THINK IT Services

Today’s deepening economic crisis is testing the mettle of IT/business decision-makers, IT solution providers and technology investors alike.

IT and business decision-makers in nearly every industry must make cuts to their capital and operating budgets in order to offset rapid declines in business and tightening credit markets. In many cases, this is forcing them to fundamentally reevaluate the way that they acquire and utilize technology and business applications, and leading them to seriously consider various on-demand service alternatives such as Software-as-a-Service (SaaS), cloud computing, and managed services.

I have recently suggested in commentaries in Datamation and the Business Technology Roundtable that any IT/business decision-maker who isn’t seriously considering these on-demand alternatives is doing their organization a disservice and could be jeopardizing their jobs.

THINKstrategies’ latest customer survey in conjunction with Cutter Consortium clearly shows that organizations of all sizes are adopting SaaS solutions to reap the economic and functional benefits of these on-demand services.

However, many of my clients are also reporting that they are putting a hold on all spending until they get a clearer picture of the state of the economy in 2009. In addition, many are also issuing requests for information (RFIs) to their current suppliers, including SaaS companies they are already using, to obtain additional financial data that can help them determine which vendors are most likely to survive a worsening economy. This is the first step of a broader initiative being undertaken by many of these companies to weed out those suppliers who may fail in the coming months.

Proving their long-term financial viability will become a key challenge for many SaaS, cloud computing and managed service providers (MSPs). Compounding this problem is the growing anxieties within the venture capital (VC) community which is facing severe pressures from their limited partners (LPs)–financial institutions, universities and others–who have been seriously impacted by the economic meltdown. With many of these LPs threatening to renege on their original commitments, the VCs are carefully scrutinizing and setting higher standards for their current and prospective portfolio companies alike.

As a consequence, many of the SaaS, cloud computing and managed service companies who were hoping to capitalize on the current crisis by increasing their sales and marketing efforts to promote their business benefits in a down economy are being forced to go slow or even cut back their spending instead. Many of these on-demand service companies are also facing longer sales cycles as customers delay their purchase decisions and demand more information about the providers’ operations and financial status as a part of their due diligence process.

Given that THINKstrategies’ SaaS Showplace already has over 900 companies from around the world offering over 4500 SaaS solutions organized into 80 Application, Industry and Enabling Technology categories and there may be twice that many companies actually offering on-demand services, an industry shakeout is inevitable and likely to happen sooner than expected.

These trends were the focal point of the recent Software Business and SIIA On-Demand conferences I participated in over the past few weeks. While Salesforce.com’s Dreamforce user conference was a celebration of the accelerating capabilities of cloud computing and SaaS, the Software Business and SIIA On-Demand conferences where more somber industry events were concerns about today’s economic environment were the center of attention.

I think the reality is somewhere between the euphoria and despair these two events. The measurable benefits and growing number of customer success stories that on-demand service providers can boast give them a clear long-term advantage over traditional, on-premise software and systems. However, these companies will face stiffer challenges from incumbent players and conservative decision-makers.

An indication of the competitive challenges facing SaaS and cloud computing vendors was provided by Anthony Lye, the Senior Vice President of Oracle’s customer relationship management (CRM) division, at the SIIA On-Demand conference. Lye spent about 30 minutes of what was supposed to be a “Point/Counter-Point” keynote session challenging the fundamental benefits of on-demand solutions and questioning the long-term viability of the on-demand services model, despite the fact that he is responsible for running Oracle’s on-demand CRM solution which has experienced significant growth over the past year.

Lye’s tough-minded presentation was an example of the same kind of subtefuge which his boss, Larry Ellison, the Chairman/CEO of Oracle, has been conducting for the past year with his own statements aimed at discrediting the on-demand services market despite the fact that Oracle is one of the largest suppliers of databases and middleware for SaaS and cloud computing vendors. (Click here to read THINKstrategies’ profile of Oracle’s SaaS enablement platform strategies and solutions.)

On-demand service providers will have to do a better job than Zach Nelson, the CEO of NetSuite, did at the SIIA conference. Nelson was supposed to offer a SaaS industry response to Lye’s incumbent software vendor (iSV) arguments, but he chose to side with Lye instead and distance NetSuite from the rest of the SaaS community. Rather than dispute any of Lye’s contentions and misrepresentations of the SaaS model, Nelson decided to take only 15 minutes of his portion of the keynote session “debate” to promote NetSuite’s integrated software and new focus on the service industry based on its acquisition of OpenAir.

Anyone who wasn’t aware that NetSuite offers SaaS solutions would have thought it was a traditional software vendor based on Nelson’s presentation. It was a disappointing performance which will do little to endear NetSuite to the rest of the SaaS industry. Instead, it only reinforced the impression that NetSuite and Oracle have a mutual understanding about how they will complement rather than compete with one another.

So, the on-demand services movement will continue to be led by Salesforce.com, Google, Amazon, Facebook and other innovators. It will also be led by bold, new leaders. Although Marc Benioff of Salesforce.com is the figurehead of the movement and Treb Ryan of OpSource is another important evangelist. Josh James of Omniture has emerged as an important spokesperson as well. James delivered a captivating presentation at the SIIA On-Demand conference which elaborated on a similar talk which gave at OpSource’s SaaS Summit last February regarding the key management metric for measuring SaaS sales effectiveness–the ‘magic number’.

It will take bold ideas and actions to succeed in the on-demand services market going forward. The winning on-demand service companies will be those who can convey a compelling message regarding the fundamental business benefits of their SaaS, cloud computing and managed service solutions, and deliver these tangible results in a cost-effective manner.

Like the well known line from Charles Dickens’ book “Tale of Two Cities” goes, these will be the best of times and the worst of times for the on-demand services movement.

One of the most vexing questions in the Software-as-a-Service (SaaS) market, and broader on-demand services industry, is what role traditional channel companies will play in this brave, new world.

While Salesforce.com and other SaaS vendors are touting the enormous advantages of leveraging the ‘cloud’, there are still plenty of companies on Main Street who are just beginning to become familiar with today’s online services. Many of these small- and mid-size businesses (SMBs), and even large-scale enterprises, have relied on their local value-added reseller (VAR) and system integrator (SI) as not only their primary technology supplier but also their ‘trusted advisor’ for their technologies strategies.

These VARs and SIs have been uncertain about the impact of SaaS solutions and on-demand services on their businesses. In fact, many feel down right threatened by these services.

There is no question that SaaS solutions and on-demand services eliminate much of the upfront planning and design, installation and integration, and ongoing support requirements which have been the bread and butter of VARs and SIs’ revenue streams, not to mention the margins they made on hardware and software product sales.

However, there is still plenty of opportunities for channel companies to add value to SaaS and on-demand services across the entire lifecycle of customer requirements from needs assessment through the deployment and management processes. Appirio, Astadia, Bluewolf, SaaSpoint and Sofia Works are living proof of these new market opportunities.

Today, HP and NetSuite announced they are partnering to offer SaaS business applications to SMBs via HP’s vast channel community of 15,000 VARs in the U.S.

Under this agreement, HP and NetSuite will initiate a referral-based program for HP channel partners that will encourage them to recommend NetSuite’s solutions to their customers. They will also offer new value-added implementation and management services as part of the HP Total Care support program.

NetSuite will provide dedicated resources to support the HP resellers, along with a toll-free hotline for channel sales support and a self-service portal for channel partners to access sales tools and online training resources.

This agreement is significant on a number of levels.

First, it gives NetSuite a vast new channel to market to a broad cross-section of SMBs.

Second, it gives a wide array of VARs/SIs an opportunity to jump onto the on-demand services bandwagon with the help of HP.

Third, it gives HP a SaaS solution to sell to SMBs through its channel partners.

And fourth, it gives SMBs an opportunity to obtain a SaaS solution from their existing technology suppliers who they trust.

This agreement is a strong endorsement for NetSuite at just the right time. The company has been trying, without luck, to keep pace with Salesforce.com which continues to command the attention of the on-demand/cloud computing industry because of its brilliant marketing efforts and robust sales growth. Meanwhile, NetSuite has never been a strong marketing company and has seen its stock value severely impacted by failing to meet Wall Street expectations which hasn’t helped its standing in the SaaS industry.

Teaming with HP can be a timely shot in the arm for NetSuite. As a result of its acquisition of EDS, HP is now the largest vendor in the IT industry. HP has spent years building a strong channel network. Its willingness to expose the HP channel partners’ to NetSuite’s solution shows that HP believes it is a good fit for their customers. Otherwise, HP wouldn’t waste its time promoting NetSuite’s solution or jeopardize its channel relationships.

This agreement is also a way for HP to gain entry into the SaaS market where they have lacked a presence. In fact, I’ve been told by HP insiders that the company’s own SaaS initiatives have been slowed by their EDS acquisition. Who knows, HP might become a potential acquirer of NetSuite as a result of this relationship rather than Oracle who has been the most natural candidate in the past. On a more tactical level, the alliance also gives HP to opportunity to sell and promote more of its ProLiant servers and StorageWorks Modular Smart Arrays which are a key component of NetSuite’s service delivery infrastructure.

Ultimately, this alliance has the potential to be a win-win-win-win for all four parties—NetSuite, HP, channel companies and customers.

However, making this agreement a success won’t be easy. It will take time to train the channel companies and devise the right pricing and promotional programs to encourage them to sell NetSuite’s solutions. Even when the channel companies become comfortable with NetSuite and convinced that they can make money in this program, it will still take time to sell a enough NetSuite subscriptions to have an impact on everyone’s financial results.

Nonetheless, the evolution of this alliance will be an important indicator of how traditional channel companies will participate in the SaaS/on-demand services market. While the hoopla at last week’s Dreamforce was squarely focused on the new world of the ‘cloud’, today’s announcement may help to define the role of traditional channel companies in the SaaS market of the future.

The proliferation of on-demand services has been driven by the promise that these Software-as-a-Service (SaaS) and ‘cloud computing’ alternatives to traditional on-premise software products will be faster to deploy, easier to use and quicker to produce tangible value.

While this is generally true, it doesn’t mean that these web-based applications are entirely fool-proof or without their challenges. Sometimes there are technical nuances which have to be overcome. Other times there are integration, customization or optimization issues which have to be addressed. And like any application, sometimes on-demand solutions encounter service disruptions which need to be resolved.

Until recently, SaaS support services were taken for granted. Many SaaS vendors bundled support services into the price of their SaaS solutions, and offered ad hoc support to quickly respond to specific questions or problems. Much of this support was delivered via online services or email, with phone support offered as only a last resort.

However, a growing number of SaaS executives have been telling me that their support costs have been escalating and customer concerns about the quality of support rising as the population of SaaS users has expanded and the number of cloud computing service outages has grown.

The success of on-demand services is predicated on the speed at which vendors can acquire new customers and the rate at which they can retain and grow these accounts. Put another way, on-demand service providers cannot afford customer dissatisfaction, abandonment and churn.

At the same time, customers who are recognizing that on-demand services are a viable alternative to on-premise products are recognizing that they cannot afford to adopt point solutions from a myriad of providers. Instead, they must select a smaller set of strategic vendors who can supply the best combination of on-demand services. As a result, IT/business decision-makers are taking a closer look at the quality of support offered by on-demand service providers.

While many of the more mature SaaS vendors have recognized this growing requirement, it is just beginning to gain industry-wide attention. In response to the growing importance of customer support as a key selection criteria for SaaS solutions and pivotal part of ensuring customer satisfaction, NetSuite unveiled a new portfolio of technical support, training and professional service capabilties this week.

SuiteSuccess™ includes multi-tier technical support options that include 60 days of free support with any NetSuite solution and NetSuite support personnel on-call around the clock. It also includes free, on-demand e-learning sessions.

The company’s SuiteConsulting is based on its NetSuite One methodology that helps customers implement and customize NetSuite’s SaaS solution for their specific business needs. NetSuite is also offering Shared Consulting in which customized projects are jointly managed by NetSuite and the customer, and Guided Consulting for customers who need more standardized solutions with help from a NetSuite specialist.

Anyone who has followed the support side of the software and technology industry may not be impressed with these offerings because they follow a familar pattern and borrow from proven customer support frameworks. But, that is the point. NetSuite’s new support program is a clear indication that the on-demand services market is maturing, and trying to meet the standards of support which were established in traditional software and technology world.

The real interesting question is whether the on-demand services movement can redefine the meaning of support just as it has redefined the way solutions are delivered.

As the Software-as-a-Service (SaaS) “gold-rush” intensifies, industry consolidation is inevitable. The latest example of this consolidation process is today’s announcement by NetSuite that it intends to acquire OpenAir.

This announcement not only reaffirms the SaaS industry consolidation trend, but it also is the latest example of a company profiled by THINKstrategies being acquired shortly thereafter. Other examples include,

• Vtrenz which was acquired by Silverpop
• Everdream was acquired by Dell
• AimNet was acquired by Cognizant
• Corio was acquired by IBM

(Contact me if you’d like a copy of our Strategic Thinking profiles on these companies.)

I had the privilege of talking with Zach Nelson, CEO of NetSuite, and Morris Panner, the CEO of OpenAir, moments before today’s announcement was made public. They indicated that the acquisition was based on a trend which THINKstrategies has seen coming for a few months now.

Prospective SaaS users are not only seeking more industry-specific SaaS solutions, they are also looking for more strategic sources for these SaaS solutions. Instead of contracting for a series of SaaS point products from a wide array of vendors, corporate decision-makers, both business and IT, are taking a closer look at the SaaS vendors’ overall portfolios, platforms, partner ecosystems and financial viability so they can establish broader, long-term relationships with a fewer number of SaaS suppliers.

While the OpenAir acquisition gives NetSuite a stronger foothold in the professional services market, I think the acquisition also gives NetSuite a stronger set of human resource management (HRM) capabilities in its horizontal portfolio of enterprise applications.

Although the acquisition is another example of a Boston-based tech vendor being acquired by a west coast based company, the good news for OpenAir’s employees and the Boston area SaaS community is that NetSuite plans to use the acquisition as a beachhead for further investment aimed at establishing a greater east coast presence centered in the Hub.

Interestingly, NetSuite refers to its OpenAir plans as based on Oracle’s acquisition model and plans to operate OpenAir as a stand-alone product group with tighter integration to NetSuite’s platform. This reference just reinforces market perceptions of the close alignment of NetSuite with Oracle, and keeps alive suspicions that NetSuite may be acquired by Oracle in the future.

In the meantime, Zach Nelson and Morris Panner told me they will do all they can to maintain OpenAir’s relationship with Salesforce.com via the AppExchange, and build on their other third-party relationships, including their respective channel partners.

Having gone through a number of unsuccessful acquisitions, I know first-hand about the various issues that can get in the way of these transactions achieving their business objectives. However, I think NetSuite and OpenAir have a very good chance of succeeding because they have the right combination of complementary executive personalities, solution capabilities, channel partners and geographic orientations.

The next question is what this acquisition means for OpenAir’s primary competitor, QuickArrow? My bet is that they will also be an acquisition target in the coming months.

Last month, Bruce Richardson of AMR Research published a provocative commentary entitled, “SaaS and the Elusive Path to Profitability” that heightened the debate regarding the financial viability of the Software-as-a-Service (SaaS) model.

Bruce’s column elaborated on a presentation he gave at SaaScon 2008 entitled, “Balancing Customer Acquisition Costs and Elusive Profitability.” The talk was driven by a question which Bruce claims to ask numerous software and service companies on a regular basis: “Do you know how much it costs to win a dollar of new business?”

Not surprisingly, Bruce has found that most SaaS companies are losing money acquiring new business in hopes of gaining long-term profitability over the life of the customer relationship. This has always been the logic behind the ‘land and expand’ tactics which are at the heart of almost every SaaS company’s go-to-market strategy.

In order to make his case, Bruce referred to recent annual and quarterly financial reports from the major publicly traded SaaS companies—salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo. In every case except Taleo, Bruce found high sales and marketing, R&D and G&A costs resulting in low or negative GAAP operating income.

What his analysis fails to do is fully recognize the trends lines, acknowledge the growing success rates and admit that many of his points simply reflect the stage of life of the SaaS movement.

Ironically, he identifies numerous operating improvements that have been achieved by each of the publicly traded companies, but treats them like they are simply financial compromises rather than the gains which come from the fundamental economies of scale of the SaaS model in a rapidly growing market.

For instance, if you look at the financial results of each of the companies Bruce identified over the past year they are all showing reductions in their relative sales and marketing, R&D and G&A costs. This is leading to lower customer acquisition costs for each of the companies.

Like Bruce, I spend a lot of time talking with senior executives at SaaS companies. While they all admit that the SaaS business isn’t easy, they have also told the SaaS market is evolving more quickly than they expected.

This trend has been confirmed by a number of industry studies which have reinforced THINKstrategies’ research and consulting work over the last 3-4 years.

Not only are companies of all sizes increasingly interested in SaaS alternatives, but they are accelerating their customer decision-making processes and reducing the salescycles for SaaS vendors. They are also signing bigger deals which promise greater margins for the SaaS providers.

For instance, salesforce.com has seen a steady rise in its average contract size and recently won a 55,000-user deal with Misys, a financial software provider. And, this deal pales in comparison to Workday’s announcement last week of a 200,000-user deal with global electronic components manufacturer Flextronics.

I had the privilege of talking to Workday executives prior to the Flextronics announcement who admitted that they’ve been surprised with the level of interest in Workday’s SaaS solutions and the speed at which customers are willing to make a purchase decision.

RightNow even reported to Bruce that most of its customers will make 5-6 additional purchases and spend 8x their initial purchase value over a three-year period.

Ironically, the SaaS financial model is built on the same economic principles which have been at the heart of the IT market research business since the 1970s—the annuity of predictable subscription services.

If you look at the quarterly and annual financial reports of Gartner or Forrester, as well as those of the privately-held firms, you’ll find that their most important performance metric is their annual contract value (ACV). This is the same metric SaaS companies use to measure their performance.

In fairness, Bruce identifies Taleo as an example of the profit potential of the SaaS model. He credits the company’s targeted sales and marketing approach as the major reason for its jump from an operating loss in 2006 to a $3.7M profit last year. I’ve seen the same tactic used by privately-held SaaS companies, such as Intacct, to significantly impact their financial performance.

While disciplined management deserves some of the credit, I’m sure Taleo’s executives would also admit, as others have told me, that market momentum is also helping to produce greater profit margins for many SaaS companies.

For the past 5-10 years, salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo have been burdened with the responsibility of educating the market about the viability and business benefits of SaaS. This evangelistic work required a significant investment in sales and marketing, R&D and G&A costs.

SaaS is entering a new stage in which the same level of evangelism and market education is no longer necessary. Instead, as SaaS gains mainstream acceptance and experiences broad-based adoption, SaaS companies must content with escalating competitive pressures created by the ‘gold-rush’ effect overtaking the SaaS industry.

However, the SaaS executives I’m talking to prefer this problem and are pleased to report that their cost of customer acquisition is dropping and account penetration is rising along with their profitability.

A little over a year ago, I contributed a commentary to eWeek’s Channel Insider, entitled “On-Demand a Boon for the Channel”, that stated the Software-as-a-Service (SaaS) movement doesn’t have to be the death-kneel for channel organizations.

At that time, many resellers and integrators feared that SaaS would ‘dis-intermediate’ them because of its direct sales and simpler deployment characteristics. There is no question that these attributes will certainly disrupt the traditional business models of many resellers and integrators who capitalized on the complexities of the legacy applications in the past. However, there is still plenty of complexity in today’s enterprise-oriented SaaS solutions to give innovative resellers and integrators a new round of business opportunities to pursue.

Just as in the past, customization and integration remain challenges in the new world of enterprise SaaS solutions. A year ago, I discussed in the eWeek article about how Bluewolf Group had grown to become the largest independent integrator of Salesforce.com deployments. I also discussed how retailers, like CompUSA teaming with NetSuite, were seeking to become viable channels to market for SaaS.

Shortly after my Channel Insider commentary was published, ADP and AmEx also entered the SaaS market as potent new players with their acquisition of Employease and alliance with Rearden Commerce respectively. There entry clearly demonstrated how the SaaS market was quickly growing into a business services opportunity. It also showed that a new set of channel partners are primed to play a part in the SaaS movement.

More recently, other new entrants are also illustrating how a new array of channel opportunities can be fostered by the SaaS movement.

Yesterday, Business Objects and Thomson Financial announced an alliance to deliver financial information on-demand. Under this new agreement, Thomson Financial’s data will be delivered in pre-built, easy-to-use online reports via Business Objects’ Information OnDemand solution.

Last month, Verticals onDemand unveiled the first of a series of industry-specific customer relationship management (CRM) solutions built on the Salesforce.com platform. The company’s new VBioPharma on-demand solution is aimed specifically at the managed care requirements of U.S. pharmaceutical companies. Verticals onDemand promises to rollout other industry-specific SaaS solutions on the Salesforce.com platform.

Saaspoint is an Ireland-based integrator that has experienced the same success in Europe which Bluewolf Group has found in the U.S. Not satisfied with focusing on the European market only, Saaspoint has opened an office in Silicon Valley and plans to expand its operations across the U.S.

These examples are further proof that plenty of channel opportunities exist in the SaaS market and are ripe for the taking for those innovators who want to capitalize on this rapidly growing movement.

With the Software-as-a-Service (SaaS) movement becoming generally accepted among organizations of all sizes, a growing number of SaaS vendors are seeking to differentiate themselves by creating on-demand solutions specifically designed to address the unique requirements of particular industries or vertical markets.

THINKstrategies’ SaaS Showplace includes nearly 600 company listings by industry. Many of these companies are simply targeting specific industries rather than offering industry-specific solutions. However, a growing number are designing their on-demand solutions to cater to the specific needs of targeted industries.

The shift in attention is timely according to THINKstrategies’ latest SaaS survey in conjunction with Cutter Consortium. In the second installment of our three-part series on the findings of this survey we will discuss how a substantial proportion of the survey respondents are either currently using industry-specific SaaS solutions or considering them.

Leading SaaS vendors, such as Salesforce.com and NetSuite, have recognized the growing opportunities for industry-specific SaaS solutions. NetSuite launched its SuiteFlex ecosystem to respond to this opportunity, and Salesforce.com recently followed suit by expanding its AppExchange to encourage vertical market solutions.

Another indication of the growing focus on industry-specific SaaS solutions is the entry of venture capital (VC) funding for industry-specific SaaS vendors. A recent example is Procore, a SaaS vendor focused on the construction industry, which announced that it had completed its Series B financing led by Great Pacific Capital.

This same phenomena is also emerging in the managed services sector. In contrast to the SaaS trend, overall market acceptance of managed services has been slower for a variety of reasons, so managed service providers (MSPs) are attempting to stimulate greater demand by making their services more appealing to specific market segments.

A pioneer in industry-specfic marketing of managed service solutions is Perimeter eSecurity, previously known as Perimeter Internetworking. Perimeter began as a full-service network service provider, but found particular acceptance of its security-oriented services among community banks. It decided to focus nearly all of its sales and marketing resources on the community banking sector, and today is the dominant player in that market.

Through a series of acquisitions–most recently Message Secure, a managed security services provider (MSSP) focused on financial institutions and other businesses in the U.S.–and alliances with Internet Service Providers (ISPs), Perimeter has expanded into other segments of the market.

I think the verticalization of the SaaS and managed services markets will be one of the major trends in 2007.