Sharp practices take the shine off SaaS

By Nicola Brittain
22 Jun 2010 View Comments
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Liz Herbert
Herbert: Prices tend to go up when contracts come up for renewal

The software-as-a-service (SaaS) rental model has attracted a growing army of users over the past few years. It has allowed recession-hit companies to switch from traditional on-premises systems that tend to incur increasingly costly maintenance charges and other operating overheads to more economical, subscription-based online services.

But is the business case for using SaaS really all it is cracked up to be? It seems that problems are emerging around licensing payments and return on investment on the user side, not to mention profit issues for SaaS vendors themselves.

Further reading

Several recent reports have highlighted these problems, and cast doubt on whether or not the model as it stands is sustainable in the long term. Gartner released a report this month entitled Organisations Need to Re-evaluate the Rationale for SaaS which argued that many of the bad practices that occurred in the on-premises world are now moving their way into SaaS.

David Cearly, vice president and fellow at Gartner, said one of the worst is shelfware-as-a-service – the concept of paying for a software subscription that is not being put to use by an end user. “This happens most notably when a company has downsized a workforce or oversubscribed to trigger a volume discount,” he said.

In a keynote at Forrester’s IT Forum EMEA last week, principal analyst Liz Herbert argued that more than half of 11 big software vendors she questioned felt that SaaS in its current form is not sustainable, with most vendors barely making a profit – SaaS pioneer has only just moved into the black after 10 years of operation. Additionally, many of the pricing models are unworkable or unpopular with end users.

Freemium is one of four main pricing models, and it is the way many end users are introduced to SaaS. It offers a free experimental trial that allows early tech adopters within a company to prove the value of the service and make an investment case to the head of finance. However, users only get a partial piece of the software, or limited functionality, or access rights for only a short period.

Although this is often the way users start using SaaS, they are falling foul of “bait and switch” tactics, according to Herbert. “These see clients surprised with hidden costs when they try to extend their contracts. But the firms may have saved customer or employee information into the system during the trial and so cannot always back out,” she said.

This is a general model that can be based on numbers of users or devices, and it can mean users have to subscribe to various versions and components of a software package. The model gives the perception of less commitment – no dreaded “lock-in” – and freedom to scale up or down, but Herbert argued that the reality is quite different.

“As companies want to scale down their usage or move to a different software addition, they’re not able to do so,” she said.

Herbert also argued that initial discounts seen by end users – often of between 50 and 80 per cent – are soon eroded: “At contract renewal, the discount disappears and the price of the software goes up. Also, end users need to ask questions around the long-term cost of ownership – this is not a finance model.”

A pay-per-use or transactional model can see end users pay for SaaS services according to the number of log-ins used or documents printed, for example. But charges can be hard to predict and end users can be surprised by the size of their bills. “We don’t want SaaS and cloud services to become like telcos and phone bills,” said one delegate at the session.

Unlimited licence agreements
Unlimited licence agreements (ULAs), in which end users agree to take on unlimited service for an agreed time period, can be good for both parties and are currently provided by Oracle and SAP. Vendors get more strategic commitment from buyers and buyers benefit from fixed costs. But problems can arise in the event of the SaaS provider being acquired, after which contracts may no longer be honoured. Also, ULAs will only cover the software available at the time of the licence being signed.

Finally, with ULA and subscription contracts there may be significant costs around management, especially when a firm has many contracts coming up for renewal at different times.

So will SaaS survive? Herbert argues probably yes, but in a modified form.

“Vendors need to start making money and users need pricing models that suit their business better. One way is for users to become more savvy in their purchases by convincing vendors of their size and importance, thereby securing discounts, and vendors will need to lock customers in for longer periods – thereby securing guaranteed income for a significant period of time,” she said.

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