In-Depth

Get Ready for Software as a Service

Microsoft is bracing for a "services wave." But what will it mean for you? Here's what to expect -- and how to prepare

• By Rich Freeman
• March 01, 2006

In a famous 1995 memo, the Microsoft chairman declared (belatedly, many said) that an "Internet tidal wave" was transforming the technology landscape. Ten years later, in October 2005, Gates issued another memo to Microsoft executives and engineers, this time forecasting a wave of new, scalable applications and experiences to be delivered via the Internet. "This coming 'services wave' will be very disruptive,'' Gates warned in the memo, which has since been made public. "The next sea change is upon us." Sounding a similarly urgent note, Chief Technology Officer and newly appointed Services Czar Ray Ozzie argued in a second memo that if Microsoft fails to respond rapidly to the surge of Web-only services, "our business as we know it is at risk." (To read excerpts from the Microsoft memos, see "What Ozzie Said" below and "What Gates Said" below; for more on the impact of disruptive technologies, see "Technology Tsunamis" below.)

Here's another good bet: If Microsoft views a technology trend as potentially lethal, Microsoft's partners should probably be concerned about it too.

Indeed, according to Ben Pring, a research vice president at Stamford, Conn.-based analyst firm Gartner Inc., the rise of "software as a service" (SaaS) will mean big changes for IT firms of every size and description, including ISVs, system integrators and solution providers. How well they adapt will be a major competitive differentiator over the next five to 10 years, Pring says. He and other experts offer varying recommendations on how best to approach SaaS, but all agree on one thing: The time to start preparing is now. "It's a pretty brave company that's ignoring this altogether," Pring says.

Ready to Jump
SaaS solutions come in many shapes and sizes, but all share a few traits: they're run entirely over the Internet, require no infrastructure on the customer's side -- except Web access -- and are billed on a recurring per-user or amount-used basis. Examples of SaaS range from Apple's iTunes online music-download store to Research in Motion's BlackBerry mobile-messaging service, and Pring says other companies are marketing SaaS-based compliance-management, document- management and procurement applications. But Salesforce.com, the well-known ISV specializing in customer relationship management (CRM), may offer the best current SaaS model for most Microsoft partners. That's because the San Francisco-based company targets businesses rather than consumers and competes head-to-head with providers of traditional on-site CRM solutions.

Given the amount of media attention SaaS is receiving, spending on such solutions remains surprisingly small -- but it's growing fast. IDC, the IT research firm headquartered in Framingham, Mass., estimates that worldwide outlays on SaaS applications, which grew 39 percent to $4.2 billion in 2004 (the most recent year for which figures are available), will reach $10.7 billion by 2009. And Pring predicts that within five years, one-third of all new software will be delivered using the SaaS model.

The analysts' rapid-growth projections aren't hard to understand given the advantages SaaS offers over on-premise installations. SaaS solutions are easier to deploy and don't require expensive servers, so they offer companies lower up-front costs, reduced risk and speedier return on investment. Upgrades occur automatically behind the scenes, freeing customers from the pain of deploying updates. And lower implementation costs translate into lower costs for switching services, a factor that puts greater pressure on software vendors to ensure continual satisfaction.

Of course, experts made similar points about hosted solutions several years ago when application service providers (ASPs) first appeared on the scene. But Robert Bois, a research director at Boston, Mass.-based analyst firm AMR Research, says SaaS has a critical edge over ASP offerings. While SaaS applications are "multi-tenant," securely supporting multiple customers on one deployment, ASP systems are "single-tenant," requiring a separate, expensive set of software and hardware for each customer (see the sidebar "What's in a Name?"). Says Bois: "The SaaS model is much cheaper for a service company to run, support and maintain, so it can ultimately sell its applications at a fraction of the cost of the ASP model."

Low costs are one of the key reasons that small and midsize businesses, with their limited IT budgets, have been especially eager consumers of SaaS. Consider, for example, Houston-based IT consulting company Insource Technology Corp., a Microsoft Gold Certified Partner and Salesforce.com user. For years, says Sales Director Bill Breslin, the company relied on various frustratingly limited small business CRM packages. "We're a 70-to-80-person company," Breslin says. "We're not going to buy a million-dollar sales system." But in Salesforce.com, he says, "we found a million-dollar application that's really full-featured, [and] really customizable" -- and that costs just $10,000 a year in subscription fees. "That's cheaper than maintenance on a million-dollar package," Breslin observes.

But smaller companies aren't the only ones adopting SaaS. Pring notes that many enterprises are "sourcing elements of their overall portfolio via this model," usually for specific departmental, needs. For instance, he says, salespeople at Merrill Lynch & Co. Inc. are using Salesforce.com, and BP plc is using a SaaS-based compliance-management system from Axentis Inc. of Warrensville, Ohio.

With momentum building behind SaaS, it's no surprise that many Microsoft partners are contemplating services initiatives. "We're about ready to jump in that direction," says Breslin, who cites SaaS versions of Microsoft Exchange and Microsoft Office Small Business Accounting as possible initial offerings. He sees the ripest market opportunity in small businesses that simply can't afford to invest upward of $10,000 in their server rooms. "If we can sell them a piece of a world-class facility and have them pay $1,000 a month, then the economics are there for them," he says.

Executives at Network Engineering Solutions Inc. (NES), a Clearwater, Fla.-based solution provider and Microsoft Gold Certified Partner with competencies in Microsoft Business Solutions and Networking Infrastructure Solutions, are more wary. According to Stephanie White, NES's director of business solutions, the company's customers are curious enough about hosting to explore that option, but when it's time to actually shell out the money, they still want the software on-site. SaaS is "definitely something we're keeping an eye on," White says, but adds that the company needs to see more widespread activity in that area before investing in new hardware and skills.

Liz Herbert, an analyst at Forrester Research Inc. of Cambridge, Mass., agrees that on-premise solutions won't disappear any time soon. "There are still going to be companies that think it's a huge competitive differentiator to have their solutions in-house," she says. But with SaaS rapidly gaining popularity, most software vendors will soon have little choice but to create SaaS versions of their on-site products and let customers pick which option they prefer. "It will be like going to the grocery store and being asked whether you want paper or plastic," Herbert predicts.

Making the Transition
But creating a SaaS offering isn't quite as easy as ordering up a new batch of shopping bags. ISVs face a host of thorny challenges, from modifying application code to implementing monthly billing processes to either building data centers or finding hosting partners.

Treb Ryan, CEO of Microsoft Certified Partner OpSource Inc., says one of the trickiest feats is managing the switch from large up-front customer payments to smaller sums paid over time. "A recurring revenue stream is a great long-term business proposition, but you're going to have to work through some transition" as your cash flow adjusts, says Ryan, whose Santa Clara, Calif.-based firm helps software vendors build and run SaaS applications. Herbert advises software-makers adopting SaaS to do so gradually, especially if they're publicly held companies. Otherwise, jittery investors, seeing what looks like a sudden drop in sales, may dump their shares.

Meanwhile, channel partners may require some hand-holding as well, says AMR Research's Bois. Resellers are used to receiving commissions up front, Bois notes, but because SaaS revenue arrives in small bundles, most ISVs prefer to pay commissions in smaller increments as well. As a result, many companies are having trouble reaching agreement with their partner communities about what's fair.

SaaS vendors face the same problem with their sales reps. For instance, Insource Technology, the Houston-based consulting firm, offers a solution-outsourcing service, so it already has experience with salespeople immediately demanding their commissions on a deal worth $1 million over three years. Instead, Insource gives reps a percentage of each customer payment as it's made. "They get paid a little less, but they get paid for longer," Breslin observes.

The rise of SaaS heralds especially challenging adjustments for solution providers and system integrators who will see once-trusty revenue sources become less lucrative for several reasons. First, as Ryan points out, someone who's buying Salesforce.com isn't buying servers. That means demand for hardware configuration and support is likely to drop. Additionally, SaaS applications needn't be installed on-site and then integrated with a company's existing infrastructure -- bad news for companies that make their money helping customers deploy and connect systems.

As the market for integration and maintenance declines, smart partners will look for ways to "go up-market" and add strategic value for their clients, says Gartner's Pring. Bois agrees, system integrators and consulting firms will move toward business consulting roles and away from architecture and technology provider roles, he predicts: "They're going to be working a lot more on best practices, and defining business processes and work flows, rather than spending their time doing software implementation."

They'll also be helping customers with vertical needs, suggests Bois, who advises partners to beef up their vertical skill sets. Line-of-business applications typically require more customization than most SaaS vendors can deliver cost-effectively, which is one reason SaaS has been most prevalent among horizontal applications such as CRM so far. "The big software providers are going to try to do the 80/20 thing, where they provide a base application that meets the needs of 80 percent of their customers," leaving the remaining 20 percent to smaller companies, Bois says. That spells opportunity for solution providers and system integrators. "It's all about getting more industry-specific," he says. "There's going to be much less requirement for technology expertise and more requirement for industry expertise."

Getting Nervous
Complicating the SaaS picture for Microsoft partners specifically is the uncertainty surrounding Microsoft's future plans. In November 2005, Microsoft previewed the forthcoming release of Office Live, a set of Web-based services targeted chiefly to small businesses. Though details remain sketchy, Microsoft says that a free version of Office Live will provide a domain name, a hosted Web site and e-mail capability, while subscription versions will add access to more than 20 business applications for managing everything from customer information to expense reports.

Microsoft has also dropped hints about SaaS versions of Exchange, SharePoint Portal Server, and its Dynamics line, but has so far kept mum about whether it intends to sell them itself or solely through partners.

One possible clue appeared in December 2005, when Microsoft released a hosted version of Dynamics CRM that partners can license for $24.95 per user per month (leaving plenty of room for resale markup compared with Salesforce.com's $125 monthly per-user list price). But rumors soon followed that Microsoft would begin selling customers hosted CRM itself this year, with a hosted ERP offering likely to follow. Would that shut partners out of the equation?

"In theory, it might. In practice, I don't think it will," says Paul DeGroot, an analyst with Directions on Microsoft, an independent research firm based in Kirkland, Wash. "There's no such thing as a vanilla Microsoft CRM solution," he says. "The [Microsoft] Business Solutions products are not shrink-wrapped. They still require a partner to get involved in setting them up." (Like most other Microsoft Business Solutions products, Microsoft's CRM offering was re-branded with the Dynamics name late in 2005).

However, DeGroot adds, until Microsoft clarifies its plans for SaaS, it's impossible to know just what partners are in for. "I don't want to say that the current strategy is bad for partners, because I don't know what it is," he says. "There's a serious lack of definition [about SaaS] on Microsoft's part and it is very confusing for customers and for partners."

Microsoft declined to comment on its forthcoming services initiatives and how they'll impact partners. Rich Adolph, an account director for Microsoft's PR agency, Waggener Edstrom Worldwide Inc., of Seattle, Wash., said late in 2005 that company officials felt it would be premature to discuss their SaaS plans because they were still vetting them with Microsoft partners and other stakeholders.

For many partners, though, Microsoft can't start talking specifics soon enough. Even Insource's Breslin, who serves as president of the International Association of Microsoft Certified Partners (IAMCP) and has friendly relations with Microsoft, is "very nervous" about the company's intentions. "Is it going to start writing applications and selling pieces of them? To what degree will that compete with me in my business space?" Breslin asks. "If it starts selling its small business accounting [system], and even its large business accounting packages, [Microsoft is] going to have a lot of partners not happy with them." However, he hastens to add praise for Microsoft's sensitivity to its partner community. "Every decision I've seen it make has been for the betterment of its partners," he says. "I have no reason to distrust [Microsoft]."

Far from being anxious about Microsoft's entry into services, Greg Frankenfield welcomes it. The CEO of Magenic Technologies Inc., a custom application developer headquartered in Golden Valley, Minn., believes that Microsoft's interest in SaaS legitimizes it with customers. That's good news for Magenic, a Microsoft Gold Certified Partner that has recently started a new line of business building, hosting and supporting SaaS solutions for software vendors. More and more companies want SaaS, "and we want to provide the infrastructure and services structure they can use as they build their own capacity," explains Frankenfield.

That's the kind of strategic thinking Pring says all Microsoft partners should be doing. Ready or not, he argues, SaaS is on the way. Smart partners will try to catch the wave rather than hiding their heads in the sand. Preparing for SaaS and the disruptive changes that are likely to accompany it may seem overwhelming, but there's no time like the present to get started. Pring uses an old Chinese proverb to remind partners about how to do just that: "A journey of a thousand miles begins with a single step."