Hosted Software Enters the Down Side of the Hype Cycle

“SMB SaaS sales robust, but holdouts remain” reads the headline on a piece from SearchSMB.com Website. (For the acronym impaired, SMB is “small and medium sized business” and SaaS is “software as a service”, a.k.a. hosted systems.) The article quotes two recent surveys, one by Saugatuck Technology and the other by Gartner. According to the article, Saugatuck found “SMB adoption rose from 9% in 2006 to 27% in 2007” among businesses under $1 billion in revenue, while Gartner reported “Only 7% of SMBs strongly believed that SaaS was suitable for their organizations, and only 17% said they would consider SaaS when its adoption became more widespread.”

These seem to be conflicting findings, although it’s impossible to know for certain without looking at the actual surveys and their audiences. But the very appearance of the piece suggests some of the bloom is off the SaaS rose. This is a normal stage in the hype cycle and frankly I’ve been anticipating it for some time. The more interesting question is why SMBs would be reluctant to adopt SaaS.

The article quotes Gartner Vice President and Research Director James Browning as blaming the fact that “SMBs are control freaks” and therefore less willing to trust their data to an outsider than larger, presumably more sophisticated entities. Maybe—although I’ve seen plenty of control freaks at big companies too. The article also mentions difficulties with customization and integration. Again, I suspect that’s a contributing factor but probably not the main one.

A more convincing insight came from an actual SMB manager, who pointed to quality of service issues and higher costs than in-house systems. I personally suspect the cost issue is the real one: whether or not they’re control freaks, SMBs are definitely penny-pinchers. That’s what happens when it’s your own money. (I say this as someone who’s run my own Very Small Business for many years.) On a more detailed financial level, SMBs have less formal capital appropriation processes than big companies, so their managers have less incentive to avoid the capital expense by purchasing SaaS products through their operating budgets.

One point the article doesn’t mention is that SaaS prices have gone up considerably, at least among the major vendors. This shifts the economics in favor of in-house systems, particularly since many SMBs can use low cost products that larger companies would not accept. This pricing shift makes sense from the vendors’ standpoint: as SaaS is accepted at larger companies with deeper pockets, it makes sense to raise prices to match. Small businesses may need to look beyond the market leaders to find pricing they can afford.

Everest Software Balances Hosted and On-Demand

The public debate between on-premise and on-demand (hosted) software has largely been won by the on-demand side, particularly where small businesses are concerned. Faster, cheaper and easier deployment seems an overwhelming advantage, even though on-demand long-term costs may be higher, integration more difficult, and functionality not quite as rich as for on-premise systems.

And yet—plenty of on-premise software is still sold. In fact, although I haven’t seen actual figures, I suspect on-premise continues to hold a larger share of the market. Small businesses are reluctant to make a change, so they’re likely to stick with their existing systems and incremental upgrades as long as possible. In addition, many small business owners (and here I speak from personal experience) prefer to have as much control as possible over their business operations, and find the notion of such heavy reliance on a remote system to be distasteful.

Everest Software produced a good white paper summarizing the issues, “On-Demand vs. On-Premise Software Deployment”, available here (registration required). Everest provides enterprise management software (everything from CRM to ecommerce to inventory and accounting) for small businesses. It offers both on-premise and on-demand options, so its paper is free to present a balanced view of the choices.

I have just two factual quibbles with the paper. One is it assumes on-premise systems have richer user interfaces: although this was true in early implementations, today technologies such as AJAX allow even purely browser-based hosted system to provide pretty much the same interface as systems that install local software. The other is the statement, repeated twice, that “after a period of three to five years, many businesses achieve a lower total cost of ownership with On-Premise software deployments (exclusive of personnel costs).” This might be literally correct, but personnel costs can’t really be excluded. Once you count them in, on-demand systems are very likely cheaper in the long run as well as the short run for many small businesses.

In any event, long-run total cost of ownership is unlikely to be a key issue for most small businesses. Capital tends to be scarce at such firms, so the smaller up-front investment of on-demand is a more compelling consideration. Again, I suspect the real obstacles to on-demand are the emotional one of control and the practical one of integration. Of those, integration is really the key. This won’t be solved by publishing APIs, as some hosted vendors seem to hope, because most small businesses lack the technical resources needed to take advantage of APIs. We’ll see whether simpler integration capabilities become available, similar to “mash up” features now available on some consumer Web sites. If I were a hosted software developer, that’s where I’d put my energy.