Increasingly, our SaaS portfolio companies find that mid-size corporations, i.e., companies with $200M to $1B in annual sales, are the more aggressive adopters of on-demand solutions.  Saugatuck Technology in this report makes similar observations.  During the last few months, and as part of the sales process, companies in this segment are asking for detailed analyses of each SaaS solution’s Total Cost of Ownership (TCO).  See Joel York’s blog for another perspective at such analysis.  I don’t know whether this is due to the current difficult macroeconomic environment, or whether companies are genuinely starting to worry that SaaS solutions are not providing them with the economics that vendors advertise.  It appears that the need for detailed TCO analysis arises particularly when a company has a full-fledged IT organization (which is the case with the larger of the mid-size enterprises) and when an on-demand solution can be compared with a corresponding on-premise one.

A SaaS solution’s TCO is negatively impacted because:

1. Proper solution deployment requires
   1. The purchase of additional services that were not identified during the initial sales process.  For example, a vendor may charge extra for backup and recovery services.
   2. More work than was claimed by the vendor.  Slower deployment can lead to lost benefits and thus higher costs (for example, slower on-ramping of a sales force automation solution can lead to lost sales because the application’s intended users may not be able to properly monitor their sales pipeline).
   3. Software customizations that must be performed for a fee by either the vendor or a systems integrator to adapt the solution to a customer’s environment and business process.
2. Broad use of the particular on-demand solution is more expensive than the use of a corresponding on-premise solution.

Hidden costs to a proper solution deployment, or slower than expected deployment, are vendor issues.  The customer must obviously keep the vendor in line.  We had thought that the need for customizations will disappear along with on-premise software.  However, we are now finding out that the larger the company that wants to adopt an on-demand solution, the higher the probability that it has customized its business processes.   Companies with customized business processes find it hard to accept the one-solution-fits-all approach of on-demand software.  They want the software to be customized but they also want to economics of the typical on-demand solution.  Vendors who agree to perform such customizations find that they need to run the modified software on a standalone basis, essentially becoming hosted software providers rather than true SaaS vendors.  This type of customers can’t take advantage of the two biggest cost savers of on-demand software: all customers run on the same version of the application, and all customers run on the same computing environment that is based on a multi-tenant architecture.

It is possible that broad usage of a SaaS solution within an enterprise (hundreds or even thousands of seats in the case of mid-size companies) can entail licensing fees (and overall application support costs) that are higher than those of the corresponding on-premise solution, whose acquisition costs in such instances are typically better controlled through a perpetual enterprise license agreement.

The cost differentiation can be particularly pronounced when an on-demand application is considered as a replacement of an on-premise application, or in order to run side-by-side with an on-premise application (e.g., as is the case with several of Host Analytics’s customers that in addition to its on-demand corporate performance management application they use Oracle/Hyperion’s on-premise application).  In such situations, unless the SaaS vendor is able to show that the use of the on-demand application will lead to IT headcount reduction and significant reduction in future IT capital expenditures, the on-premise application will be less expensive.

If a larger mid-size enterprise is simultaneously considering on-demand and on-premise alternatives to automate a specific business process, then again, even with similar licensing costs, it is possible for the SaaS alternative to be more expensive provided that the customer’s IT organization can support the on-premise solution without adding personnel and deploy the solution without adding IT infrastructure (servers, storage, etc.).

The above analysis implies that the easiest sale and TCO justification to larger mid-market enterprises arise when the on-demand solution automates a process and there is no on-premise application alternative.

As was mentioned, detailed cost comparisons between on-premise and on-demand solutions are more frequently requested by companies that have full-fledged IT organizations.  In fact they are often initiated by the IT organizations that use such analyses in order to inject themselves in the sales process.

The broader adoption of on-demand software, particularly during tougher economic times, will undoubtedly put pressure on vendors to provide details of their solutions’ TCO.  Mid-size enterprises are emerging as the more aggressive adopters of on-demand software and as such are actively pursued by SaaS vendors.  However, my sense is that the smaller of the mid-size companies that have more standardized business processes and don’t require application customizations, smaller IT organizations that can’t easily and quickly deploy a new business solution are today the best sales prospects for SaaS application vendors.  They may still ask for a TCO analysis but they are more likely to be reasonable and not prolong unreasonably the sales process.  My analysis attempts to show that in the larger of the mid-size enterprises the sale of on-demand solutions, particularly when on-premise equivalents exist, can be difficult.  Vendors should proactively develop TCO calculators that allow them to demonstrate their solution’s costs and gain the customer’s confidence and trust that they are getting great value by using the SaaS solution.

Discussion of Business Intelligence Investing, as in this presentation:

http://www.tridentcap.com/Newsletters/Trident%20Capital%20BI%20Investing.pdf

Discussion Digital Media Investing, as in this presentation:

http://www.tridentcap.com/Newsletters/Trident%20Capital%20Digital%20Media%20Investing.pdf

Discussion of SaaS (Software as a Service) Investing, as in this presentation:

http://www.tridentcap.com/Newsletters/Trident%20Capital%20SaaS%20investing.pdf

Discussion of Video Gaming Investment Opportunities:

http://www.tridentcap.com/Newsletters/Video%20Gaming%20Investment%20Opportunities.pdf

Discussion of Digital Requires New Thinking:

http://www.tridentcap.com/Newsletters/Digital%20Requires%20New%20Thinking.pdf

CleanTech is an important new investment sector for Trident Capital. The field of CleanTech is currently undergoing an innovation transformation and represents a compelling growth market for venture capital investment.

Read about it here:

http://www.tridentcap.com/Newsletters/Trident_Capital_Newsletter_volume5_issue_4.pdf