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Software as a Service Erp

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Software-as-a-Service ERP Versus On-Premise ERP Through the Lens of Total Cost of Ownership
Global Headquarters: 5 Speen Street Framingham, MA 01701 USA P.508.988.7900 F.508.988.7881 www.manufacturing‐insights.com

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.

©2010 IDC Manufacturing Insights

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.
TABLE 1
As-a-Service 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

©2010 IDC Manufacturing Insights

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The delivery of either hosted or SaaS applications may use the cloud, but they are not, in and of themselves, the cloud. It is also important to point out that as-a-service offerings exist in two distinct forms: single tenant and multitenant. In a single-tenant approach, what we refer to as "hosted," the software vendor maintains an independent version of its application for each manufacturing client. In a multitenant approach, multiple clients can be hosted on a single instance of the application and on a single logical database. Early hosting was single-tenant because it appeared to be easier for the hosting company to manage; however, it is error-prone when applying fixes and upgrades to tens (or worse, hundreds) of independent hosted versions of the software. Multitenant is an emerging best practice for SaaS that reduces operational and upgrade costs and enables the application provider to better scale to demand without interruptions to service levels. These translate to potential savings that can be passed to the customer. The multitenant approach must be designed from the ground up to provide, among other things, appropriate levels of security and data protection. In a traditional, "on-premise" software implementation, the software vendor sells a packaged license that the manufacturer installs and maintains on servers within an owned datacenter. The manufacturing company is responsible for paying the initial license fee, some level of installation/integration cost, and an annual maintenance fee. Within the owned datacenter, there are the regular cycles of buy and replace for hardware, along with the software infrastructure (e.g., DBMS and OS) and personnel costs. There may be variations of this basic model in which the software vendor (or third-party service provider) runs/hosts the application on its own servers within its datacenter and provides access via a secure subscription process. In a SaaS deployment, the application is built from the ground up to be hosted and, furthermore, to allow a single instance of the database and software to be used by all manufacturers using the software. Whether hosted, or pure SaaS, the nature of the subscription pricing can vary. In some instances, it is based on the size of the user company (typically revenue based); in other cases, it may be based on the number of users or on transaction volumes. In either case, SaaS would be viewed as a primarily variable-cost approach, whereas traditional installations are more fixed cost. This becomes an important distinction as we note in detail later in this paper. There is little question that SaaS is well established as a way to deliver business applications. Based on our research, over 50% of manufacturing companies are using hosted applications, and another 35% are considering it. The most popular application areas for SaaS are transportation related (TMS, GTM), where the "network effect" (i.e., carrier pooling, regulatory impact) can leverage both shared knowledge and existing connectivity, with CRM, ecommerce, and business intelligence/analytics next. Enterprise-level applications delivered as a service are most appealing to small and midsize manufacturing
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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.

©2010 IDC Manufacturing Insights

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TABLE 2
TCO Comparison Between Software-as-a-Service ERP and On-Premise ERP
SaaS ERP License fee — initial License fee — upgrades Subscription fee One-time Periodic Annual/recurring None None Charged by user, volume/usage or company size Included in subscription fee On-Premise ERP $$$ variable $$ variable None

Maintenance cost (plus extra for customization) Support costs

Annual/recurring

15–25% of license annually

Annual/recurring

Included in subscription fee

May be part of or in addition to maintenance fee Extensive Extensive

Hardware costs IT infrastructure costs

Periodic Recurring

Minimal (browser) Minimal (Internet connection) Minimal $$ variable

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

Recurring One-time

Extensive $$$ variable

One-time

$$ variable

$$$ 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

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©2010 IDC Manufacturing Insights

end up reallocating and/or stretching resources across the business, reducing the ability to manage unexpected business conditions, or utilize some level of outsourcing capability. In either instance, there is a cost to the business that may go unaccounted for. Another area of costs that can be avoided through the use of SaaS includes security, backups, and disaster recovery. This is a major area that IT organizations do not generally consider — certainly not to the degree that these are costs that can be avoided with a SaaS implementation — and that many small or medium-sized businesses cannot afford. Particularly in the current economic climate, where business conditions are unparalleled in their unpredictability, SaaS can offer a level of adaptability that is enormously helpful to companies that may be looking for more flexible IT tools — as we pointed out earlier — for both easier expansion and contraction. Integration and upgrade coordination are also issues that SaaS can ease. At IDC Manufacturing Insights, we have seen a pretty consistent view on the part of technology buyers that they will sacrifice that final little bit of functionality for an easier integration. There is little question that especially large companies are delaying the refresh rates of IT systems, certainly to postpone capital expenditures from up-front licensing fees and replatforming but also to avoid the inevitable business interruptions and risk from long implementations. The same occurs on a smaller scale with version upgrades. Opportunity costs are associated with extending refresh cycles, and while these costs can be difficult to quantify, they may manifest in terms of lagging capabilities, poor agility, and inability to react quickly to changing business conditions. We see this as a particularly acute problem in the current business climate where application modernization has enabled companies to react quickly to changing business conditions. In this recession, IT has really proven itself as companies with more sophisticated and comprehensive tools have been able to respond more quickly to marketplace changes and protect cash and profits. To the extent that "no good idea goes uncopied," we expect to see application modernization accelerate out of the recession and, along with the desire to move to a more variable-cost approach, bring SaaS front and center as an alternative. As we discussed earlier in this white paper, there is a persistent view on the part of many technology buyers that a SaaS ERP installation is "ERP lite" and that functionality will be sacrificed. While this may have been true, and may still be in some cases, particularly for newer players, IDC Manufacturing Insights believes that it is no longer the case. Vendors in the marketplace are offering ERP applications via a SaaS model that give very little, if any, functional ground to the on-premise alternatives while providing the inherent advantages of SaaS.
©2010 IDC Manufacturing Insights #MI223417 Page 7

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.

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©2010 IDC Manufacturing Insights

FIGURE 1
IT Cost/Capability by Company Size

2.1%

Large Enterprise

IT Cost (% Rev)

2.8%

Medium‐Sized Enterprise

3.5%

Small Enterprise

Limited

Comprehensive IT Capability

Source: IDC Manufacturing Insights, 2010

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)

As we point out in Table 2, a number of less obvious costs are associated with on-premise ERP implementations that can easily fly under the radar. Including these costs in the above calculation can dramatically increase the savings. The other important point to note is that this less mature view of economics is based on a prerecession paradigm. Although we expect a shift to variable-cost structures as a response to market uncertainty, we do not yet know how it will change the perspective on SaaS. It is entirely likely, as SaaS continues to mature and the benefits that accrue become clearer and more comprehensive, that this shift to variable-cost structures will drive higher levels of SaaS adoption and also increase the potential savings.
©2010 IDC Manufacturing Insights #MI223417 Page 9

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.
TABLE 3
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.

Source: IDC Manufacturing Insights Client Discussions, 2006–2010

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©2010 IDC Manufacturing Insights

The numbers are not suggesting that in 2010, for example, we expect 75% of applications to be hosted; rather, they suggest that in 2010, we expect SaaS to be considered as a viable alternative in 75% of the evaluations. TCO is driving many of these perceptions. As we have outlined, in the right circumstances, SaaS can drive significant savings. SaaS is not without its problems, however. Limited functionality and security concerns linger, and while these concerns are more perception than reality, it is important when considering ERP from a SaaS vendor that appropriate due diligence be applied to ensure the functionality meets critical business needs. But then, this is really no different from the evaluation done on an on-premise application, at least not with regard to functional requirements. With regard to security concerns, one can make the argument that there are bigger internal threats than external threats. Small and medium-sized companies cannot afford a full-time security officer. Overworked employees, a lack of appropriate diligence, or poor internal security policies can expose internal applications. Leading SaaS vendors with clear and documented practices focus significant effort on maintaining high levels of security; indeed, their very livelihoods depend on a stellar reputation. But, beware, not all SaaS vendors are as thorough. Pay close attention and make sure the SaaS vendor has the infrastructure and business practices in place to ensure that your business systems are in reliable hands. Perhaps the more problematic view of SaaS is its role in perpetuating "shadow IT." SaaS has proven popular in large companies, particularly, when functions or business units have trouble getting systems approved through traditional IT channels. Implementing software in this "go around" way can result in fragmented systems and inconsistent business processes. This kind of "shadow IT" is less likely in the case of enterprise applications such ERP, but it is something to watch out for regardless. ESSENTIAL GUIDANCE Application delivery via SaaS is maturing rapidly and is now a wellestablished alternative to delivering business applications and IT tools. Beyond early-adoption categories such as transportation, global trade, and CRM, manufacturing companies are increasingly willing to consider enterprise-level applications such as ERP. Implementation costs and timescales may be improved and ease of use facilitated. Based on our conversations with CIOs and technology buyers, economic results are positive. While we caution users to look broadly at benefits, the pure cost associated with SaaS is generally very positive, and most companies report either meeting or even exceeding expected savings. SaaS is particularly compelling where:
©2010 IDC Manufacturing Insights #MI223417 Page 11

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.
Copyright Notice

Copyright 2010 IDC Manufacturing Insights. Reproduction without written permission is completely forbidden. External Publication of IDC Manufacturing Insights Information and Data: Any IDC Manufacturing Insights information that is to be used in advertising, press releases, or promotional materials requires prior written approval from the appropriate IDC Manufacturing Insights Vice President. A draft of the proposed document should accompany any such request. IDC Manufacturing Insights reserves the right to deny approval of external usage for any reason.
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