By Aaron Houghton, CEO, Preation

Why are traditional software powerhouses like Seibel Systems, Avaya Telecommunications Systems, and Intuit struggling to compete with companies a fraction of their size?

How are companies like SalesForce.com, WebEx, and PayCycle rising to the top of their respective markets despite market dominance by companies with decades of experience and business relationships? Traditional software delivery methods are changing and some business models, and businesses, are being left behind.

The web has long been defined as a new communications platform that allows various types of information to move freely around the globe. And for digital products like videos, games, music, and software the Internet also serves as a commerce and distribution platform.

For over a decade now, each of these types of media has been available for purchase and download from any computer with an Internet connection. Sites such as QuickTime.com, EpicGames.com, mp3.com, and download.com have led the way and served up millions of these downloads over the years. With time, businesses like Adobe and Ipswitch began offering business applications for purchase and download directly from the web as well.

For the world of business software, this transition meant that software products could be sold faster and delivered at a lower cost.

From the viewpoint of pre-Internet days where applications were delivered on CD by the postal service, website based application downloads seemed like a no-brainer. But, although the method of software distribution changed, the competitive model stayed mostly the same. This was primarily because the changed affected such a small part of the software’s lifetime in a business.

Understanding cost of an application
To understand the cost of owning an application, which was usually purchased for the job of creating some type of automation, organization, or efficiency within business processes, we must look at each cost a company incurs over the software’s lifetime. For the typical business application, costs are realized in the following areas:

• Initial application licensing price
• Ongoing application updates for improvements and fixes
• Unique computer hardware to run the application
• Certified staff to maintain the hardware and software

For many companies, the ongoing cost of these requirements was hard to determine upfront. In result, business people spent a lot of time managing their software, not their business. Furthermore, software investment decisions were made based on cost assumptions that were subject to change without warning.

Solution to challenges
A solution to these challenges began to form in the late 90s. Along with many other ideas, the concept of software being delivered as a service and not as a product may have first been met with skepticism in part because of the number of companies beginning to experiment with this model that crumbled in the midst of the dot-com bubble burst.

But, a number of them were able to persevere. Companies such as SalesForce.com (1999) and WebEx (1996) prevailed and even grew in the midst of a market collapse.

What was different about these companies? Simply put, they were breaking out of the mold of traditional licensed software. Where the old model involved investments in licensing, hardware, and specialized people the new model provided a one-stop solution for solving the same business challenges without the need for all the additional considerations.

Again, the Internet served as the conduit for the advancement, but this time the Internet’s role didn’t stop when the application reached the business. Now, the Internet continued to live in between the business customer and the application, in the web browser.

In the late 90s and early 2000s, companies that offered software applications for use online through a Web browser were commonly referred to as Application Service Providers, or ASPs. Later, around 2005, the term Software as a Service, or SaaS became more common in identifying the business model.

The SaaS business model in a nutshell involves an application provider installing its software on a technical infrastructure that they manage and that their customers interact with remotely via a Web browser on an Internet-connected computer.

Now, businesses purchasing software could focus their efforts on using the tools instead of maintaining them.

With this change in the delivery and consumption of software came drastic changes in the financial model of software investments. Over traditional installed software, software provided as a service resulted in cost savings and the ability to predict the cost of the investment over time. In most cases, customers paid a recurring monthly fee for use of the software (typically measured by the number of software users) with little or no startup fees required.

Non-obvious factors
Within the SaaS model, the cost savings are driven by a few important but non-obvious efficiency factors inherent to the structure:

Infrastructure Efficiency: The physical infrastructure costs required to support the application scale with volume so that when the application provider totals his infrastructure costs and divides it by its users, the cost-per-customer is significantly lower than if the customer managed this in a smaller volume internally.
• Update Efficiency: Since software upgrades are easily rolled out to all customers the cost of software upgrades to the application provider is spread evenly over all customers (not just customers requesting the upgrade) and is centralized which entirely removes the burden of upgrade installations from the customer.
• Distribution Efficiency: The simple web-based setup process removes the need for the application provider to invest in packaging and traditional distribution methods like web downloads or postal mail for recorded media.
• Entry Level Efficiency: With traditional software, the minimum hardware investment required to run a base installation of the application might support more users than the customer intends to utilize, thus wasting infrastructure.

Additional factors driving adoption
The SaaS model reaches its efficiencies simply by allowing the customer to purchase a license to use the software, and nothing else. The cost for the service more closely matches the customer’s actual level of utilization.

A number of additional factors continue to drive the adoption of SaaS solutions. As the reliability of the Internet increases businesses are more and more able to make the decision that critical services that depend on the Internet’s availability are of appropriately low risk. Additionally, with businesses having more computers connected to a faster Internet, data security requirements have also advanced greatly. Many companies now prefer to outsource the responsibility of meeting the heightened levels of data compliance that apply to digital business information.

Legislation such as the Health Insurance Portability and Accountability Act (HIPAA) and the California Security Breach Notification Law have set the bar so high that the management of information covered under these regulations is an entire business in and of itself. SaaS providers have been quick to provide exceptional assurances for data management and compliance and have made this a core competency of their teams.

Because of new efficiencies in software delivery brought about by the Internet, traditional software, a business model that reigned supreme for over three decades, now faces extinction. Outside of the customer relationship management (CRM), video conferencing, and payroll service competitors I mentioned previously, the most interesting clash is just beginning to unfold. It’s the battle for our primary document production applications, a market that Microsoft has owned for decades with their Microsoft Office Suite.

Over the last three years, Google, a company that many consider Microsoft’s greatest threat, has been slowly and without much fanfare buying companies and releasing web-based applications whose uses overlap many traditional Office products.

So far products very similar to Word, Excel, PowerPoint, and FrontPage have been released, each as a freestanding application and each available for free on Google’s website. It seems like it’s only a matter of time until Google wraps all of these solutions into a single application and launches a direct attack at Microsoft Office.

If this occurs, the move will be paramount not because of the scale of the companies in the match or the size of the market share reward but instead because it will represent the largest showdown of traditional software vs. software as a service business models that we’ve seen to date.

With SaaS, now more than ever, the playing field for business software is being leveled. Both the businesses utilizing the software and the companies that produce it are able to enter the market with fewer barriers.

Efficiency and profits are met with a renewed focus on achieving business goals. With the move to SaaS solutions gaining momentum, the large traditional software companies are being left behind.

It will be interesting to see if they continue fight the direction of the tide or if they jump on board and build web applications of their own.

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