As SAP prepares to unveil its new software-as-a-service offering – codenamed A1S – at its big Sapphire conference in Atlanta this week, it’s highlighting the big cost savings that on-demand software offers in contrast to traditional installed programs. SAP CEO Henning Kagermann, who once scoffed at the SaaS model, now seems well on his way to becoming a true believer. Although the A1S system, which is aimed at small and medium-sized businesses (the big growth market for enterprise software), comes in both installed and SaaS versions, Kagermann tells Business Week that the SaaS version can offer huge cost savings over the traditional version:
SAP plans to offer A1S in two flavors: as a software package midsize companies can install on their servers and customize to their needs, and as an online software suite that SAP will run on its own computers and deliver over the Internet for small companies with fewer options. The online software could cost half as much as the packaged version of A1S, says Kagermann. “That’s the only way to lower the cost of ownership by factors,” he says.
The shift toward providing software over the Net poses some big challenges for the German giant. First, it’s going to have to get into the data center business – and that will mean substantial new capital investments. As Business Week reports: “The investment will shave its expected 2007 operating margin by 1% to 2%, to around 27% of sales. That’s slightly lower than in 2006. ‘You have a lot of costs up front,’ says Kagermann. ‘It’s a different model.'”
Second, as the cost savings of the SaaS option become apparent, big customers will likely put pressure on SAP to reduce their prices as well:
Making matters trickier, SAP’s twin goals of reaching down to smaller customers and updating its traditional customers are somewhat at odds. “The midmarket is the last mining opportunity for enterprise software companies,” says [a Morgan Stanley analyst]. “The problem is once you go downstream, it can lead to pricing pressure at the top end,” as large companies demand discounts to close the gap between what they and smaller users pay.
Kagermann is still careful to avoid using the term “software as a service.” Like his counterparts at Microsoft, he prefers to say that the future of software will involve a “hybrid” model of both installed software and Internet services. He’s right – for the foreseeable future, anyway – but as long as the SaaS model offers dramatic savings to customers, it will be the model that shapes the economics of the business and the costs and profits of software firms. Sooner or later, Kagermann will have to call a spade a spade.
UPDATE: The way SAP is distinguishing between the SaaS and traditional versions of its software, as Kagermann’s comments above make clear, is through “options,” or “features.” The SaaS version is a lot cheaper, but the traditional, expensive version has more features. (This is the standard “versioning” practice in the software world, as Carl Shapiro and Hal Varian described in their excellent book Information Rules. The lack of features in cheaper versions is due less to technological constraints than to the vendor’s deliberate decision to hamstring the cheaper version.) Today, Dan Farber reports on an observation SAP executive vice president Uwe Hommer made this morning: “He said that customers typically use 30 percent of functionality of SAP solutions.” That kind of makes you wonder about the real business value of all those expensive “features.”