Software as a Service (SaaS) is an application delivery model that provides businesses with cost-effective access to sophisticated software applications over the Internet. Instead of having to purchase applications and servers and hire IT staff to support them, businesses can pay to use them, often on a month-to-month basis. This new B2B application delivery option can be attractive to small businesses that need sophisticated software to compete and grow but lack the financial resources necessary to purchase and support the applications and systems.

The pricing for B2B SaaS solutions is typically based on use. Free, consumer-oriented applications also are available via the B2C SaaS delivery model. However, users of "free" SaaS applications are subjected to banner ads that SaaS providers sell to support the services.

SaaS solutions increase the availability of sophisticated software applications to small businesses. The solutions will become increasingly important as competition among businesses increases and credit becomes more expensive. Even though the penetration of SaaS business offerings is extremely small, an increasing number of SaaS applications are available, especially for customer relationship management (CRM), human resources, and procurement. Companies that provide SaaS offerings are both large and small and include ADP, Arriba, Concur Technologies, Oracle, Salesforce.com, SAP, and SuccessFactor.

How It Began

The concept of sharing the cost of IT solutions across multiple users or multiple companies has been around a long time. Service bureaus or time-share systems were first introduced in the 1960s and early 1970s because computer hardware and software were extremely expensive. Only the largest and most profitable companies could afford their own computers, but many companies needed the economies and efficiencies that computer solutions could provide. As a result, many IT solution providers provided time-share systems, which let companies rent time on computer systems over leased, dedicated communication lines.

Over the next 10 years, prices of computer hardware and operating system software dramatically declined, while the costs of dedicated communications remained high. The cost for a company to own and operate its own computer system became cheaper than purchasing application access over expensive leased lines from a service bureau. As a result, service bureaus almost disappeared in the 1980s.

Then, the cost of secure communication access declined dramatically with the rise of the Internet. The most expensive components of a solution became the costs of the applications and the associated IT support for those applications.

Once again the service bureau concept resurfaced as a viable option for sharing the cost of an IT solution across multiple customers, but now the driving force was sharing the costs of applications and corresponding IT support rather than the cost of systems. The new solution providers were called application service providers (ASPs) because the focus was on spreading the cost of expensive applications across multiple small companies.

A Comparison of ASP and SaaS Models

Both the ASP and SaaS models deliver access to software applications over a network, typically the Internet. But the ASP model is more like the fee-based SaaS model.

Traditional ASPs leased applications from the software companies that created them and then web-enabled those applications and charged a fee to customers for accessing them over the Internet, but SaaS solutions are typically designed and released by software companies specifically for web serving and increasingly for access via portable devices. The name Software as a Service was introduced to reflect that the service offers communications and system support in addition to application access and to differentiate the new SaaS offerings from the spectacular ASP failures of the mid-1990s.

SaaS providers have addressed the problems that caused many ASPs to fail, including performance and security issues. In addition, declines in data center costs have made SaaS offerings more economically viable. Now, corporate managers who once feared hosted applications are much more web savvy and willing to consider accessing application services over the Internet.

Fee vs. Free

SaaS offerings fall into two major categories — fee services and free services. The free B2C SaaS offerings typically are either sponsored by a business or tied to advertising. With business-sponsored services, an SaaS provider offers access to selected software as part of existing service. For example, many Internet service providers deliver virus protection software at no extra cost as part of their customers' access package. With ad-based services, an SaaS provider sells Internet advertising to cover the costs of providing SaaS solutions.

Now let's look at the fee services. Most business applications are currently sold as part of a total solution, including the hardware, operating system, and infrastructure support for effective use of the applications. This makes sophisticated applications very expensive for small businesses, which typically lack the financial depth for such investments.

Software as a Service lets small companies gain access to sophisticated business applications and pay a user fee or usage charge. There are a limited number of client/server SaaS offerings, but most of the popular solutions are web based. A company purchasing a web-based SaaS solution needs only a browser interface for each user, a high-speed Internet connection, and end-user training. There are no incremental capital investments in systems and software to host the applications, no incremental investments in IT infrastructure to support the sophisticated applications, and no need to hire, train, and maintain an IT staff to support the applications.

So SaaS is ideal for any company that wants access to sophisticated applications but doesn't want to invest in the software, systems, and IT resources necessary to install, run, and maintain the applications. Even though this application delivery model is an option for many companies, it is ideally suited for small businesses or departments within enterprises.

Total Cost of Ownership

When a company considers purchasing application functionality, it has two basic options: traditional software or SaaS. When comparing the costs of these two options, it is important to consider the total cost of ownership (TCO). Examine the information in Figure 1, borrowed from a September 2006 white paper prepared by the Software-as-a-Service Executive Council for the Software & Information Industry Association and called "Software-as-a-Service: A Comprehensive Look at the Total Cost of Ownership of Software Applications" (siia.net/software/pubs/SAAS_TCO_WP.pdf). Although the paper might be considered a biased source, it provides a comprehensive list of the components of the TCO for both traditional software and SaaS.

When comparing the TCO of traditional software with SaaS solutions, it's important to include the ongoing cost of personnel necessary to support traditional software, because it's typically between 50 and 85 percent of the TCO. When looking at SaaS's recurring costs, it's important to realize most of the ongoing personnel support costs associated with traditional software are covered by SaaS subscription charges.

When reviewing the TCO for small businesses, you should consider a few differences vis-à-vis the numbers in Figure 1.

• The cost of hardware and software (i.e., startup costs) will be a much higher percentage of the TCO for traditional software. This consideration is especially important for small businesses that will have a small number of application users.
• The up-front costs of an SaaS solution are much less than the up-front costs of traditional software. In today's tight financial markets, many small businesses cannot afford to make up-front capital investments in systems and applications to support their businesses.
• SaaS subscription charges are operational expenses that can be deducted from income in the year they are billed for immediate income tax relief. Investments in hardware and software for traditional solutions are capitalized and then depreciated over the life expectancy of the investments (typically, three to five years). You don't get the total income tax benefits for these investments for three to five years.

How to Choose an SaaS Offering

Most SaaS business offerings have a user-based or usage-based pricing structure and delivery method that lets a solution provider distribute the total solution cost across multiple businesses or users. This cost distribution can make the SaaS offering affordable to small businesses, but only if the solution provider doesn't impose a premium price on the service.

It's important that a business review all the costs associated with an SaaS solution, especially since SaaS offerings are beginning to be introduced into the SMB marketplace. Here are some key points to consider when selecting an SaaS offering:

Negotiate contract terms. Don't sign a long-term contract for an SaaS solution. You're renting access to an application, typically on a monthly basis. You should expect to receive significant value from using the application to help run your business. If using the application does not deliver the expected benefits, you should be able to terminate the service without any appreciable penalty.

Employ startup strategies. Start small and grow. Train a couple of employees to use the application. These employees should be the "tool junkies," the employees who enjoy trying out new tools and applications. Run a pilot program with a small number of users and then expand the number of users based on the benefits. This minimizes up-front application training costs, disruptions to operations, and initial SaaS usage costs. Ensure that there are no penalties for adding more users to the system.

Evaluate the results. Monitor all the costs and benefits associated with the SaaS solution. Often the greatest benefit of using an application is reducing the number of operational errors. Eliminating late deliveries and improving stock turnover may yield more benefits than improving employee productivity.

Plan for future requirements. Make sure the SaaS solution will address both your short-term and medium-term needs. You probably need the application automation to effectively grow your business. Make sure the cost structure will not be an impediment to growth.

Understand user requirements. Although the SaaS provider should be responsible for application and system maintenance, the user is responsible for the integrity of the application data.

Establish a Service Level Agreement (SLA) with your SaaS supplier. You should ensure that an SLA is part of your SaaS contract. The SLA should include the hours of application operation and application support, the expected application response times, the education and training provided on the application, and the penalties associated with noncompliance of the SLA targets.

Make sure the SaaS solution is intuitive and easy to use. The pricing structure of a SaaS solution can make it affordable to small businesses, but if the SaaS application is difficult to learn and use, the education and training requirements will be too extensive and expensive to make the offering viable for a small business. (The pilot program can identify these types of problems before a substantial investment is made.)

Know what type of server is running the SaaS application. Some servers have a better reputation for reliability, scalability, and security.

Final Considerations

Before you commit to any SaaS provider or solution, be sure you consider the following points:

• SaaS users don't have to apply patches and install upgrades.
• SaaS solutions are more reliable because fixes are designed and tested for the SaaS production-system level rather than for a specific version of a software application.
• Many of the newer SaaS solutions have more extensive security protocols than traditional software, but users still should ensure the offering provides adequate data security. SaaS users have to ensure that their disaster recovery plans also cover their SaaS solution.
• SaaS users must ensure that the SaaS solution has adequate processes and procedures in place to address data governance issues.
• SaaS users should ensure that a confidentiality agreement is in place with their SaaS provider.
• SaaS users don't have access to SaaS application code, so you must be concerned about and negotiate any customization or integration requirements before signing an SaaS contract.
• SaaS users should ensure that SaaS application providers can and will provide unrestricted access to their data in the event that the user wishes to change vendors.

Sassy Solution

Small businesses that lack the financial resources necessary to purchase and support traditional software applications should consider the SaaS application delivery model. It can deliver cost-effective access to sophisticated applications. Just be sure to review all the costs associated with a SaaS solution and take it step by step as you would any software purchase.

David Slater has been involved in the midrange market for the last 28 years. Before he retired from IBM in November 2006, Dave was the IBM product manager and marketing manager for iSeries Application Development Products. He was responsible for the introduction of WebSphere Development Studio and the IBM WebFacing Tool. David has written more than 50 technical articles and case studies about application development strategies and directions.