models possess an air of inevitability -- the case “for” is far more compelling than the case “against” -- I am not quite ready to extrapolate their impact to the extent that Nicholas Carr does in his new book.

But give me some time and I will probably come around.