Software or Services?

16 August 2006

Much of the software that you need to run your own business can now be 'rented' as an Internet-based service rather than being installed on your own systems. But is it the best option for a start-up?

How much software will you have to buy to run and manage your business? Accounting and payroll are a given, although you might be content to outsource them for the time being. But what about managing your sales leads, customer contacts and marketing programmes? How are you going to handle all your employees as your business expands and you start to administer expenses, holidays, sickness, performance reviews and other HR and financial issues? And if you're manufacturing and distributing products, how do you plan to automate those processes and all the reporting that comes with them?

Much of the focus in the business application software space over the last few years has been on building products for smaller and mid-sized businesses (SMBs) to tackle these kinds of needs. Vendors like Sage and Intuit have long targeted organisations from the start-up stage onwards, while industry giants SAP and Oracle - historically better known for serving larger enterprises - have been moving down into the SMB space. Microsoft has also been rapidly expanding its presence in the sector. While they offer traditional packaged applications that you can install and run on your own systems, many vendors also offer an alternative in the form of hosted services, an approach that's starting to look increasingly attractive for start-ups.

Based on the principle of software 'rental', hosted services are designed to take away the hassle of installing, running and maintaining software applications. Instead of buying a package, the hosted service provider runs it all for you remotely: you simply access your application over the Internet, typically paying on a per-user, monthly basis. In some respects, this is a real-time evolution of the managed services model long offered by outsourced payroll service providers. It's also a model that you're probably already using without thinking about it - Internet search and hosted web conferencing services are both examples of hosted services, albeit with different pricing structures.

The hosted services model has something of a chequered past. During the Internet boom, waves of services companies - then known as Application Service Providers - rushed onto the market, most of them disappearing as quickly as they arrived when the bubble burst. The problems weren't just down to dot com economics and its unsustainable focus on revenue rather than profit: many providers also ran into technical problems as they tried to force conventional packaged software into an Internet-based model and cope with limited broadband capability. Today's market, however, is far more mature. Organisations like Salesforce.com, one of the best known hosted services providers, have proven the model, and many leading providers offer services to the smallest and largest companies.

For start-ups, this approach offers a number of benefits. Firstly, much of the aggravation associated with running software is taken away, from the initial implementation effort to ongoing maintenance and upgrades. In addition, it gives you a lot of flexibility. 'The great thing about hosted services for start-ups is that it's really easy to add new users,' says Phil Wainewright, CEO of consultancy Procullux Ventures and a seasoned authority on hosted applications (see http://blogs.zdnet.com/SAAS/). 'You don't face technical hurdles as your business scales up: you just add some more user accounts.' He points out that hosted services work well wherever the user is - a lot of start-up employees work from home, for example, and it's helpful that you don't have to invest in extra infrastructure to support them outside the corporate firewall.

In addition, says Wainewright, you only pay for hosted services once they're up and running - by contrast, you pay for on-premises software as soon as you take delivery of it, regardless of whether you actually get it to work. 'That has knock-on effects for how vendors design their applications,' he says. 'They make them as easy to get started with as possible and they usually provide lots of support to help you use the application to maximum effect. It's in their interests to maximise your usage because then you'll sign up more users.'

The payment model itself is also attractive to many start-ups. Because you're typically paying per user, per month, it's easy to predict the cost of expanding or cutting back your business. Compared to purchasing software - which requires you to shell out on a licence fee upfront - the monthly payment scheme also lets you spread the load. (That said, if cashflow is your main concern, several large vendors also offer financing schemes to support in-house package purchases.) Wainewright argues that vendors are likely to experiment with other forms of pricing over time, such as consumption-based charges based on the value of a transaction or the amount of storage or processing space you're using.

Needless to say, every IT model has its downsides, and there are a number of factors to consider before taking the hosted route. Firstly, some people are uncomfortable handing control of their sensitive data to a third party, particularly when it comes to customer and financial information, and you'll need to get assurances about the supplier's viability and security controls. Bear in mind that you can always back up your data on your own site.

Some new users also get concerned about what happens when an online system goes down, something that affected Salesforce.com last year amid a blaze of negative publicity. To put this in context, however, every IT network suffers outages, and the availability figures for the top hosted providers are high. 'Salesforce.com is achieving better than 99.7% availability, which is far more than any typical enterprise data centre achieves,' says Wainewright. 'It's a psychological issue rather than a practical one.'

There's also debate about the long-term economics of the model. Some suppliers that offer both packaged software and hosted services - and could therefore be considered neutral - argue that logically, the monthly payments for a hosted service must eventually exceed what you'd pay to buy a package outright. Service providers respond by arguing that when you throw in the cost of installing, maintaining and upgrading the software and the extra infrastructure you need to run it, renting remains cheaper.

For his part, Wainewright is a fan of a model that replaces what he sees as a somewhat illogical historical preference to purchase. 'The key question is, are you confident this is something you can do better, cheaper in-house, and still keep pace with new features and changing business requirements? I've never quite understood the fuss about 'owning' packaged software when all you're doing is paying someone else for a licence to use the same automated processes as all their other customers. How much independence and competitive advantage does that give you, exactly?'

By Keith Rodgers, Webster Buchanan Research