At Business Week, Sarah Lacy has a good article on the daunting challenges that software-as-a-service companies face as they try to build vibrant, profitable businesses. Some traditional software powerhouses, like SAP, are spending a lot to develop web versions of their applications, but they have little to show for the investments so far. Pursuing two radically different business models simultaneously, they’re running a race with their legs tied together.
Oracle, for its part, is deliberately moving slowly in shifting to the cloud model, preferring to milk the old, lucrative license-and-maintenance-fee model for as long as possible. Writes Lacy:
[Oracle] has offered a “hosted” version of its software for about 10 years, and CEO Larry Ellison clearly foresaw the on-demand wave, personally funding Salesforce.com and NetSuite. But spreading any kind of on-demand religion throughout his own company is another matter. Nowhere was this more clear than on Oracle’s most recent earnings call. Why isn’t Oracle a bigger player in on-demand software? It doesn’t want to be, Ellison told the analysts and investors. “We’ve been in this business 10 years, and we’ve only now turned a profit,” he said. “The last thing we want to do is have a very large business that’s not profitable and drags our margins down.” No, Ellison would rather enjoy the bounty of an acquisition spree that handed Oracle a bevy of software companies, hordes of customers, and associated maintenance fees that trickle straight to the bottom line.
More evidence of the challenges came yesterday with the announcement of Microsoft’s disappointing profits for the last quarter, attributable at least in part to the weak results of its online services business. The company has been spending billions building big utility data centers, but the revenues generated by all that capital investment remain paltry.
Anyone who thinks the software-as-a-service business is a gold mine for vendors is wrong. The economics are fundamentally different from those of the traditional software business – and not in a good way. As Lacy writes, the Web is “just as good at displacing revenue as it is in generating sources of it. Just ask the music industry or, ahem, print media. Think Robin Hood, taking riches from the elite and distributing them to everyone else, including the customers who get to keep more of their money and the upstarts that can more easily build competing alternatives.” Web apps remain a hard sell when it comes to big, conservative enterprises, and the capital and marketing costs are daunting, particularly if you’re running your own data centers. This revolution in business software will play out slowly and, for most suppliers, painfully.
So far the smartest players appear to be Ellison and his former protege, Marc Benioff of Salesforce.com. The unsentimental Ellison will wait until the profits from traditional software begin to decay, and then will buy his way into the software-as-a-service business, cherry-picking attractive suppliers. Benioff wisely chose the right target for his initial web app – salesforce automation, or CRM, which had become an advertisement for the flaws of large-scale enterprise software – and has built his business over the course of a decade through steady technical improvements and relentless marketing (aimed at both customers and investors).
“On-demand software,” Lacy writes, “has turned out to be a brutal slog.” Don’t expect it to get easier anytime soon. Success will come to a few smart, tenacious companies, but it will be hard-won.