Opinion: Software as a Service: Time for the IT Industry to Take Notice

Computerworld - Software delivered as a service — that is, enterprise applications that are hosted by a third party and accessed only for a subscription fee — is becoming increasingly attractive not only to CIOs (who are eager to capture lower costs and higher service levels) but also to venture capitalists (who increased their investments in software-as-a-service companies by 18% between 2002 and 2005). Our annual survey of CIOs found that those who planned to use some form of software as a service over the next 12 months grew from 38% in autumn of 2005 to 61% a year later. Market indicators also support the notion that momentum is growing. Our index of companies whose main business is software delivered as a service — including Salesforce.com Inc., RightNow Technologies Inc., WebEx Communications Inc., WebSideStory Inc., Concur Technologies Inc., Workstream Inc., Taleo Corp., Digital Insight Corp., Ultimate Software and Digital River Inc. — outperformed the overall software company index (excluding Microsoft Corp.) by more than 13% from January 2002 through December 2006.

There are several reasons why this trend seems bound to gain traction where an earlier generation of hosted software failed to do so a decade ago. First, new software design and delivery models make it more viable and less expensive to share one application across hundreds of companies by allowing many more instances of an application to run in a common environment, vastly improving on the old client/server model. Second, bandwidth costs continue to drop, making it affordable for companies to ensure levels of connectivity that allow online applications to perform gracefully. Third, and perhaps most important, many customers are eager for the shift because they’re frustrated by the traditional cycle of buying a software license, paying for a service contract and then having to buy upgrades. Many customers believe they would have more control over the relationship if they simply paid monthly fees that could be switched to another vendor if the first failed to perform.

Investors seem tuned in to this shift, and many share our belief that although SaaS companies may be slightly less profitable than traditional independent software vendors, this is primarily a result of smaller scale. Whereas large software companies (other than Microsoft) typically have operating margins around 25%, those with annual revenue under $1.2 billion hover around 14% -- close to the 13% margins of SaaS vendors. Several vendors have much higher margins (WebEx at 26%, Digital Insight at 19%) because they’ve been able to achieve scale and a leading position in their niches. We expect the economics of online delivery to improve as the market grows.