Software As A Service: Nightmare Or Dream Margins?

Their nightmare vision is of a flock of Salesforce.com clones pumping out software services from their own servers, managed by them, billed by them, to customers far and wide. Traditional resellers might get a onetime referral fee—Salesforce.com, for instance, offers 10 percent—but then bubkes. That&'s not enough scratch for survival, let alone profitability.

It certainly didn&'t help that when Microsoft trotted out its consumer-focused SaaS pitch in November, there was nary a public mention of any solution provider role. (Well, one slide mentioned resellers, but it was skipped during the presentation, according to reporters at the San Francisco event.)

That raises a haunting question: If the partner-centric Microsoft can&'t articulate an inclusive SaaS plan, what hope is there for partners dealing with less-channel-savvy companies?

Some forward-thinking software vendors are making the move to SaaS more palatable by cutting partners in not only on up-front sales, but on the recurring subscription-type revenue stream SaaS engenders.

NetSuite, for example, is launching a sales development kit aimed at helping partners sell more software—not even necessarily just NetSuite&'s software—and at helping them learn how to hire and mentor inside and outside salespeople, said Adam Ross, vice president of channel sales at the San Mateo, Calif., company. Next month, NetSuite plans to launch an analogous partner program for market development.

But smart partners aren&'t waiting for vendors to lead.

“From a customer point of view, SaaS can make a lot of sense,” said Scott Jenkins, CEO of EBS Group, Lenexa, Kan. “Many companies do not want to make intensive investments in licensing and re-upping and patching software. They want someone to handle that. Customers say, ‘I have skill gaps internally. Why do I need so many [database administrators]? If I can run software as a service, and I can redeploy my internal people on things, that helps me compete.”

EBS characterizes itself as a professional services specialist in enterprise portals, business intelligence, ERP/CRM, collaboration applications as well as application integration and J2EE development. While it can and will resell software—from Oracle and other partners—a growing part of its revenue comes from services.

“SaaS provides predictable SLAs [service-level agreements] and keeps the environment current and running and the customer happy,” said Jenkins. “We&'re moving more into that; we&'re moving to manage your environments and run the applications.”

Solution providers like EBS are transitioning their own businesses first from product-centric sales to more of a services model and from there to software-as-a-service. They know an army of solution providers will deliver the “last mile” of application customization. They will “verticalize” the software, analysts and providers said. And for this, they will be paid.

Many will private-label and adapt software services from ISVs like SMBLive, Apptix, NetSuite and others. Webex, through its WebOffice collaboration service, for example, lets partners self-brand. WebOffice, which offers group calendaring and scheduling along with messaging, whiteboarding and instant messaging, can be billed directly from Webex—typically at $10 per user, per month in volume. Or the partner can bill, marking up the service as appropriate, said Rich Faulk, president of Webex Small Business, Burlington, Mass.

So, smart solution providers aren&'t despairing, although they also watch their vendor partners warily. Everyone knows that in the battle for more profit, account control will be hotly contested. In SaaS scenarios, in which the billing entity tends to be the software company, that raises the anxiety level.

Where&'s The Model?
There are a lot of questions yet to be answered.

One East Coast Microsoft solution provider is therefore weighing his options. “I haven&'t seen a [good SaaS] business model yet from anyone. I&'ve heard that the market is going that way and I believe it, but we&'re still feeling it out. As a Microsoft partner, I&'m looking for more direction.”

Asked what he thinks Microsoft&'s game plan is, he shrugs. “It&'s not baked yet. Everyone talks about this revolution, blah blah blah, but it&'s not done. We make money on software, but we&'ve already made the transition largely to services to insulate ourselves [from software margin erosion],” he said.

He is not alone. Amy Wohl, president of Wohl Associates, a Narberth, Pa., consultancy, says the transition will be tricky but worthwhile. “Everyone has to figure out the model, but there&'s a lot of opportunity,” she said. “Software vendors and ISVs have to understand that to sell into the tier below the largest companies, you need system integrators and VARs. This stuff does not sell itself. You need partners to sell this stuff and you need to pay them to do that and, by the way, the way you pay them is to offer them recurring revenue for ever and ever as long as the customer is there,” she said.

For those willing to navigate the move from software-license-sales-plus-ancillary-services to a model where the software and service become more of a utility meted out, and billed, over time, there is the promise of an annuity or ongoing subscription revenue.

“SaaS has many [comparatively] attractive financial components,” said EBS&' Jenkins. “Now, you might do a large license transaction but it&'s typically so heavily discounted that at the end of the day what you keep is fairly meaningless, maybe 2 or 3 points. With SaaS done right, you can do 30, 40, 50 points and get recurring revenue.”

The Appeal Of An Annuity
Ah yes. Recurring revenue. The one, but not the only, potential upside. What partner doesn&'t want a predictable and repeatable stream of dollars flowing in as customers subscribe? The issue is account control. And some partners decry what they see as a power grab for customer control by vendors in the SaaS mode.

Of course, the shift from a large up-front software license sale to a more measured revenue flow over time will be painful in the short term for vendors and partners alike. If you&'re a reseller used to reaping big up-front dollars from a once-a-year license sale, it may be hard to give up that immediate influx in favor of a smaller annuity stream. But not impossible. And many partners argue the slower flow of dollars is healthier in the long term.

“Moving to an annuity from big-bang dollars is very painful for any company,” said Ken Winell, CTO of VisAlign, a King of Prussia, Pa.-based solution provider. “But so was transitioning from a product focus to a services focus. Or vice versa, as many partners have.”

Recurring revenue is the way NetSuite is distinguishing itself. Partners get “30 percent now and forever,” NetSuite CEO Zach Nelson has been known to chant, mantralike. More specifically, NetSuite partners can get from 30 percent to 50 percent margins on the initial sale, while recurring revenue remains at 30 percent for the duration of the customer&'s use of NetSuite.

NetSuite channel chief Ross says once long-term commitments are factored in, SaaS can be as profitable—or more so— than traditional license sales.

“The average cost of a Sage/Navision/Great Plains seat is about $1,500. If you hit 50 percent margins on that, you earn $750 but that&'s at the highest level. If you sell NetSuite at 30 percent margins, you make $360 for the first year, then another $360 for year two. That $720 is comparable to Great Plains at 50 percent margins,” he noted. The difference is the partner keeps getting compensated over the life of the contract. If the partner hits 50 percent margins based on volume for first-time sales, NetSuite becomes more profitable, he said.

Model Mayhem
Folks at Salesforce.com, Webex, NetSuite and other SaaS–rooted vendors maintain that legacy providers like Microsoft face a tough road both in providing software under this model and in protecting their current base of—and revenue from—on-premises applications. Simply put, executives like Webex CEO Subrah Iyar maintain that these older companies—well, let&'s face it, he means Microsoft—have too much to lose in client and server software sales to fully embrace SaaS.

Brad Wilson, general manager of Microsoft CRM, has said repeatedly that on-premises software is not dead but that there is also opportunity for SaaS offerings. The fact, however, that Microsoft execs have sent mixed messages to their partners about the availability of a Microsoft-hosted CRM offering illustrates that even a typically disciplined company has been flummoxed by the specter of SaaS and Internet-era competitors from Google to Salesforce.com, none of which ships any disks of software.

It is Microsoft CTO Ray Ozzie&'s task to formulate the company&'s SaaS strategy and sell it—both internally and outside. Ozzie maintains that there will always be a place for a VAR&'s or integrator&'s talents.

“The business value of solutions rises dramatically in proportion to their fitness-for-purpose, which means that the domain expertise of a VAR, or the integration expertise of a [systems integrator], will be in great demand whether the solution is deployed on the rich client or the browser, the enterprise server or a services platform in the cloud,” he told CRN via e-mail. “We believe that there is no ‘one-size-fits-all&' solution environment—there are trade-offs in each choice. Businesses will select solution platforms based on their own mix of requirements such as mobility, cross-enterprise collaboration, structured process integration, quality of service, confidentiality, compliance, speed and, of course, cost. Our goal is to provide platforms, tools and frameworks for clients, servers and services that enable customers to make the choice that best suits their specific needs, and that enables VARs and developers to leverage their expertise and build profitable businesses.”

Redmond, Wash.-based Microsoft is hedging its bets. One partner said the company sees three delivery scenarios. The fat-client, thin-network world is where Office and Windows reign supreme, where people are not always connected via a broadband link, and where “knowledge workers” need a lot of local processing power and storage. The thin-client, fat-network scenario presupposes ubiquitous, fast Web connections and server-based logic either in the cloud or on premises. There, browser-based software becomes the face of the application. And large companies that need to mix and match the two will be free to do so. Road warriors may be forced to depend on dial-up or wireless connections and so need both the rich client and the rich network at times.

For those who doubted that on-premises software still has a future, last month&'s public Salesforce.com outage was a reminder why many companies still do not trust mission-critical applications to servers and forces outside their own firewalls.

Mike Rhodin, IBM Software&'s general manager for the Workplace, Portal and Collaboration unit, is in violent agreement on the mixed-use worldview. SaaS, he maintains, is an interesting topic because it&'s more than one thing. He segments the potential market into three parts. There&'s the consumer-based model, where Microsoft Windows Live/Office Live would appear to fit, that would be supported by advertising revenue and has been ably pioneered by Google. There is the more traditional “next-gen ASP” model that delivers Web-based services like Webex and Salesforce.com. And then there is the outsourcing model where businesses may outsource a lot of infrastructure but still retain control of their intellectual property and data.

Progressive software vendors know they have to allay partner concerns.

“Disintermediation is the fear,” concedes NetSuite&'s Ross. “I thought it would be simple to tout recurring revenue as a draw. But what I&'ve found is there&'s fear that the customer will not be owned by [the partner]. That they get the invoice from us and that the data is in our data center. We have to educate the channel about what SaaS really is. It is not the old hosted model which was so scary.”

SMBLive hopes to preach the SaaS-is-good message to partners. And Alex Hawkinson, CEO of SMBLive, Reston, Va., a provider of hosted services, says there are good technical reasons why the SaaS revolution will succeed where the ASP revolution went bust. “One is the applications themselves,” he said. “What works is not taking a traditional client/server application and slapping it into a hosted model. The successful vendors are those who designed software from the ground up to be delivered as a service,” he noted. A corollary is that good SaaS applications take advantage of rich clients without requiring them.

Second, the near-ubiquity of broadband Internet access is a major boon to SaaS models. Broadband was not nearly as widespread five years ago when ASPs crashed. And finally, customers “get” SaaS. “There are customers having a history of success—Salesforce.com and Webex have proven that,” Hawkinson said.

Of course, there is no one monolithic partner type for SaaS. For very small businesses and consumer applications, the partner might be the cable or telephone company. But where a business application requires customization and specialization, regional integrators and VARs with domain expertise will be key, Hawkinson and others said.

Philippe Vincent, an Accenture partner based in Palo Alto, Calif., is following the SaaS wave very carefully. The advent of SaaS, service-oriented architectures and Web services “seems to shift the value-add away from technology integration toward things like process and domain knowledge,” he noted.

What that means for software vendors and their partners is not crystal clear. Undoubtedly, some channel partners that continue to push diskettes full of bits will find themselves out of the loop if they don&'t adapt. But high-margin services and expertise can cushion the blow for those who develop them.

Face it: For as long as we&'ve been hearing from software vendors about how easy their wares are to deploy, install and maintain, do you know any non-IT pros who relish the thought of doing those things? We&'re more likely to use an expert.