THINK IT Services

One of the myths about software-as-a-service (SaaS) is that it is primarily geared toward small and mid-size businesses (SMBs). While SMBs may feel the most immediate benefits from SaaS, large-scale organizations have become big beneficiaries of SaaS as well.

Just as Internet leveled the playing field for many SMBs competing with major corporations by giving them instant access to global markets via eCommerce, SaaS has done the same by giving SMBs equal access to many of the enterprise applications which big companies have relied upon for years to manage their businesses.

However, SMBs aren’t alone in recognizing the business benefits of SaaS.

Fortune 500 companies and other brand-name corporations are showing up on the customer lists of many of the SaaS providers that are now listed on THINKstrategies’ online SaaS Showplace directory.

These companies have found that many of today’s SaaS solutions are not only easier to deploy and administer, but they are flexible and scalable enough to satisfy their internal and external business requirements. As a result, many major corporations are using Salesforce.com to satisfy their customer relationship management (CRM) and salesforce automation (SFA) needs; Taleo to handle their recruitment and talent management needs; and others to support a variety of back-office and customer-facing functions.

The broad-based adoption of SaaS across demographic categories was also confirmed by a recent industry survey conducted by THINKstrategies, in conjunction with Cutter Consortium. The survey found little variation in customer perceptions and buying intentions when it comes to SaaS by size of company.

[Let me know at info@thinkstrategies.com if you'd like to obtain a summary of the survey results when it is published.

The rapid acceptance of SaaS as a viable alternative to traditional ’shrink-wrapped’ software is driving leading independent software vendors (ISVs), such as SAP and Microsoft, to accelerate their rollout of SaaS options for their legacy applications.

“Mash ups” has become a popular term in the rapidly changing IT industry. It generally refers to the convergence of divergent technologies and markets to create new solutions.

For example, we are currently seeing a surge of mash-ups that are bringing together digital content and mobile communications to create new media alternatives such as a variety of ‘on demand’ music and movies now readily available on your Ipod or cellphone.

The merging or “mashing” together of disparate markets is also occuring in the outsourcing and software-as-a-service (SaaS) markets.

The prime example of this new trend is the recent announcement of a strategic alliance between Tata Consultancy Services (TCS) and Salesforce.com.

Under this agreement TCS will use many of the SaaS solutions in Salesforce.com’s AppExchange as the basis of new outsourced services. Instead of relying entirely on traditional long-term outsourcing contracts, TCS intends to develop a new set of ‘on-demand’ business services that will be more palatable and profitable than its current labor-intensive engagements.

As my previous blog stated, the traditional outsourcing business is struggling under the stress of escalating globalization and intensifying price competition. The established players can no longer afford the long salescycles and uncertain breakeven points of mega-outsourcing arrangements. Especially, when approximately half of these deals fail to achieve their original business or service level objectives (SLOs) and are terminated or restructured.

TCS is among the first major outsourcers to establish an alliance with a SaaS provider to create more cost-effective alternatives. Just as the outsourcers did in the 1980s-1990s when they teamed with the major enterprise application vendors, I expect the outsourcers to partner with leading SaaS providers to create ‘out-tasking’ [my term] alternatives that better respond to customers’ ‘on demand’ preferences.

The cover-story of this week’s issue of BusinessWeek sings the praises of the rapidly expanding outsourcing business. The article points out that corporations of all sizes are leveraging services from a myriad of providers in India, China, Eastern Europe and beyond to satisfy nearly every aspect of their R&D, manufacturing, distribution and support needs.

Yet, today’s outsourcing business hasn’t been kind to many of the traditional industry leaders. IBM announced on 1/17/06 that its Global Services division had another disappointing quarter because of rising competition in its core outsourcing business. Even one of its primary offshore competitors, Wipro, reported on the same day that it was having trouble matching the margins of its India-based peers despite a 25% rise in its fiscal 3rd quarter net profits.

Given these discouraging financial results, it is not surprising that the deal to sell Affiliated Computer Services (ACS) to a consortium of private equity firms also collapsed this week.

What’s the problem?

The most obvious answer is the escalating competition which is pinching profits by forcing outsourcers to rapidly expand their global operations while at the same time withstand intensifying pricing pressure. But, there is an even more subtle problem with the fundamental structure of today’s outsourcing business that the business or trade pubs have mentioned, but haven’t fully assessed. This is the downsizing of outsourcing contracts.

Even as the size of the outsourcing market grows and nearly every corporation is outsourcing a greater proportion of their operations to third-parties, the size of outsourcing contracts has been dropping for the past two years according to nearly every major market research firm.

Why is this happening?

The track record of success for outsourcing has never been great. In the IT industry, at least half of today’s outsourcing deals will fail to meet their original business objectives according to Gartner. As a result, these deals will either be terminated or substantially restructured.

In order to mitigate the risks associated with a failed outsourcing arrangement, corporations are reducing the scope and lifespan of their outsourcing agreements. They are also relying on multiple providers to perform a variety of more specific tasks, rather than be dependent on a single outsourcer to do everything. This is a trend that I began calling “out-tasking” over ten years ago, and it is still the most common method used to leverage third-party service providers.

This trend is also fueling the growth of more focused managed services and software-as-a-service (SaaS). These solutions address specific IT and business requirements, and use shorter term subscription-based fees. THINKstrategies’ research has shown rapid adoption of both managed services and SaaS as enterprises of all sizes become comfortable with these outsourcing alternatives.

Interestingly, none of the major outsourcers has been able to restructure their existing business models to capitalize on the rise of managed service and SaaS. The outsourcers have either overlooked the significance of managed services and SaaS, or they have been unable to convert their traditional people-intensive outsourcing sales and service engines into effective platforms for selling and delivering more automated and targeted managed services and SaaS solutions.

Until they figure out how to add managed services and SaaS to their portfolios, traditional outsourcers like IBM and offshore players like Wipro are going to face rising costs and increasing price competition in their primary service businesses.

The January 11th issue of the Wall Street Journal included an interesting article entitled, “Bertelsmann AG Repairs Phones? Yes to Diversify.” The article described how the world’s fourth largest media company is building one of the fastest growing services organizations that is providing call-center services, repairing mobile phones, running printing presses and even storing medical supplies for companies such as Nokia, Microsoft, MacDonald’s and BG Group Healthcare SAS.

The service division, called Arvato, isn’t a new venture but a longstanding and major component of Bertelsmann’s business, generating an estimated $5 billion in revenue in 2005 via 250 operating units in over 30 countries. Arvato’s origins stem from Bertelsmann’s success outsourcing printing services as an extension of its core publishing business. It has leveraged its technical skills to generate over $500 million repairing mobile phones, and is now reselling its warehouse facilities to pharmaceutical companies to store their products.

Another company that is finding fertile ground in the services business is the heavy equipment manufacturer, Caterpillar. The company is refurbishing and reselling old equipment to offset cyclical new product sales. The company’s remanufacturing business was worth over $1 billion in 2005 and is growing at 20% a year. IT is part of a larger services business that includes Logistics and Financial Services, representing 15% of Caterpillar’s total revenues and approximately 20% of its total income. The company predicts that its services business will represent 20% of the Caterpillar’s total revenue by 2010 and could contribute 30% of its net income at that point.

While these bold service strategies may seem like a new phenomena, they actually follow a model that many attribute to GE which has built a very successful service business in the airline and technology industries. When demand for jet engines began to wane in the 1980s and ’90s, GE transitioned its focus from manufacturing engines to servicing airplanes, and is now one of the leading outsourcers of airline maintenance services in the industry. The company has also been a quiet, but significant player in the computer services market for many years.

IBM and Hewlett-Packard recognized the value of a strong services business many years ago. Dell is one of the more recent converts to the strategic value and attractive margins associated with services.

The growing success of these corporate titans in various service businesses is a major driver of the escalating interest among private equity and hedge fund firms in the investment opportunities in the outsourcing market. These savvy investors have already acquired Affiliated Computer Services (ACS) and Sungard’s hosting business, and are rumored to be considering CSC.

THINKstrategies research has found that enterprises of all sizes are rapidly adopting software-as-a-service (SaaS) and managed services to overcome the hassles and costs of implementing traditional packaged applications and administering their IT/network systems.

A recent THINKstrategies survey, conducted in conjunction with the Cutter Consortium, found that almost a third of the respondents are already using SaaS and another third are considering SaaS, with the vast majority expecting to adopt SaaS in 2006. The survey also found over 90% of the current SaaS users are satisfied with this new application delivery model, 86.5% expect to acquire additional SaaS offerings, and almost 92% would recommend SaaS solutions to others.

Despite this ‘out-tasking’ trend, there is still plenty of confusion among enterprise decision-makers regarding the difference between SaaS and managed services.

Part of the problem stems from the efforts of various SaaS and managed service providers (MSPs) to exploit both of these growth market opportunities by suggesting they are in each when they are really only in one. The other part of the problem is that there is some overlap between SaaS and managed services.

For example, a growing number of network and system management (NSM) vendors are selling and delivering their tools as a software service, but are not managing the customer’s operations. THINKstrategies categorizes these companies as SaaS providers, while others view them as MSPs.

In THINKstrategies’ view, customers subscribe to SaaS in order to acquire an IT or business functionality. Therefore, THINKstrategies defines SaaS as the delivery of a software application as a service via the web.

On the other hand, customers subscribe to managed services to offload, or ‘out-task’, a specific IT/business management responsibility. Therefore, we define managed services as any packaged solution in which the provider assumes responsibility for managing a specific IT or business function on an ongoing basis. Although managed services are primarily delivered remotely in an automated fashion, they can be augmented with callcenter or onsite support staff.

Complicating these distinctions further are the terms “on-demand” or “hosting”.

THINKstrategies views both SaaS and managed services as “on-demand” solutions because they are specifically designed to address common application and management needs quickly on an incremental or variable, pay-as-you-go subscription service basis.

THINKstrategies also recognizes that “hosting” can apply to both SaaS and managed services because in each case the provider hosts all or part of the application or management functionality.