The Software as a Service Dilemma

Updated: April 09, 2010

After a decade of deriding SaaS technology as too simple, functionally incomplete and insecure, vendors such as Microsoft, Oracle, SAP and thousands of incumbent "on-premise" software vendors are now embracing SaaS. It's an awkward embrace - one that threatens to cannibalize existing revenue steams, divert resources and eat up profits.

Of course, the innovator's dilemma doesn't destroy every incumbent. These incumbent market leaders are powerful, resilient innovators themselves. But for armchair quarterbacks like us, this the next five years will present a fascinating game to watch.

What is a Disruptive Innovation?
Disruptive innovation refers to new solutions - often technologies - that through a new delivery model, alternate pricing model or target market segment are able to disrupt existing competitive dynamics dramatically. For example, SaaS offers a new delivery model (i.e. hosted "in the cloud"), a new pricing model (i.e. subscription) and initially targeted smaller customers.

Initially, these disruptors target the least profitable customer segments - typically smaller or unsophisticated buyers. These are the only customers whose requirements are limited enough to accept the bare bones feature-set of the new system. Meanwhile, they appreciate the new model (i.e. it's cheap and easy to get started). We certainly saw this in SaaS as small businesses or autonomous departments adopted customer relationship management (CRM) systems like Salesforce.com as early as 1999. For them, SaaS CRM was "good enough."

Over time, however, disruptive innovators improve their performance and feature-set and can meet the needs of more sophisticated customers. Combine that with a little buzz around their new model (e.g. everybody's talking about cloud computing these days), and the incumbent vendors start to take note. Of course, the incumbent still has plenty of ammunition to dismiss the new technology, since it remains functionally deficient relative to incumbent products and the most demanding customer segments (e.g. SaaS penetration into the ERP market remains limited).

I'll posit that SaaS is now entering the penultimate - and most contentious - stage of disruption. At this point, the innovators start to gain serious momentum. Their products approach functional parity and they begin to steal substantial market share. The incumbents finally get serious about defending their traditional markets by releasing their own version of the innovation (in the case of SaaS, that means true web-based, on-demand, cloud computing, not just hosted client/server software). Unfortunately, it is often too late. Incumbents remain apprehensive about cannibalizing existing revenue and they face challenges replicating the innovation. Typically, most incumbents stagnate, decline and fade into obscurity. Only a few nimbly transition to the new model.

The innovator now becomes the incumbent and new innovators emerge. The cycle repeats.

SaaS Disruption Battles are Well Underway
Christensen mentions Salesforce.com in his second book, The Innovator's Solution:

This company, with its inexpensive, simple, Internet-based system, is disrupting the leading providers of customer relationship management software, such as Siebel Systems.

I worked at another leading CRM vendor back when Salesforce.com was just a start-up. I remember meetings where executives derided the system as a toy. Most Salesforce.com implementations were just a half dozen users and most customers paid their subscription fees with a credit card (Gasp!). Since then, Salesforce.com has exceeded $1 billion in revenue and incumbent market-leader Siebel Systems sold out to Oracle after hitting tough times.

While Salesforce.com in the CRM market is the best example, the SaaS dilemma is playing out in numerous software markets. Gmail and Google Apps are nascent yet serious threats to Microsoft's Outlook/Exchange and Office cash cows. We use both of the Google services extensively. NetSuite is a contender in enterprise resource planning (ERP), but hasn't dented SAP or Oracle too badly as of yet.

Most interesting, however, is how this same battle is being waged by innovators in so many lesser followed market segments: SaaS construction project management, SaaS electronic medical records, SaaS property management, SaaS retail point of sale. The list goes on…

Most SaaS Shortcomings are Addressed
As I mentioned earlier, I believe we are entering the final stages of SaaS disruption. The SaaS model and its proponents have not defeated the incumbents, but SaaS solutions have reached functional parity to the point where incumbent derisions are starting to fall on deaf ears.

Let's examine each of the top five objections to SaaS:

  1. Web browsers are not interactive enough. This was true when web applications required a full page refresh to complete a transaction, but the maturation of JavaScript, AJAX, Adobe Flex and other web user interface technologies addressed this. HTML 5 will put this one to rest for good. I find my SaaS apps faster and more dependable than any on-premise app.
  2. Hosted data is not secure enough. This one always perplexed me, since so many of us were comfortable with web banking as early as ten years ago. Few systems could be more valuable than financial transactions. Moreover, very few software buyers can afford to implement the same security infrastructure as a professional SaaS data center.
  3. It's not possible to integrate SaaS. This was true when few SaaS vendors had built APIs and there was no middleware for SaaS. Nowadays, API integration to SaaS applications is non-trivial, but not any more difficult than on-premise integration. I should know; we just finished a successful integration to Marketo, a SaaS marketing vendor.
  4. You can't customize SaaS systems. Again, this is changing. Many SaaS applications remain fairly "packaged," but many vendors have successfully positioned this as a benefit (i.e. "adopt our best practices"). At the same time, SaaS customization tools are maturing. Salesforce.com has built an entire development environment, force.com.
  5. Big companies want to own the software, not rent. This may be still be true in some cases, but in this economy the recurring nature of subscription payments is attractive. It also puts more of an onus on the vendor to earn their future subscription payments. I'm not convinced that this presents a concrete competitive advantage for incumbents.
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