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Figuring the value of software

November 4, 2009 Leave a comment Go to comments

Phil Wainewright’s discussion about the cost of running highly scalable SaaS applications like SuccessFactors comes at the right time. He says:

Speaking in the opening keynote of SIIA OnDemand in San Jose this morning, SuccessFactors CEO Lars Dalgaard let slip a statistic that set several attendees a-twittering. He revealed that the SaaS provider’s multi-tenant application infrastructure supports its 2,850+ customers and 5.4+ million users on just 150 servers.

There’s a bit of information missing here. Are we talking servers as in blades or servers as in racks? Either way it allowed Phil to segue nicely into a SaaS economics 101 argument coupled with the usual swipe at on-premise deployment costs. It’s a fair point and one that isn’t lost on the traditional enterprise players. But it also opens the way to a refinement of that discussion. One that relates to value.

While at SAP TechEd, I met with Thomas Otter, long time SAP solutions architect and now Gartner analyst. We were discussing the SuccessFactors deal at Siemens that should see SuccessFactors deployed to some 420,000 users. By any analysis that’s a HUGE deployment and arguably only possible via SaaS architectures. I am more interested in the sell side economics and asked Thomas what sort of value HR related applications have in the wider market.

He correctly pointed out that HR isn’t viewed as business critical in the same way as ERP but then I countered by suggesting that talent management might be regarded as business critical at a time when it is not only important to staff at the correct levels but ensure you have the right staff. Thomas agreed but also noted that recruitment software selling is tough in current market conditions and, by implication, might have a relatively low cost per user.

As we danced around this topic I wondered what this means for software vendors. Now that Phil has provided us with some facts on SuccessFactors user numbers, we can parse those back to the company’s results. Full year guidance from the company suggests revenue of around $150 million for the year. Taking all customers noted by the company’s CEO in Phil’s quote, that means average annualized deal value of around $52,600. At the user level that equates to a mere $28 per user per annum.

Compare that with the anecdotally quoted average per user cost of an SAP or Oracle customer running ERP: $4,000. And that’s just the license. You can argue as Jim Hagemann Snabe, an executive board member at SAP does that SAP demonstrates its scalability and resilience by being the operational back office for companies like Apple and its AppStore/iTunes. I liked the stat which says SAP runs 75% of mainstream beer production and 65% of the world’s chocolate production. And it is true that for some industries, the fact SAP has to be running with minimal downtime is business critical. But given the stark difference in cost between an admittedly narrow set of functionality such as talent management and ERP, are we honestly supposed to believe that there is a difference equating to a factor of x143? And all that before considering infrastructure, data center etc costs?

The bulk of what sells as ERP is based on accounting. Jim Snabe even referred to Pacioli’s 15 century book-keeping model during his keynote. By now these software should be commodity applications at the functional level. They should be costing the customer no more than a few hundred bucks per user. Especially given that companies like SAP are trying hard to get customers to adopt standard implementations with less or no customizations to the core functionality. But no. All the on-premise vendors continue to assume that a premium applies. That is true all the way through from SAP/Oracle down to those players who sell into the SME market. But wait a minute. We already have SaaS pricing with Business ByDesign ($149/user/month pretty much all you can eat, maintenance and infrastructure included)…but look what that does for Suite pricing?

Financial analysts fear the transition to SaaS will push SAP in particular (but why not Oracle, Infor, Microsoft?) down a path of self immolation. Not any time soon. The trailing service and support revenues from customers is baked into the deals. But here we question value delivered. Mature shops can think in terms of $5,000 amortized cost per support call. Ouch!

So just where is the value of software going to end up being priced? Or does it matter? One view of the SaaS world is it doesn’t matter because the number of deals to be done is so huge, the market so large that there is plenty enough to be mined at bucket shop prices. Monster deals such as Siemens/SuccessFactors should not surprise. Reaching a critical mass of market awareness IS a problem for all but the top handful of vendors. Hence the need for SaaS vendors to spend 60-70% of revenue on marketing activities to achiev e high run rates at break even.

Pricing as my good friend Vinnie likes to point out is a dark art. But with the attention now focused on value and pointers being offered by SuccessFactors, Salesforce.com, Workday, Intacct and others, you have to wonder how long premium on-premise pricing can hold up. If you take that line then the vendors won’t need to self immolate, the market alternatives will simply bowl them over.

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