Software-as-a-Service ERP Versus On-Premise ERP Through the Lens of Total Cost of Ownership
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WHITE PAPER Sponsored by: Plex Systems Si mon E l li s May 20 10
IDC MANUFACTURING INSIGHTS OPINION Software as a service (SaaS), sometimes referred to as "software on demand," is becoming an increasingly effective and popular way to implement various business applications. While this implementation approach has gained traction in application areas where there is value to "network" interactions or large amounts of outsourcing, there have also been a surprising number of hosted business intelligence capabilities (sometimes including "analytics as a service") and a growing recognition of the positive aspects of total cost of ownership for companywide, enterprise-level applications — particularly for small and medium-sized companies. There is little question that SaaS is becoming well established as a way to deliver business applications. Based on our research, over 50% of manufacturing companies are using some form of hosted application, and another 35% are considering it. There has tended to be the view, primarily among large manufacturing companies, that a hosted application is functionally limited; however, this view is changing. The most popular application areas for hosted applications are transportation related (TMS, GTM), where the "network effect" (i.e., carrier pooling, regulatory impact) can leverage both shared knowledge and existing connectivity, with customer relationship management (CRM), ecommerce, and business intelligence/analytics next. Enterprise-level applications delivered as a service have been most appealing to small and midsize manufacturing companies where tight IT budgets may prevent an adequate level of IT support and infrastructure to manage in-house application systems, but we are also seeing a growing interest on the part of large enterprise manufacturers to at least understand the various trade-offs inherent in proper SaaS options. There is also little question that the total cost of ownership (TCO) can favor SaaS for even large companies. In fact, for many companies, the "pay as you go" nature of SaaS avoids many overt as well as hidden costs, resulting in an attractive ROI versus more traditional forms of application use. Even beyond that, there is a growing interest on the part of
May 2010, IDC Manufacturing Insights #MI223417
Based on our research, over 50% of manufacturing companies are using some form of hosted application, and another 35% are considering it.
manufacturers to build variable-cost operations versus fixed-cost operations (at least until the longer-term effects of the global recession are better known) as a way to respond to market and sales uncertainty. For many companies, this uncertainty is creating the need to hedge at a design level, in terms of both physical supply chain capabilities (outsourced versus owned manufacturing facilities) and IT capabilities (on premise versus as a service). This trend clearly favors SaaS in the short term. In fact, IDC has raised its IT forecast for SaaS-related applications as a result of the global recession. Current projections are for an annual growth rate of 7% from 2009 to 2013, versus 4.8% prior to the recession. This white paper looks at the growing applicability of SaaS for enterprise-level business applications and analyzes the adoption rate and TCO of this technological approach. According to the anecdotal experiences of our client organizations that have deployed SaaS, a hosted option can drive significant cost savings, reduce initial implementation times, and bring new functionality with relative ease and convenience. SITUATION OVERVIEW
Issues and Pain Points Faced by Manufacturing Organizations
Manufacturing companies have done a generally good job of adopting ERP tools across their enterprise. Large enterprise companies have led their small and medium-sized counterparts in implementations, but overall adoption has been strong. On the heels of the global recession of the past 18 months, IDC Manufacturing Insights certainly sees less of an appetite among CIOs for replatforming and for major ERP upgrades, even where applications may be close to the end of their anticipated useful life. In this context, SaaS alternatives certainly are growing in their appeal. Manufacturing organizations currently face a number of pain points in terms of their current ERP implementations. Based on our conversations with both CIOs and line-of-business executives, we see issues related to the following areas: 1. Cost is a huge issue for CIOs and IT organizations. Reduced IT budgets, along with climbing maintenance costs for traditional ERP implementations, certainly are causing manufacturing companies to look for alternatives. In addition to these "obvious" costs, there are less obvious costs such as the cost of the staff necessary to manage information systems and datacenter, the energy and space required for a modern datacenter, and the capital investment in physical hardware and communications equipment. Companies also need to consider the opportunity cost tied to all of their expenses and especially to capital expenditures.
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IDC Manufacturing Insights certainly sees less of an appetite among CIOs for replatforming and for major ERP upgrades, even where applications may be close to the end of their anticipated useful life.
2. The ability to add new functionality as customizations to on-premise software implementations has also been a common problem for IT organizations. After paying for the customization, IT organizations pay the software vendor extra maintenance costs or have to rewrite the customization when upgrading. In a SaaS model, the software vendor is responsible for all system enhancements, necessary upgrades, and maintenance. Not all can support customizations, but those that can will typically handle upgrades and maintenance as part of the subscription fee. 3. Accessibility is another issue that IT organizations struggle with, particularly in organizations with increasingly virtual workplaces and remote employees. 4. IT organizations also worry about ease of use, as application users almost universally decry the complexity of use of most enterprise applications, in terms of both the levels of training required and the lack of intuitive user interface capabilities. In this context, the multiple add-ons to ERP can also create a cumbersome interface for many users. 5. IT organizations are having a hard time not only getting their arms around the issue of scalability but also responding quickly to changes in demand. Particularly in the current business climate, where many manufacturers are struggling to understand the new baseline for their business, the obligation on IT to provide the correct level of bandwidth and services is difficult. 6. Lastly, business continuity/disaster recovery capabilities are always on the minds of CIOs. If some kind of event occurs and the system goes down, is there an adequate level of redundancy, or failover, to ensure business continuity?
The Maturing of SaaS
We thought it would be useful to be clear about our definition of SaaS. A number of terms are used in the software industry to describe as-aservice offerings, and sometimes these terms create confusion. For the purposes of this paper, we would like to make some distinctions, detailed in Table 1, and recognize that as SaaS matures in the marketplace, so do the definitions.
Hosted Software as a service Cloud computing
Source: IDC Manufacturing Insights, 2010
An application that sits on an external server in a single-tenant environment An application that is hosted, but in a multitenant environment Delivery of infrastructure or IT platform
companies where tight IT budgets may prevent an adequate level of IT support and infrastructure to manage in-house application systems, but we are also seeing a growing interest on the part of large enterprise manufacturers to at least understand the various trade-offs inherent in hosted options, particularly where the ROI may be less clear or speed of deployment is particularly urgent. Although there has tended to be the perspective that ERP delivered through SaaS is "ERP lite" and most appropriate for small and medium-sized enterprise manufacturers, this view is increasingly being dispelled among large enterprise CIOs. As CIOs wrestle with lower IT budgets and pressure to deliver capabilities more quickly, they are considering SaaS alternatives and realizing that SaaS offerings are as robust as traditional vendor offerings. As a result, SaaS alternatives are become quite appealing. A SaaS alternative fits nicely within the changing view among manufacturing supply chain organizations of moving toward a variable-cost rather than a fixed-cost structure as a way to respond to market and sales uncertainty — where capabilities can be easily scaled (both expansion and contraction) based on business changes. This notion of market uncertainty — creating the need to have flexibility at a design level, in terms of both physical supply chain capabilities (outsourced versus owned manufacturing facilities) and IT capabilities (on premise versus hosted) — makes SaaS a very compelling alternative.
Benefits of the SaaS ERP Model
As CIOs wrestle with lower IT budgets and pressure to deliver capabilities more quickly, they are considering SaaS alternatives and realizing that SaaS offerings are as robust as traditional vendor offerings.
As SaaS applications mature in the marketplace, the benefits and trade-offs have become clearer. Yet, a number of misconceptions and "half-truths" continue to pervade the marketplace and bias — potentially to its detriment — the ultimate decision to purchase a "behind-the-firewall" ERP application. In an effort to set the record straight, we'd like to discuss each of the areas that technology buyers should be considering as they look to build business capabilities through investments in applications and IT tools.
SaaS Is More than Just Cost
Although the cost of an ERP implementation is not, and should not be, the sole consideration, it is often the starting consideration and the place where a conversation can come to a quick end. Table 2 summarizes many of the costs associated with an ERP implementation, the periodicity of the costs, and some examples of magnitude.
IT personnel/support costs Implementation costs — external (based on timescale/duration of install) Implementation costs — internal (based on timescale/duration of install)
Source: IDC Manufacturing Insights, 2010
Extensive $$$ variable
It is also interesting to note that financial cost analyses of major application installations consider the overt costs but often fail to account for many of the "hidden" costs. One example is the cost (both overt cost and opportunity cost replacement) of the additional hardware required to host the application along with the personnel required to maintain the equipment and the application. Another example is the implementation process. Although the external cost of implementation, typically a third-party systems integration company, is easily identified in the cost equation, it is our experience that the opportunity costs of contributing significant internal personnel to an implementation team often are overlooked. It is important to point out that the process of implementation for a SaaS ERP installation may be very similar to the implementation process for an on-premise ERP installation, just not as long. Because resources are tied up for less time, the costs will also be less. In the second example, companies
The last point we would like to discuss is the notion of accessibility or "ease of use." As manufacturing companies outsource operations and move to supply networks that are increasingly distributed, the challenges of system access for remote or virtual office employees become more acute. To date, these issues have been at the forefront for sales, marketing, and supplier system tools, but the problem also looms for enterprise-level tools such as ERP. The need for easier access, reduced training, and reduced support times can be a fundamental advantage for SaaS delivery.
Evaluating the ROI
Given the benefits of ERP in a SaaS model, how should companies proceed? Certainly we have seen adoption of SaaS applications driven by company size and IT sophistication. Midsize companies have been the most enthusiastic consumers of SaaS applications to date. In the past, these companies had to overextend their budgets with a big capital investment in on-premise software, or they would buy an inexpensive, no-frills solution that allowed them to get by. The SaaS delivery model is a new alternative that is making robust ERP systems affordable to midsize companies. We are also seeing growing interest from large companies that are now forced to reconsider the capital investment paradigm and are discovering a broadening range of applications available as a service. Indeed, based on IDC spending data, we see opportunities for ERP via SaaS across a broad range of company size and IT sophistication. At the low end of company size (below $100 million), where businesses are often living without capabilities such as disaster recovery or adequate security measures, ERP delivery via SaaS can offer a reduced TCO versus on-premise ERP and valuable additional capabilities. Midmarket companies ($100–999 million), while likely to have more extensive internal IT resources, may still be living without some of the capabilities that larger companies have, and given their business complexities, they are ideal candidates for ERP via SaaS. At the high end of the market, large companies ($1 billion and up) may not lack for IT capabilities, but given the size and breadth of their IT infrastructure, they will see significant reductions in TCO. We illustrate this situation in Figure 1, although certainly there may be outliers (i.e., small companies with comprehensive IT capabilities or large companies with more limited IT capabilities). The compelling value proposition for ERP via SaaS is that regardless of where companies may sit relative to the cost and capability axes, a SaaS ERP deployment can put a company on the path to the top right corner.
We are also seeing growing interest from large companies that are now forced to reconsider the capital investment paradigm and are discovering a broadening range of applications available as a service.
Given the potential benefits of an ERP via SaaS deployment in both cost and capability, we sense that these benefits may in fact be understated. In discussions with manufacturing CIOs, we found that ROI or net present value calculations are based on less mature economic cost models that do not factor in all of the costs associated with on-premise ERP implementations when they make the comparison. Most of the companies IDC Manufacturing Insights has spoken to on this topic still use a fairly basic approach:
(# of users * subscription fee) >=< (annualized cost of license fees + maintenance)
It is also important to point out that sometimes the underlying ROI for an ERP implementation can be unclear. The business rationale of moving to a newer, on-premise ERP implementation can be difficult to justify versus the existing state (i.e., doing nothing). In such cases, a SaaS alternative can be appealing as a way to "kick the tires" on new functionality and modernized capabilities. FUTURE OUTLOOK Clearly SaaS applications are maturing. Companies that either are using or plan to use SaaS applications in the next year have grown considerably over the past few years, suggesting that the barriers to adoption — either real or perceived — are being overcome. At IDC Manufacturing Insights, we see a bright future for SaaS across a broad range of application areas and for companies ranging from small to large. We see both SaaS offerings from an increasing number of small and medium-sized software vendors and hosted options from the wellknown, large industry players. But not all SaaS vendors are created equal. We talked earlier in this paper about the difference between single-tenant and multitenant implementations of SaaS and how the latter are able to more easily scale to demand without interruptions in service. As SaaS grows in popularity, and postrecession demand stabilizes, the ability to scale seamlessly is a critical consideration. Even considering the scale economies, a poor implementation of SaaS will deliver neither the expected savings nor the required capabilities. The other point to consider is one of risk — in terms of both disaster recovery and security breaches. There are immature SaaS vendors in the marketplace, and thus, particularly when one considers an enterprise application such as ERP, the level of security and maintenance of business continuity should not be compromised. There is no doubt that manufacturing companies are much more open now to considering SaaS as a delivery option, and technology buyers view it as an increasingly competitive and viable option. Table 3 illustrates the changing perceptions.
Technology Buyers Consider SaaS Alternative
SaaS as an Option 2010 2008 2006 75% 45% 15% On Premise Only 25% 55% 85% Companies that either are using or plan to use SaaS applications in the next year have grown considerably over the past few years, suggesting that the barriers to adoption — either real or perceived — are being overcome.
1. Business or transaction volume is either variable or unpredictable. 2. Speed of deployment is critical. 3. The ROI of an ERP implementation may be difficult to calculate. 4. Capital expenditure budgets are constrained. 5. In-house IT staff/skills are either limited or required for alternate tasks. As technology buyers investigate SaaS options versus on-premise options, IDC Manufacturing Insights recommends keeping five key points in mind: 1. Clarity around key functionality. While ERP SaaS offerings have closed the functionality gap versus ERP on-premise offerings, it is important to ensure that the selected application is adequately robust and scalable and that it offers capabilities that meet your business needs. 2. Understand the economics. How are the usage fees generated, and what is the length of the contract? Can I easily scale usage up and down without any assessment of penalty fees? 3. Implementation/integration capability. What is the duration of the initial implementation process, and to what degree can the SaaS ERP integrate with systems I might still have on premise? 4. How secure is my data? We've talked about the expectations for appropriate security measures; however, doing due diligence is critical to ensuring the robustness of the security provisions and disaster recovery capabilities. 5. How are new capabilities added to the product, and will they be available to my business as I need them? Lastly, and in many ways most importantly, remember that not all SaaS vendors are created equal. As we have pointed out, SaaS is a maturing capability. Make sure to select a vendor that brings experience and a good reputation for working effectively with manufacturing companies to ensure business benefits, scalable growth, and business continuity.