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Cloud offerings known as Software-as-a-Service (SaaS)1 present several advantages over on-premises delivery of software, such as bundled charges, reduced time to implement, flexibility, and scalability on demand. However SaaS is generally licensed differently, and as a service model poses some challenges of its own in terms of data security and portability between providers. You should consider such differences before selecting delivery platforms for application workloads.

First, understand the difference

Traditional delivery mechanisms for application workloads include on-premises hosting2, co-location services (customer's own infrastructure which is co-located in a third party data centre), and managed hosting services3 . SaaS extends the range of delivery mechanisms yet further, by including the application software managed by a service provider. SaaS gives customers the option of using cloud providers' applications running on cloud infrastructure (e.g. networks, servers, operating systems and storage), all of which are managed by the service provider. 

Usage rights for application software installed on-premises are generally purchased via a once-off perpetual licence fee, and restricted to a particular version of the software only. Customers are typically required to pay an annual maintenance charge if they wish to secure ongoing version rights and obtain vendor support for software bugs. The annually recurring maintenance charge is usually levied as a percentage of the initial licence cost (approximately 22% – 25%) and is often a cause of friction when vendors seek to increase it, for little or no additional benefit to the customer.

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The significance of this licensing model is that the purchased licence is an asset, and its value may be written off over the prescribed accounting period. Theoretically, customers may use perpetually licensed software for as long as they wish (subject to compliance with licence terms), enabling them to “sweat the asset” beyond its book value. However a practical end date for software life, and the requirement to refresh, is often imposed by the need to maintain supportable and interoperable IT infrastructure.

By contrast, the right to use the SaaS provider's application software is generally purchased via an annually recurring subscription fee, which bundles several charges together. The single annual fee (usually a per-user charge) covers software use rights, platform use rights, and support.

Given that SaaS subscription fees automatically include version rights while the subscription remains active, it may be attractive to purchase applications which are developing rapidly in functionality, and which are frequently updated with material enhancements, under this model. However once a customer ceases paying the annual subscription charge, the rights to use the bundled stack cease.

Somewhat confusingly, subscription licensing is also available for some on-premises deployments of software (such as Microsoft's Subscription Enrolment for on-premises desktop deployments under its Enterprise Agreement volume licensing arrangement). The point to remember is that subscription fees for on-premises software cover application software only; whereas the subscription fees for SaaS cover use of the application software and the underlying delivery infrastructure.

Some of the attractions of subscription licensing are that it incurs lower upfront costs, is purchased from operating expense budgets (vs often constrained capital budgets) and is renewable annually, allowing customers to match usage to demand. On the other hand, perpetual licensing retains its appeal for some customers because it provides greater predictability of costs over the longer term, and gives the customer ownership of the software asset. Some customers in capital intensive industries (such as mining) are not necessarily driven by a desire to reduce planned capital spend too drastically, as they risk losing deferred tax benefits based on depreciation schedules.

Consider all costs

The cost savings enabled by SaaS are often quoted as a reason for preferring SaaS over on-premises deployment of software, so it is worth spending some time on this topic.

The business case for any investment will usually assess the benefits or returns from that investment against its cost. The business benefits of cloud services are readily identifiable: essential characteristics such as broad network access, rapid elasticity, resource pooling, measured service and on-demand self-service4 theoretically give rise to the business benefits of reduced time to implement, increased flexibility, and scalability on demand.

In addition, it is true that SaaS pricing can provide tangible cost savings in the areas of labour, licence and maintenance charges, and IT infrastructure charges. (Customers save the cost of having to stand up and support their own servers, operating systems and storage to host the application software).

Watch for hidden costs

Some of the perceived licence savings you may get by moving to SaaS may result in additional licensing costs if your SaaS application accesses data contained in an ERP system, or ERP functionality. ERP vendors (eg SAP) have strict licensing rules about any use of their software functionality independently of the technical interface used to access it.

Under SAP's “indirect access” rule, any user access of functionality or data must be licensed. For example, if your SalesForce software accesses SAP systems or data on a real time basis, SalesForce users must be appropriately licensed for SAP also. Similarly, if you deploy a third party application such as SalesForce on the SAP NetWeaver integration platform, you may need to licence that application also to use SAP functionality.

I mention these additional licence costs simply to ensure completeness when building the business case; costs apply equally to on-premises and SaaS deployments.  A further aspect often overlooked when considering investment in SaaS is the category of once-off deployment costs.  Although annually recurring subscription charges are readily quantifiable, mitigating an application workload to a cloud delivery platform may incur costs in one or more of the following areas:

  1. Network - cloud based applications are increasingly accessed by customers via a thin client interface, such as a web browser, over the public internet. For first time SaaS deployments, this may necessitate a review of network architecture and bandwidth to ensure security and an optimal end user experience. It is worth noting that access to reliable and available network connectivity can be an issue in remote geographies, meaning SaaS is not always a suitable deployment model.
  2. Implementation services – consulting costs may be incurred for SaaS software configuration, implementation and integration with on-premises systems.
  3. Training – IT staff and end users may require training in the management and use of the SaaS offering.
  4. Organisational change – some customer processes may require re-engineering to accommodate SaaS-specific requirements in areas such as user access provisioning.
  5. Cloud management platforms – if customers leverage public and private cloud deployments in a hybrid model, they may require new tools or third party integration assistance to ensure that the new services are properly federated with enterprise service catalogues, and consistently orchestrated and managed.

Importantly, the business case should also consider and mitigate the risk of lock-in, in the event that a SaaS provider running a mission-critical application workload implements substantial price increases once the initial fixed term contract expires. To ensure portability in such a case, you should allow for the costs that might be incurred by migrating between service providers. This would include extracting data from the first cloud provider and validating their completeness and accuracy; staging in on-premises infrastructure (if required) and then migrating to the new provider.

Read the fine print

SaaS providers generally adopt a highly standardised approach to contracting with customers, driven by their lower margin business models. Where a contract is fixed and offers little room for negotiation, reviewing its terms and assessing whether they are commercially acceptable should be an important part of your evaluation process. If a standard contract does not meet the following minimum requirements, you should consider whether the relevant SaaS offering presents an acceptable commercial risk:

  1. Changes in service terms – ensure the SaaS provider cannot change its licence model without at least six months' prior notice. This notice period is to ensure you have time for an orderly exit if required.
  2. Service architecture and technology - ensure the SaaS provider cannot change its service architecture (eg where data is hosted) and technology without at least six months' prior notice. You may need to exit if a new hosting jurisdiction renders you non-compliant with local privacy laws; or if proposed technology changes are incompatible with your on-premises architecture and security posture.
  3. Cancellation rights – the SaaS provider must not be able to terminate for convenience without at least six months' prior notice. This is to enable an orderly exit process.
  4. Return of data - ensure the termination provisions provide for all data to be returned in a predefined format within 30 days of termination at no additional cost, and for the SaaS provider to maintain, back up and secure the data until it is returned.
  5. Use by affiliates – perpetual licences generally allow for use of the licensed software by affiliated group companies, subject to definition of “affiliate” in the licence agreement itself. Consider whether your SaaS terms allow similar group access, and if it is required by members of your corporate group.

…then make your decision.

As illustrated above, SaaS is not necessarily the right answer for every application workload.

In determining if it is the right solution for you, the first step should be to scan the market for service providers. Is there a viable SaaS provider for the relevant functionality that you trust, and who has the requisite financial and commercial credentials for an ongoing corporate relationship?

If there are no SaaS providers who immediately pass this initial filter, then consider more traditional software deployment models as alternatives – e.g. via a managed hosting service. 

If viable potential SaaS partners exist in the market, your next step should be to assess the relative merits of on-premises vs SaaS deployment models in a structured manner. As discussed above, cost and budget impact are key financial attributes often discussed when deciding between the two; but operational factors which may be relevant to your application workload, such as ability to customise, data sovereignty, degree of control, portability and security should also be included in the assessment.

Finally, don't forget to review and evaluate the contract terms and attendant commercial risk.

Table 1 shows how on-premises vs SaaS offerings generally compare against each of these attributes. How you rate them will depend upon the nature of the SaaS offering you are considering, and the specific requirements of your application workload.

Attribute

On premises

SaaS offering

Use rights

Perpetual

As long as subscription payment is maintained

Version rights

No (unless customer also purchases maintenance)

Included

Budget impact

Capex

Opex

Ownership

Customer

SaaS provider

Platform

Provided by customer

Included in SaaS

Cost

Upfront costs high

Pay as you go

Ability to customise

Depends on vendor

Configuration only

Data sovereignty

Customer controls location of data

SaaS provider controls location of customer data

Control of environment

With customer

With SaaS provider

Portability

Migration to cloud may require application and data remediation

SaaS to SaaS portability unlikely (may require on-premises staging)

Security

Access via corporate network

Access via internet

Contract terms

Software licence terms can generally be modified via addenda; customer specific discounts may apply

Generally fixed, no customer specific discounts

Conclusion 

Although SaaS deployments are gaining popularity, using the traditional on-premises software deployment model may be better for specialised applications if they contain sensitive data, or require large data transfers, or the customer wants to control and customise. In this scenario, a perpetual licensing model will appeal to customers who view the software as a long-life asset which will outlive its depreciation schedule.

END NOTES

1.   The US National Institute of Standards & Technology (NIST) defines three cloud service models: Software-as-a-Service, Platform-as-a-Service and Infrastructure-as-a-Service. Descriptions of each can be found at:  http://csrc.nist.gov/publications/nistpubs/800-145/SP800-145.pdf

2.   On-premises hosting refers to an operating model in which the customer locates servers, operating systems and storage on its own premises, manages infrastructure performance itself, and stores data within its own local network

3.   Managed hosting refers to an operating model in which a service provider leases servers and associated hardware to a single customer, and manages the infrastructure on the customer's behalf. The equipment is located at the service provider's environment

4.   As defined by NIST

ABOUT THE AUTHOR

Bronwyn Ross trained as an IP / IT lawyer before gaining commercial experience in technology product portfolio management, and more recently working on buy-side issues in the IT procurement lifecycle. She assists clients with sourcing strategy, contract drafting and negotiation, implementing governance frameworks and designing organisational structure. She has experience negotiating SAP and Microsoft licence agreements for clients.

ABOUT HAMILTON SHAW CONSULTING

Hamilton Shaw Consulting is a Melbourne based consultancy founded by Managing Director Lisa Shaw in 2004. Focused on the ICT procurement lifecycle and technology related business change, the company has a reputation for delivering pragmatic analysis and solutions to meet its clients' business challenges.  Hamilton Shaw Consulting employs only senior consultants with more than 15 years' experience, able to turn knowledge into action and value for clients.

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About Globality

Globality’s stated mission is to “give all companies an opportunity to compete and win based on the merits of proven performance, expertise, and passion.”

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