As Economy Falters, On-Demand Apps Must Prove Value

Technology stocks are sustaining substantial losses in the current economy, particularly in the on-demand sector, which is down about 30 percent year-to-date, according to one stock index.

But the state of the economy could be good news for SAAS (software as a service) vendors if a simple premise holds true: that companies really do save money with on-demand software and in a tight economy they will turn to on-demand applications to save cash.

The answer to the long-term cost savings question of SAAS is somewhat difficult to determine and can differ by market segment or type of application deployed, according to industry watchers.

"For companies with 100 users, they definitely see a savings in two areas. Total cost of ownership and the total economic impact on return on investment [are] higher for SAAS," said Forrester analyst Ray Wang. "Where it gets dicey is for companies with 500 employees and 250 users or more. At that point it's a lifestyle decision."

In its most recent earnings call Feb. 27, Salesforce.com CEO Marc Benioff characterized the company's fourth quarter as "the most incredible quarter for winning business in our history."

Salesforce.com's fiscal fourth-quarter 2008 earnings jumped 50 percent from the previous year's quarter to $217 million, and the company expects to reach $1 billion in revenues this fiscal year on sales of its on-demand CRM (customer relationship management) software and related services. On the February call, Benioff specifically pointed to the economy as a driver for the company's fourth-quarter earnings.

But while all fingers tend to point to Salesforce.com, the standard-bearer in a still emerging market, as a gauge of success for the overall market, the numbers may not bear that out.

Rick Sherman, founder of Athena IT Solutions and a frequent blogger on all things IT, publishes an On-Demand Index. The March 20 Index showed that while Salesforce.com's year-to-date overall investor return is -11.45 percent, it's one of the better-performing stocks among the 18 companies Sherman tracks. DemandTec and NetSuite, for example, showed a respective -53.71 and – 49.77 overall return since Jan. 1.

Sherman's On-Demand Index is down about 30 percent year-to-date and the individual stocks are down an average 45 percent from their 52-week highs. In comparison, as of March 17 the Dow was down 9.74 percent and the Nasdaq Composite index was down 17.92 percent.

The decrease in on-demand stock performance can be attributed, in part, to tightening IT budgets in the face of an uncertain economy. In a Feb. 22 research note, AMR Resarch analyst Rob Bois looked at the 2000 economic downturn as an indicator for what might pan out in the 2008 downturn.

"During the economic downturn of the early 2000s, many enterprises slipped into a fairly aggressive cost-cutting mode … this had a profound impact on the customer management and CRM software market," Bois wrote. "Many organizations decided these software projects were a luxury, and plans were subsequently shelved. As a result, we saw the customer management software market go from boom to bust … culminating in Siebel Systems' acquisition by Oracle in 2006."

One insight gained from the first downturn is that buyers chose less risky—in other words, less costly—application investments, according to Bois. "The rise in SAAS showed us that the demand for front-office software didn't disappear when budgets began to tighten," he wrote. "IT may have shelved projects, but business executives demanded a thriftier way to pay for and consume these applications. SAAS, now the fastest-growing software delivery model in front-office applications, shows no signs of letting up, regardless of economic conditions."

But the bottom line in an uncertain economy is that companies need to save money—and justify expenditures.   

In a 2006 research paper, Forrester's Wang wrote that in medium to large businesses with 250 users there is a "direct benefit" to on-premises ownership over SAAS deployments, despite greater integration costs, higher implementation factors, increased projects risks, initial license fees and on-going maintenance.

In large enterprises with 2,500 employees and 500 users, on-premises ownership was found to outweigh SAAS. "Like medium-large businesses, large enterprises seeking to deploy subsidiaries in other multiple geographic environments or requiring rapid deployment often should continue to consider SAAS options and treat these cases based on the number of users versus the size of the enterprise," Wang wrote.

Athena's Sherman said he sees a difference in expectations versus cost of implementation when working with his clients.

"Total cost of ownership, when you're talking licensing costs and getting deployed, [is] cheaper with SAAS," Sherman said. "But with the business intelligence and data warehousing applications I am involved with, the problem with the SAAS model is expectation-setting. Vendors, analysts and journalists tend to over-hype the cost savings of SAAS. The licensing cost is very small compared to the overall data warehouse project. In an enterprise with $500 million in sales, SAAS my be the most effective way to deploy to a large number of employees, but all too often [those companies] are oversold [the idea] that it's going to create some massive savings."

Sherman said his warning to clients is that while SAAS is cost-effective, it's not going to be a significant cost reduction in the long run because there are so many other costs involved. "[Companies] think vendors are going to be able to do implementations in days," he said. "[SAAS] takes much longer than that to implement and to understand."

What about SAAS vendors facing declining investor returns? AMR's Bois wrote that to effectively weather a potential economic storm, vendors need to have a good product and a solid message about increasing efficiency, improving service levels, retaining sales or increasing promotion effectiveness—all areas that transcend short-term shifts in the economy.

"SAAS continues to offer a great means for reducing up-front capital expenditure, reduces deployment risks, and holds vendors more accountable as they need to ensure a renewal a year or two down the road," Bois wrote. "The cliché that what doesn't kill us will make us stronger, while trite, applies perfectly to the CRM market through the last economic downturn. Vendors and buyers alike learned valuable lessons the last time around that should make this market more durable and able to withstand rapid change than any time in the past."