software as a service - mvp systems software | enterprise

SOFT WARE & INFORMATION INDUSTRY ASSOCIATION, 1090 VERMONT AVE NW, SIXTH FLOOR, WASHINGTON, DC 20005 +1.202.289.7442WWW.SIIA.NET

S I I A S O F T W A R E D I V I S I O N & T R I P L E T R E E

SOFTWARE AS A SERVICE:CHANGING THE PARADIGM IN THE SOFTWARE INDUSTRY SIIA AND TRIPLETREE INDUSTRY ANALYSIS SERIES

Software & InformationIndustry Association

CUSTOMIZED INVESTMENT BANKING

JULY 2004

SOFTWARE & INFORMATION INDUSTRY ASSOCIATION, 1090 VERMONT AVE NW, SIXTH FLOOR, WASHINGTON, DC 20005 PAGE 1WWW.SIIA.NET

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TripleTree, LLC and the Software & Information Industry Association (SIIA) are pleased to provide you with our report on“Software as a Service: Changing the Paradigm in the Software Industry.” As observers and proponents of the hosted soft-ware space from its earliest days , TripleTree and the SIIA have teamed up to produce this research report on the “Softwareas a Service market”. “Software as a Service” is one of our mega trends in the software industry.

In this report, we offer our perspectives on what constitutes software as a service, including the evolving business model andthe core value proposition, the overall landscape including major participants and market growth, and analysis of competi-tive trends. The report also includes a spotlight of the on-demand CRM sector as well as a review of some of the other soft-ware categories with specific company examples and our viewpoint on the keys for success.

Several major trends are identified including:

Disruptive technologies with software as a service redefining ways to deliver and sell software;

Growing end-user adoption being paved by emerging, privately-held software as a service companies;

Endorsement becoming more mainstream with small, mid-market, and large enterprises alike increasingly replacinglicense relationships in favor of hosted applications;

Mounting competitive tensions with software companies taking defensive positions & maneuvers through internal devel-opment and/or acquisitions in reply to pressures posed by a new group of competitors; and

Shifting value drivers with new account / subscriber growth, customer retention, deferred revenue, and cash flow analy-sis more suggestive of long-term value than the P&L.

We have assembled a vast body of knowledge about the companies that are beginning to re-shape the software industry. Ourresearch and perspective encompasses years of experience in the application hosting and outsourcing sectors, to interactionswith a wide range of software as a service companies in sectors such as customer relationship management, supply chain man-agement, content management, e-commerce, security, transportation & logistics, human capital management, healthcare, back-office applications, among others. TripleTree and SIIA would like to extend special thanks to the over 25 company interviews,executive discussions with software as a service firms, and interactions with leading venture capital investors that went intoassembling this report. In addition, IDC's research on the SaaS industry was a key resource for this report, as well as otheranalysis and research. If you are a software as service firm or an investor with portfolio investments or interested in thistopic, we would welcome a discussion.

This is the second in a series of collaborative reports published by TripleTree and the SIIA, collectively labeled the “SIIA &TripleTree Industry Analysis Series” designed to complement SIIA's Software Division Initiatives. To learn more about ourorganizations and to review additional research reports and other IT-related resources (including our first Industry Analysisreport on Web Services and our forthcoming report on Mobility/Wireless), please visit www.triple-tree.com and www.siia.net.

Best Regards,

Kevin Green Brian Klemenhagen Fred HochManaging Partner Senior Principal Vice President, SoftwareTripleTree, LLC TripleTree, LLC SIIA(952) 832-3358 (952) 832-3359 (202) [email protected] [email protected] [email protected]

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TRIPLETREE, 7601 FRANCE AVENUE SOUTH, SUITE 150, MINNEAPOLIS, MINNESOTA 55435PAGE 2 WWW.TRIPLE-TREE.COM

TABLE OF CONTENTS

PREFACE 1

INTRODUCTION 3

SOFTWARE AS A SERVICE OVERVIEW 4

Evolution 4

Segmentation 5

The Changing Rules of Conduct in the Software Industry 7

Software as a Service Value Proposition 9

Software as a Service Deployment 11

Market Growth 12

COMPETITIVE LANDSCAPE 14

Enterprise Application Service Providers 14

Independent Software Vendors 14

Outsourcing Companies 15

Proprietary Software as a Service Vendors 15

Special Call Out Section:On-Demand Consumer Relationship Management 16

On-Demand CRM Company Profiles 18

PROPRIETARY SOFTWARE AS A SERVICE LANDSCAPE 22

Challenges with the ISV Transformation to Software as a Service 22

Software as a Service Success Stories 23

RECOMMENDATIONS FOR SAAS FIRMS 28

CONCLUSIONS 30

APPENDIX: GENERAL RESOURCES 31

APPENDIX: PROPRIETARY SOFTWARE AS A SERVICE VENDORS 32

PROJECT ARCHITECTS:SIIA: Fred Hoch, VP, Software Programs; Anne Griffith, Director, Research & PublicationsTriple Tree: Brian Klemenhagen, Senior Principal; Rob Rogers, Senior Analyst

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The Software as a Service (SaaS) market has experienced a number of fits and starts since it rose to prominencein the late 1990s. In the last years of the Internet boom, high-profile application service providers (ASPs) enteredthe marketplace with promises to revolutionize the enterprise software landscape. These firms delivered complexenterprise software packages via a hosted model, generally with little or no specialized or proprietary IP. Withinseveral years most of these firms had exited the market, changed their business models and positioning, or scaledback operations after failing to gain sufficient momentum. However, a select group of first and second genera-tion SaaS firms continued to execute, generally offering specialized, proprietary applications, and these firmshave quietly but steadily contributed to the increasing acceptance of service-based software delivery among enter-prises. In particular, the on-demand CRM space is emerging as an early “hot spot,” with companies likeSalesforce.com, RightNow Technologies, and SalesNet paving the way in terms of market acceptance and businessmodel validation.

Software as a service effectively redefines the software deployment model from packaged applications with up-front licensing fees and lengthy implementations to one that constitutes a dynamic, “pay-as-you-go” Internet-delivered service relationship. This shift fundamentally changes the assumptions, relationships & partnerships,and value proposition between software vendors, clients & end-users, and third-party service providers. The SaaSfirm changes the dynamics and definition of a software and service provider and merges these concepts into asingle source entity. This is akin to the role played in other outsourcing sectors, such as payroll processing firmslike ADP, or the “timesharing” model that achieved prominence during the 1970s. At the same time, as softwareas a service firms reach critical mass and profitability, they stand to benefit from a higher level of revenue visi-bility and more certain & predictable cash flows than traditional software vendors.

After its early development and shakeout period, the SaaS model is poised to undergo rapid growth and to playa very meaningful role in redefining the software industry. Today, the impact of software as a service is alreadybeing felt with companies performing well and changing the dynamics in certain software sectors. Large estab-lished IT firms are expressing renewed interest in this area, due in part to defensive maneuvers needed in replyto disruptive SaaS firms. As a result, we believe the time is right for an in-depth analysis of the market and itsimplications on the NEW software industry.

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EVOLUTION

The software as a service market has evolved signifi-cantly over the last five-plus years, when the notion wasfirst conceived based on early successes in businessprocess outsourcing (BPO), application outsourcing &management, and the aforementioned timesharingmodel. (Figure 1).

First Generation. Starting in 1998 and 1999,application service providers likeUSinternetworking and Corio attracted a greatdeal of attention to the hosted software space,offering Web-based access to applications frommajor enterprise software vendors such asPeopleSoft, Siebel, SAP, Microsoft, Lawson,Broadvision, and Ariba on a subscription ratherthan licensed basis. The concept of leased andhosted software proved to be an attractive one toIT services and software firms as well as the finan-cial community: according to John Hagel's Out OfThe Box, this sector was the recipient of approxi-mately $3.6 billion in venture capital investmentsduring 1999 and early 2000, with over 2,000 com-panies labeling themselves “ASPs.” 1 However anumber of factors, including economic sluggish-

ness, reduced IT spending, the shakeout in thedot.com world, difficulty in achieving scale, andASP performance issues prevented most of thesefirms from living up to expectations. In particular,enterprise-class applications designed for licensingin a client/server architecture have not been ideal-ly suited to be delivered in an on-demand model,leading to a “customization trap” in attempting toexploit application efficiencies across a “one-to-many” dimension. These firms also compet-ed against the very firms they were workingwith, since they were not providing new prod-ucts but acting as a channel for establishedsoftware vendors.

Second Generation. Through the ensuing shake-out period, a select group of firms continued tomove the software as a service market forward byamending earlier imperfections and validating thebusiness model with an increasingly-receptive end-user population. Most of these companies wereprivately held businesses operating somewhat“below the radar” of the broader market. These

S O F T W A R E A S A S E R V I C E O V E R V I E W

Source: TripleTree

Figure 1: Wave of Evolution in the Hosted Application Market

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John Hagel III, Out Of The Box: Strategies for AchievingProfits Today and Growth Tomorrow Through Web Services.Harvard Business School Press, 2002, p. 45.

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1998 2000s Beyond“First Generation” “Second Generation” “Evolving Business Concept”

ApplicationService Providerss Corios USi

Software as a Services Intaccts CrownPeaks Salesforce.coms Salesnet

Services OrientedArchitecture (SOA)based on Web Services &Web-native Applications

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companies were building new, purely Web-basedapplications that directly addressed importantbusiness functions, provided a quantifiable returnon investment and a strong value proposition,while addressing specific business functions and“pain points” like customer relationship manage-ment, HR, procurement, and messaging.

Evolving Business Concept. Since the second halfof 2003, there has been a definite shift in momen-tum and renewed interest in the software as a serv-ice model. SaaS providers are reporting increaseduser subscription and rapid sales growth, stronginterest from both large companies and small-to-medium enterprises (SMEs) alike, and moreknowledge of and confidence by end-users in host-ed applications. The first generation models werepredicated on 'renting' world-class enterprise soft-ware to mid-market firms, that typically could notafford the upfront, ongoing and hidden costs asso-ciated with traditional software licensing nor timeto fully implement it properly. Many of these end-users also lacked the in-house resources to keeptrack of the changing IT landscape. Since then,market acceptance has clearly been driven by thissegment of the marketplace. However, interesting-ly enough, a trend is emerging with large enter-prise 'buy-in' across business divisions as well as atthe enterprise level.

In certain market segments, software as a servicecompanies are now emerging as serious competi-tors to top-tier independent software vendors(ISVs) and creating significant disruptive effects.We believe that this new generation of SaaSproviders represents a crucial next step in theongoing evolution towards a service-orientedarchitecture (SOA) composed of Web-nativeapplications and XML-based Web services - pro-viding a higher level of integration and customiza-tion than is currently available. Additionally, atthis next phase, software as a service creates thepossibility of offering even more functionalitythan its counterparts by providing end-users withmuch more frequent upgrades and releases with-

out facing integration complications. We will return tothis discussion in the ensuing Value Proposition sec-tion of this report.

SEGMENTATION

Broadly speaking, our definition of “software as a serv-ice” (SaaS) refers to any model built around deliveringaccess to software applications via a network (publicInternet or private intranets and extranets). The appli-cations reside at an offsite data center where they aremaintained by the service provider and customersaccess the application remotely via their Internetbrowsers and back-end Web servers. SaaS businessmodels are predicated on a “one-to-many” or multi-ten-ant delivery model whereby the application is sharedacross all clients, providing a minimal level of applica-tion customization to avoid major implementation andintegration costs. Figure 2 provides a simplified depic-tion of this arrangement, although we recognize that anumber of variants exist. A key premise of this modelis that the software as a service firm invests in the tech-nology, hardware, and ongoing support servicesinstead of the customer. In return, customers “pay-as-they-go” according to a subscription and Service LevelAgreement (SLA) that ensures the customer a specifiedlevel of performance & availability, and provides theSaaS company with a long-term customer relationship.

There are several distinct types of companies withinthe broad software as a service sector. In furtherdrilling down into this market, we follow IDC's seg-mentation 2 into the following categories:

Application Service Providers (ASPs): Probablythe most widely-recognized component of this mar-ket, firms in this segment host and manage pack-aged software applications and provide remoteaccess to them, with pricing generally consisting ofa one-time license & set-up fee (significantly lessthan a standard software licensing fee) and a recur-ring stream of periodic subscription, hosting &

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From IDC report #31267 “U.S. Software as a Service 2004-2008 Forecast by Delivery Model,”May 2004.

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maintenance charges, typically on a monthly basis.These charges may be modified to reflect applica-tion usage in terms of number of users, number of“clicks,” or by some other metric. Prominent ASPsinclude USinternetworking, Corio, Surebridge,and NetASPx.

Web-native Applications: A growing portion of thesoftware as a service landscape, this segment con-sists of proprietary applications that have beenspecifically architected for Internet-based deploy-ment and delivery. Less costly and more rapidlyimplemented than their traditional enterprise soft-ware counterparts, Web-native applications are gen-erally narrowly designed around a specific businessfunction or process. Pricing generally consists of a

recurring payment stream combining licensing feesand hosting charges. The key distinction being pro-prietary Web-based application designed for opti-mization in a 'one-to-many' shared applicationenvironment.

Hosted Web Services Applications: Comprised ofself-describing, Web-based software components,Web services represent a rapidly-growing sub-mar-ket within software as a service. As this sector isstill developing, no single delivery model hasemerged. Services can be utilized on a standalonebasis or in combination with other applicationcomponents, may be hosted by an external vendoror by an enterprise's IT department acting as aservice provider. Likewise there is as yet no pri-mary pricing scheme associated with Web Services,and we expect to witness an array of models testedas this market develops.

A brief note on nomenclature: we distinguish betweenfirms hosting third-party applications and vendorsdelivering their own software over the Internet, usingthe term “proprietary software as a service” to refer tothe latter (which encompasses categories 2 & 3 in oursegmentation above). Because the proprietary SaaSvendors are generating a high degree of momentum inthis market, we will focus most of our attention ondevelopments among these companies and provide anumber of company profiles in a later section.

Source: TripleTree

Figure 2: Multi-tenant Software as a Service Delivery Model

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Shared Application: “One-to-Many”

CUSTOMERS & END USERS

SOFTWARE AS A SERVICE PROVIDER

Customer Service, Training & Support

Web-Native Application Delivery

Data Center Infrastructure(three-tier option)

3rd PartyHosting

Back-up orCo-location

DisasterRecovery

CLIENT A

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THE CHANGING RULES OF CONDUCTIN THE SOFTWARE INDUSTRY

The software as a service model is a complete retrans-formation of the traditional methods for selling anddelivering software. This redefinition changes thescope and economic relationship between the vendorand end-users. The fundamental differences betweentraditional ISVs and SaaS firms can best be illustratedin three basic categories (see Figure 4):

Revenue Model. As stated previously, the soft-ware as a service model is quite different from thelicensing model in that the large, upfront licens-ing fee and the resulting professional service feesand maintenance costs are replaced by periodic'all-in-one' subscription payments - typically on amonthly or installed basis. The tradeoff being thatsoftware as a service firms have significantly small-er upfront revenue and cash flows in exchange forlonger-term and more predictable cash flows thatare the result of a service-based relationship.Consequently, the true measure of success orvalue for a software as a service firm is not neces-sarily tied to revenue growth or the P&L, but is

measured by metrics for new customer acquisition,rate of customer retention, predictability & visibil-ity of cash flows, and the growth of deferred rev-enue on the balance sheet.

Cost of Revenues. Significantly different from theISV model, software as a service firms require lessinvestment in upfront professional services due tothe rapid time to deployment and Web-based deliv-ery. Many ISVs partner with top-tier systems inte-grators to provide upfront professional services andimplementation, but also maintain internalresources to support these functions initially andgoing forward. Instead, software as a service firmsinvest in customer service & training, account man-agement, and application support and manage-ment, which includes network operations, to ensuresuccessful application delivery, virtually 100%uptime & performance, and high user adoption.

Operating Expenses. An area of key distinctionbetween ISVs and software as a service firms lies inthe approach for R&D and sales & marketing.The ISV typically supports multiple code basesacross different technical environments

Source: TripleTree

Figure 3: Application Outsourcing & SaaS Business Model Comparison

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DEVELOPMENT BUSINESS MODEL PRICING

ApplicationMaintenance

Outsourcing Growth External service provider manages, supports, and maintains on- or off-site application development & use of internal or 3rd party applications

Typically fixed price or cost-pluscontractual relationship overmulti-year agreement

ApplicationService Provider(ASP)

Growth Customers remotely access Web-enabled versions of 3rd party enterprise applicationshosted & maintained by ASP

Generally consists of upfrontlicense fees plus monthly hostingand maintenance charges;sometimes additional per-use fees are charged

Web-nativeApplications

Emerging Growth Applications specifically developed &designed for Web-based deployment &browser-based access

Generally a recurring paymentstream combining subscriptionand hosting fees

Hosted WebServices

Early-Stage /Developing

Application components deployed in combination or in isolation to address particular functions; hosted by external service providers or internal IT department

Under development

Software as aService

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(client/server, mainframe, Web-based, etc.) anddelivered in a single-tenant model that is main-tained on the client's premises. Conversely, soft-ware as a service firms base their technology on asingle Web-native code base that is capable of sup-porting numerous end-users in a multi-tenant,shared application environment. The end result isthat software as a service firms are able to lowerthe incremental R&D costs with each new cus-tomer acquisition. Additionally, while ISVscharge for software upgrades, maintenance, andgenerally have new software release cycles everytwo to three years, software as a service firms pro-vide free software upgrades, include maintenance& support in the service relationship, and sup-port more frequent and seamless software releases& upgrades. In terms of the sales and marketingapproaches, there are also noticeable differences.Since the ISV supports a model that is based onlarge upfront professional services and implemen-tation that are often more than two times the soft-

ware license fee, major consulting and IT servicesfirms have been natural allies and partners indeveloping sales alliances and indirect channels.Conversely, software as a service firms have need-ed to be much more creative in their sales & mar-keting approach, since traditional alliances &channels pose unique challenges due to thechanged economic relationship for the systemsintegrator. Consequently, many software as a serv-ice firms have invested in multiple indirect chan-nels to the market (vertical industry partners,infrastructure alliances, OEM, VAR, privatebranding relationships) as well as building directsales channels; albeit, very cautiously and deliber-ately. In the end, software as a service firms aremanaging the tradeoff and conflict posed by rapidgrowth that require significant investment in multiplesales and marketing channels as opposed to stable cashflows that require more patient growth expectations asthe model and customer acquisition grows over a longerperiod of time.

Source: TripleTree

Figure 4: Fundamental Differences Between ISVs and SaaS

KEY MEASUREMENTS ISVs SOFTWARE AS A SERVICE PROVIDER

Business Model Characteristic

Business Model s Large, upfront $s Cashflow upfront

s Periodic subscription $s Predictable cashflow

Pricing s License pricing s Subscription service pricing

Revenue Mix s 40-60% license: 20-30% maintenance: 10-40% P/S s 90% subscription: 10% P/S

Cost of Revenues

License/Subscription - -

Professional Servicess Partnership with top-tier SIss Large, multi-million projects (>2:1 services-to-product ratio)s 6-18 month deployment cycles

s In-house services & trainings Small projects, often included in recurring components Less than 3 month deployment cycles

Customer Service and ApplicationSupport & Management

s Technical help desks Cost centers Do not “own” NOCs or “manage” application system

s Technical+customer services Manage uptime, availability, performance & user adoption

Operating Expenses

R&D and Technology Delivery

s Multiple code basess “On-premises”, single-tenant deliverys “Pay-for” upgradess 2-3 year software releases / re-deployment cycless “Pay-for” maintenance (-20% license)

s Single code base - Web-natives “on-demand”, multi-tenant shared applications “Free” upgrades provided seamlessly over Webs Frequent & continuous feature delivery (several times / year)s “Free” maintenance & support

Sales & Marketing s Direct saless Partnership with professional service

sMultiple indirect channels to market & directs Account management in service relationships Difficult to partner with SIs

G&A - sManaging accounts & billing functions

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SOFTWARE AS A SERVICE VALUE PROPOSITION

As this market has developed over the last several years,the value proposition driving adoption has alsoevolved. In application hosting's original incarnation,the reasons for contracting with a service provider large-ly mirrored the motivation for any other outsourcingrelationship: more predictable costs and a greater abili-ty to focus on core competencies while leveraging theexpertise of a specialist service provider. These coreprinciples are quite similar to the software as a servicevalue proposition where an affordable, “pay-as-you-go”relationship provides small- and mid-size organizationswith a suite of enterprise applications that are similarto those available to Global 1000 organizations and aservice relationship with the provider that ensuresongoing value. However, we believe revisiting a few ofthe key principles and the evolving trend toward arange of enhanced value drivers is important in under-standing the differentiation between SaaS and licensingmodels. These value drivers include:

Lower cash outlays for enterprise-class softwarepurchases by replacing large, upfront cash outlaysfor software licenses with a smaller, subscription-based pricing model that is much more frequentbut at a fraction of the cost. Such a shift in pric-ing moves a great deal of enterprises' expendituresfrom fixed costs to variable costs, increasing theflexibility of their cost structures.

Ease of implementation and quicker time-to-market or value with deployments generallyrequiring less than three months compared to sixto 18 months with traditional software. The focusof a deployment is on end-user training andacceptance, since customers do not have to installor maintain servers, networking equipment, secu-rity products, or other hardware.

Reduced technology investment risk and higherROI with lower upfront capital, resource commit-ment, and levels of complexity. The customeravoids the risk of additional 'hidden costs' thatcreep up over the application lifecycle such as

ongoing support and maintenance costs,upgrades, user acceptance risks, etc. Many on-demand providers are able to provide a breakevenpoint in a six months or less while licensing mod-els require a longer payback period. In someregards, the timing for software as a service couldnot be any more opportune with small and largecompanies alike trying to maximize every dollarspent on IT and demanding a clear and measura-ble ROI before each investment decision is made.

Frees up internal resources by reducing internalIT staff required to manage applications, keeptrack of upgrades, maintain performance, etc.

Full application lifecycle involvement, from ini-tial deployment through ongoing support, mainte-nance and upgrade, that ensures that there is acomplete alignment of interests with the SaaS firmhaving a vested stake in the success of the applica-tion beyond initial deployment. Consequently,SaaS firms are redefining the relationships withclients by managing the application and the clientrelationship over the full lifecycle of use.

Continuous support & seamless upgrades withnew features and functionality, upgrades, customersupport, and other operational services all includ-ed instead of being treated as incremental costs.

Shared risks and single-source accountabilitywith customers demanding a different vendor rela-tionship that results in more accountability andflexibility in the actual execution of the software.Just as importantly, the SaaS firm 'shares' in theexecution risk of the application, since the SaaSprovider also earns their own return over the termof the relationship and consequently 'loses' in theequation when customers are dissatisfied and seekother alternatives.

New functionality and improved application per-formance with on-demand firms receiving contin-ual client feedback in a service-based relationshipand often interacting with end-users in the appli-

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cation environment itself to determine prioritiesfor new features and to fix bugs & glitches. A crit-ical differentiator is that new product revisionsare made more frequently - three to four times ayear or more - compared to one new release every12 to 18 months with traditional software.Consequently, software as a service providers areable to continually refine the product with newreleases that add customer-driven functionalitythat can be utilized by all clients in a shared appli-cation and across a multi-tenant model. Majornew product releases and application improve-ments can literally be made overnight or duringoff-hours such as weekends resulting in little serv-ice disruption for end-users.

Lower total cost of ownership (TCO) with licens-ing, implementation, customization, mainte-nance, upgrades, and hardware & support costsbeing bundled into an on-demand service rela-tionship. The first year total cost of ownershipcan be five to ten times less expensive than enter-prise software with the majority of savings result-ing from the elimination of upfront integrationand customization projects (see Figure 5). Thus,the payback period is considerably shortened.The lack of large implementation opportunitiesposes special challenges for SaaS firms seeking to

draw on partnerships and alliances with top-tierconsulting firms that thrive on providing thesetypes of upfront services. While harder to quanti-fy due to 'hidden' costs, the SaaS model is alsobased on a longer-term value.

The application's functionality and ability to addressend-users' needs remain important factors in any tech-nology expenditure decision. That being said, the keypoint is that the cost and the success of the applica-tion's operation are crucial factors in evaluating hostedapplications versus license. As these core tenets becomecommonplace, their relative value becomes somewhatless valuable over time and another set of critical suc-cess factors rises to the surface. While still early, webelieve that a higher-level rationale is evolving that com-bines these “base case” factors already mentioned withother important business and technology issues. Suchissues include access to best-of-breed vertical- andprocess-specific solutions, support for standards-basedintegration that leverages Web services protocols, newlevels of customization combining unique workflowrequirements, and a concern for enhanced client serv-ice and account management.

Going beyond these factors, however, the top-perform-ing software as a service firms derive their success at

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Source: Salesforce.com & The Yankee Group

Figure 5: Lower Total Cost of Ownership (TCO)

FIRST YEAR TCO TRADITIONAL CRM SALESFORCE.COM ENTERPRISE EDITION

Number of Users 500 500

Application License / Subscription $1,250,000 $750,000

Implementation & Customization $6,250,000 $187,500

Training $150,000 $75,000

IT Infrastructure / Hardware $500,000 $0

IT Personnel $500,000 $0

Support / Upgrade Cost $225,000 $0

TOTAL $8,875,000 $1,012,500

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least in part from their ability to reconcile the tensionbetween the two sides of their business - in other words,to transform the software purchase process into a long-term, intensive, service-based relationship. As we willdiscuss in subsequent sections, this ability is preciselywhat makes the SaaS model so disruptive to the tradi-tional software model. Figure 6 illustrates this concept,depicting how software delivered as a service draws out“the best of both worlds” from each model and wherethe lines of demarcation between software and servicesare becoming much more blurred. It is possible themodel will bifurcate at some point, with enterpriseclients signing up for full-feature, process-oriented serv-ices bundled around hosted technology platforms, andSMEs adopting best-of-breed applications addressing aparticular niche.

SOFTWARE AS A SERVICE DEPLOYMENT

SaaS providers have been making inroads into bothlarge firms and SMEs across several layers of the enter-prise software stack. While still too early to draw con-

clusions, SaaS firms have been most successful in pene-trating the functional application (point-based solutionssuch as human resources, messaging, and vertical indus-try functions) and enterprise application markets (e.g.CRM, procurement, etc.). In addition, a number ofthese companies are finding success in the informationmanagement space, bringing the on-demand world toanalytics and content management functionality (seeFigure 7).

In our estimation, SaaS momentum will continue to bemost prevalent in these sectors for the foreseeablefuture. The infrastructure software layers present a setof challenges that are still best addressed by more tradi-tional on-premise deployments or outsourcing relation-ships. However we are aware of some exceptions, suchas service-based offerings from Keynote Systems,Mercury Interactive, Symantec, and VeriSign, and wedo expect to see this situation will change somewhat atthe margins, driven by Web services-based integrationand the accompanying transition to service-orientedarchitectures (SOAs).

Figure 6: Convergence Between Software & Service in SaaS Value Proposition

Enterprise-class software functionalitywith service-based relationship

Subscription-based, “pay-as-you-go”

New functionality & improved application performance

Lower initial cash outlays

Lower total cost ofownership (TCO)

Shared risks & single-source accountability

Full application lifecycle operation

Continuous support & seamless upgrades

Reduced investmentrisk & higher ROI

Ease of implementation &quicker time-to-market

Frees up internal resources

SOFTWARE SERVICE

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Source: TripleTree

Figure 7: Enterprise Software Infrastructure

“On-premise”

Infrastructure Applications

Integration Application Server Systems Management Information Technology Security

Databases

Operating Systems

Legacy Systems

“On-demand”or SaaS

Functional Applications

Human Resources Messaging /E-mail Finance / Accounting Veritical Industry

Information Management Applications

Business Intelligence / Analytics Content Management

Enterprise Applications

Enterprise ResourcePlanning (ERP)

Customer RelationshipManagement (CRM)

Supply ChainManagement (SCM)

Procurement / E-commerce

MARKET GROWTH

Throughout our research and interactions with compa-nies, we continue to witness steadily increasing marketdemand for software as a service, with most of thegrowth driven by privately-held emerging SaaS firms.Although the ramp-up has not occurred as quickly asmany commentators initially predicted, this market ison pace to become a key driver in the overall softwareindustry within the next few years. To a large extent thesame arguments and drivers advanced by the first waveof ASPs remain valid today - the service-based modelfacilitates lower upfront costs and total cost of owner-ship, faster implementation and an accelerated rapidtime to value, a more rapid application upgrade cycle,and reduced ongoing application maintenance respon-sibilities, allowing the end-user to focus on the func-tionality of the application.

Among the other factors contributing to growth in thisarea is the well-documented slowdown in corporatetechnology spending. Enterprise IT spending prioritieshave, to some extent, split over the last couple of yearsto focus on integrating the major software packagesdeployed during the late '90s - early '00s and deployingpoint solutions requiring little integration to addressspecific business functions. Both of these trends signal a

hesitation to implement additional large-scale enterpriseapplications and thereby add more layers to already-com-plex computing infrastructures. Accompanying this hes-itation is an opportunity for software as a service ven-dors to position their solutions as an alternative to morecumbersome enterprise software packages. Finally, webelieve that the success of flagship SaaS companies likeSalesforce.com is creating a “ripple effect” that is gener-ating new interest in this market by end-users and newcompetitive entrants alike.

As a result of the drivers discussed above, the softwareas a service opportunity is projected to expand from a$2.3 billion market as of 2003 to a $7.2 billion marketby 2008. The IDC forecast below breaks out this databy delivery model (see Figure 8).

The data in Figure 8 presents a bit of a paradox.Although the 25.6% CAGR projected for the SaaS mar-ket is impressive as a standalone metric, viewed in thecontext of the software industry as a whole, software asa service represents just a fraction of total spending.We think the contrast illustrates an important fact:although the SaaS market has evolved rapidly in a shortamount of time, it will take years for the full disruptiveimpact of this new model to manifest itself.Secondarily, the SaaS model is several orders of magni-

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tude smaller than upfront licensing arrangements and,consequently, its full effect does not fully come intoplay at the outset but will be experienced over time. Inother words, a $7 billion SaaS market could translateinto $25 billion or more when compared to the tradi-tional software licensing model. Consequently, itsimpact could be much more profound than the projec-tions might initially suggest.

Nonetheless, we continue to believe that companiesmust move to address the on-demand opportunitysooner rather than later. We also believe the SaaS mar-ket will remain highly fragmented, with most of theestablished players providing application hosting andmaintenance with a new breed of proprietary SaaSfirms capturing the highest level of growth. This predic-tion is confirmed in our interactions with SaaS firmsand by IDC's projected ramp for the Web-native/Webservices market segment.

In addition to the quantitative data cited above, quali-tative evidence continues to mount indicating theincreasing momentum of the software as a servicemodel. In part, the SaaS model may be benefiting fromthe trend toward utility-based models as exemplified bynew initiatives from IBM and Hewlett-Packard. Webelieve these initiatives can only help fuel the transitionfrom an IT environment marked by the traditional“license & install” approach to one characterized by aservice-oriented architecture and an “on-demand”model. A related factor facilitating SaaS market growthis the increased buy-in from larger software vendors,which is contributing additional credibility to the serv-ice-based model. In addition, many large enterprisesare still entrenched in 10-year product lifecycles due tothe ramp up to Y2K. We expect that as these contractsstart to end that many firms will look to the SaaS modelas an alternative to installed enterprise products.


Source: IDC report # 31267: “U.S. Software as a Service 2004 - 2008 Forecast by Delivery Model,” May 2004.

Figure 8: US Software as a Service Spending Forecast 2003-2008 (in millions)

2003 2004 2005 2006 2007 2008 ‘03-’08 CAGR

SaaS Spending $2,296 $3,028 $3,879 $4,845 $5,972 $7,177 25.6%

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During the late 1990s and early part of 2000, interestin software as a service centered around the pure-playenterprise ASPs, and their performance was perceivedas indicative of the prospects for the market for out-sourced software delivery as a whole. Although ASPscontinue to sell into this market, the scope of firmsadopting a service-based approach have broadenedconsiderably over the last 4-5 years. Currently, compet-itive dynamics are driven by tensions between severalsets of vendors:

ENTERPRISE APPLICATION SERVICE PROVIDERS

Companies that provide access to third-party enterpriseapplications from major software vendors will likely stillplay a role in the application hosting market despite thesetbacks they experienced during the post-bubble years.Although enterprises are becoming increasingly well-educated with regard to the distinctions between vari-ous SaaS models, for many organizations ASPs areviewed as synonymous with software as a service. Thusthe public perception of these companies will remainan important driver for the overall SaaS market.

Many of these companies remain formidable competi-tors in their own right. In addition to ASPs that wentthrough high-profile IPOs several years ago, there are ahandful of second-tier ASPs like Surebridge (recentlyacquired by Navisite), BlueStar Solutions, and NetASPxthat continue to grow and make progress toward prof-itability. These firms have faced early challenges, giventheir lack of proprietary IP, the difficulties in deliveringnon-Web-native applications over the Internet, and theneed to share revenue with ISV partners. However, assoftware companies reengineer their products for Webdelivery and dedicate more resources to addressing theSaaS opportunity, these ASPs will emerge as valuableISV partners.

INDEPENDENT SOFTWARE VENDORS (ISVS)

Although initially divided on the concept of software asa service, with some vendors moving quickly toembrace the new delivery channel while others were

more dismissive, at this point many of the major ISVshave accepted the fact that service-based software repre-sents a significant and growing component of the soft-ware market, and are in at least the early stages of for-mulating their strategy. Driven by growing customerdemand for an alternative to the costly and complicat-ed software licensing and implementation model, themore proactive enterprise software vendors have movedto re-architect their products and make them availablefor delivery over the Web. This process has been accel-erated in certain market segments wherein SaaS firmsare competing (and winning) against ISVs for largeenterprise accounts, forcing the incumbent vendors torespond with their own service-based offerings.

Those ISVs that have embraced the SaaS model haveapproached the market both through internally-man-aged hosted platforms and alliances with enterpriseASPs. Based on our research as well as IDC's WorldwideEnterprise ASP Competitive Analysis3, this section summa-rizes the SaaS initiatives announced by the major enter-prise software vendors.

ISV Interest. A recent high-profile example of thiswas Siebel's October 2003 announcement intro-ducing its CRM OnDemand solution. Designedfor small-to-medium enterprises, CRMOnDemand is a Web-optimized version of Siebel'sflagship CRM product priced on a per-user, per-month basis. As part of this initiative, Siebelannounced a broad partnership with IBM underwhich IBM will provide hosting services as well asparticipating in the marketing, selling, and sup-port of the solution.

Following the launch of CRM OnDemand, Siebelannounced two relevant M&A transactions,acquiring UpShot (a provider of hosted CRM andsales force automation applications) and InetoServices (a provider of hosted contact center solu-tions). Siebel's aggressiveness is noteworthy, giventhat the CRM giant's past experiences in the space


3 Report #29813 by Amy Konary, published July 2003.

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have been regarded as less-than-successful, andsent a clear message to the industry validating theconcept of software as a service. Siebel is nowestimating that as much as 15% of all CRM soft-ware sales will involve hosting services within thenext few years, and is positioning itself around abusiness model that combines both traditionaland on-demand deployments.

Oracle. Oracle has been steadily building its soft-ware as a service business since launching itsOracle Outsourcing initiative (since renamedOracle on-demand) in the fourth quarter of 1999.Oracle on-demand has experienced strong growth(over 70% year-over-year) among both mid-marketcompanies and divisions of large companies, withseveral hundred customers accessing Oracle's e-business applications through a services-basedmodel. Oracle has also been active in partneringwith pure-play SaaS firms, establishing relation-ships with companies such as NetSuite (co-found-ed by Larry Ellison) and AppShop to handle small-er clients.

SAP. SAP's hosting initiative serves over 100client companies, with particularly strongmomentum in verticals such as financial services,manufacturing, and retail. Taking a differentapproach than many of its rivals, SAP has orient-ed its hosting-related sales efforts toward largerenterprises. The company has also entered intopartnerships with Hewlett-Packard and EDS toprovide the necessary infrastructure in order tobetter focus on the application layer.

PeopleSoft. PeopleSoft has allied with Hewlett-Packard to jointly market, deliver, and supportservice-based access to PeopleSoft's applications.The ERP vendor is also making a concerted effortto convert existing licensed customers to hostedclients when their upgrade cycle comes around.

These leading ISVs are playing an important addition-al role in terms of validating the software as a servicemodel. Among mid-tier ISVs, there have been a num-

ber of success stories, such as Intuit's finance & tax andsmall business accounting software, WebEx's conferenc-ing solutions, eCollege'sonline education platform, andthe aforementioned initiatives from Keynote, Stellent,and Mercury Interactive. In addition, ConcurTechnologies, a provider of corporate expense manage-ment applications, was recently singled out by SummitStrategies as “the first publicly-traded conventionalsoftware company to build a profitable software-as-serv-ices business.”

OUTSOURCING COMPANIES

As a logical extension of their service offerings, busi-ness process and IT outsourcing companies are movinginto the software as a service space. Within the businessprocess outsourcing sector and particularly among HR-focused companies, technology is taking on a greaterrole, with BPO firms increasingly building their servic-es offerings around software platforms. We think theend result is a deliverable that blurs the line between“software” and “services,” at least from the perspectiveof the customer.

Platform IT outsourcing companies and managedservice providers (MSPs) are also positioning them-selves within the SaaS market, primarily by partneringwith ISVs to host large-scale enterprise applications.In certain cases these outsourcers have also partneredwith ASPs in order to take advantage of the depth oftheir expertise; one example of this trend is EDS' rela-tionship with Microsoft Exchange hosting specialistMi8 Corp. Some MSPs are also taking a more aggres-sive approach to building out their application host-ing business, as evidenced by Navisite's recent acquisi-tion of Surebridge.

PROPRIETARY SOFTWARE AS A SERVICE VENDORS

The proprietary SaaS category includes software compa-nies providing their own applications via a service-based delivery model. Generally these applications arefocused along a particular functional or vertical lineaddressing a specific business process. In addition, wealso draw a distinction between pure-play vendors,


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which derive all of their revenues from their SaaS offer-ings, and hybrid (or transitioning) vendors, whichbegan operations as traditional licensed software com-panies and have since added a hosted component totheir product offering (see Figure 9).

Functional. This segment includes SaaS firmsoffering point solutions that address specific busi-ness functions, ranging from mission-critical func-tions such as CRM to collaborative applicationslike messaging & scheduling to back-office func-tions such as procurement, human resourcesmanagement, and travel & expense management.

Vertical-Focused. Service providers within thiscategory offer applications addressing a particularfunction or set of functions within a given indus-try (e.g. Digital Insight's financial services soft-ware). This degree of focus establishes the SaaSfirm's credibility in terms of business processexpertise, enabling them to build a referable baseof clients and potentially move upstream intoenterprise accounts fairly rapidly.

Hybrid Vendors. The hybrid category refers tocompanies that have an historic go-to-market strat-

egy using a traditional software licensing model,but are currently augmenting with services-baseddelivery and/or subscription pricing models.Aside from the companies previously mentioned,a range of public software companies includingComputer Associates, VeriSign, Symantec, CheckPoint Software, etc. are 'testing the waters' andannouncing new offerings or pricing models.Among private companies, access control and e-commerce billing software provider eMeta andsupply chain and e-commerce vendor SPSCommerce are two examples of firms employingsuch a model.

SPECIAL CALL OUT SECTION: ON-DEMAND CUSTOMER RELATIONSHIP MANAGEMENT (CRM)

With all eyes on Salesforce.com’s initial public offer-ing, the $7 billion Customer RelationshipManagement software space is rapidly emerging as thehottest segment within the software as a service mar-ket. According to IDC, CRM remains a highly compet-itive and fragmented sector, with top vendors - Siebel,Oracle, SAP, and PeopleSoft - controlling only 30% ofthe market in 2002.


Source: TripleTree

Figure 9: Competetive Landscape & Industry Players

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The fact that CRM is one of the earliest SaaS marketsto experience this level of momentum is counterintu-itive in some respects, given that enterprises have beenunderstandably hesitant to allow their mission-critical,customer-facing applications and customer/prospectdata to reside on offsite servers. In addition, early pre-dictions suggested that SaaS market acceptance wouldbe driven by non-mission-critical functional applica-tions, rather than something considered as vital to anenterprise's operations as its CRM software and cus-tomer information.

Nonetheless the CRM market is leading the way for-ward on several key fronts and paving the way for otherhosted applications.

There is a core group of strongly performingCRM firms that are demonstrating the financialviability of software as a service to enterprises aswell as to the financial community;

CRM applications actually lend themselves todelivery over the Internet relatively easily versus aclient/server environment, even given the workhabits of its end-users. With sales and marketingprofessionals accessing information from outsidethe office, Internet delivery and hosted applica-tions have provided a viable solution.

CRM is one of the first sectors in which SaaS ven-dors have been able to move up-market and startwinning large enterprise accounts;

CRM is also one of the first sectors in which soft-ware as a service providers have been competinghead-to-head against large enterprise vendors andwinning enough deals to create a disruptiveimpact;

Finally, these companies are establishing a level oftrust in terms of customer data security & integri-ty and application performance that is essential inlaying the foundation for mainstream enterpriseadoption.

In determining the reasons why the CRM market hasgained such momentum relative to other sectors, sever-al factors come to mind. First, the widespread dissatis-faction and well-documented failure rates associatedwith large-scale ERP and CRM implementations pro-vided insurgent SaaS firms with an opportunity to dif-ferentiate their solutions from products offered bySiebel, PeopleSoft, Oracle, and other incumbent firms.According to an AMR Research study, over 80% ofCRM software deployments either fail to add value,encounter significant adoption issues among end-users,or fail outright. As a result, enterprises are increasinglyunwilling to bear the risks associated with large-scalesoftware implementations and are growing more recep-tive to alternative solutions.

The economic climate of the early 2000s provided bothchallenges and opportunities for SaaS firms. While cor-porate reluctance to invest in IT created a difficult salesenvironment for the software industry as a whole, thistrend appears to have favored the SaaS providers andhad a disparate impact on ISVs. To an extent, stalledlicense sales among the incumbent vendors gave emerg-ing companies some “breathing room.” It gave them anopportunity to ramp up sales even as the larger playersstumbled, and shifted focus to ROI and an emphasis onvalue, which played to the strengths of software as aservice. According to IDC, between 2001 - 2002 theCRM software market as a whole declined over 7%. Incontrast, CRM software as a service providers pros-pered and grew during this same time period:Salesforce.com's revenues rose 175%, RightNowTechnologies' sales increased 10%, and customer analyt-ics provider WebSideStory's rose 150% albeit all on asmaller revenue base than top-tier ISVs.

Another factor is the level of interest in CRM applica-tions displayed by mid-market enterprises. Findingexisting software packages too complex and costly, andthe risk of a failed implementation prohibitive, many ofthese companies began exploring on-demand optionsrather than installed solutions.

Finally, Siebel's recent foray into the hosted CRMmarket has proven to be something of a double-


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edged sword. Although the entry of such a formida-ble competitor is obviously of concern to on-demandCRM firms, they have also repeatedly stated thatSiebel's initiative has thus far served mainly to vali-date the on-demand model and drive more interestin hosted solutions.

ON-DEMAND CRM COMPANY PROFILES

As stated above, a select group of private firms areresponsible for much of the attention that the hostedCRM market is receiving. By examining the variousstrategies and tactics employed by these companies, wehope to provide other emerging vendors with actionableinsights as to the keys to success in the SaaS market.

Salesforce.com

The obvious poster child for both the CRM marketand the software as a service market as a whole, thestrong performance exhibited by Salesforce.com hascontributed a great deal toward instilling confidencein the on-demand model. With 9,500 subscribingcustomers and 140,000 users in 70 countries,Saleforce.com boasts one of the industry's largest userbases and has been experiencing strong growthamong large, Global 2000-type companies.Generating approximately 90% of its revenues fromrecurring subscription and support fees (generallypaid annually or quarterly), the company's contractstypically run from 12 - 24 months. The companyreported fiscal 2004 revenues of $96 million andachieved positive operating income of $3.7 million.Salesforce.com has established itself as such animportant industry player that it will be viewed notjust as a benchmark for software as a service but as abellwether for the broad IT industry.

In examining the factors behind Salesforce.com's suc-cess, several points must be made:

Sophistication of Hosted CRM Platform.Initially launching as a sales force automationapplication, the company rapidly expanded itsoffering into a full-scale, Web-native CRM solu-

tion encompassing such functions as sales forceautomation, customer service and support, mar-keting automation, document management, ana-lytics, contract management, and custom applica-tion development.

Enterprise Accounts. From the outset,Salesforce.com's solution was designed to be anenterprise-class application and the company hashad a great deal of success penetrating large corpo-rate accounts such as AOL Time Warner, DowJones, ADP, and Honeywell.

Development Platform. In addition to the depthof Salesforce.com's flagship product, the compa-ny's technology “ace in the hole” is sforce™, an on-demand integration and development platform.Sforce's™ Web services-based API enables rapidintegration with existing systems, a feature thathas played a vital role in the firm's ability to winbusiness from Global 2000 firms. In addition,sforce™ provides a development environment thatenables users to create custom data tabs (for exam-ple to add industry- or customer-specific datafields) or to customize the Salesforce.com userinterface, business logic, or database. Used in con-junction with the company's Studio product, theplatform also enables an enterprise's IT personnelto build and deploy J2EE- and .NET-based applica-tions, creating further value and extendibility forSalesforce.com clients. The level of flexibility andcustomization provided by the sforce™ platformled one Aberdeen analyst to comment that“Sforce™ has the potential to be an even greaterdisruption than the subscription model.” 4

Aggressive Sales Channels. It is also worth not-ing that just as Salesforce.com began developingan enterprise-class solution at an early stage,they also built an enterprise-class sales organiza-tion. Although initially targeting the SME mar-


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ket, the company moved quickly to hire sales-people from industry leading firms, includingSAP, Siebel, IBM, and PeopleSoft, in order tobetter position itself to sell into Global 2000-level companies. Salesforce.com has also beenaggressive in terms of industry partnerships,establishing alliances with Borland, Sun, IBM,and BEA Systems in order to enhance the valueof the sforce™ development environment.

Salesforce.com serves as an example of the challengesSaaS providers face in terms of reaching critical mass,i.e. building a customer base large enough to supportpositive cash flow. The proprietary SaaS model is achallenging business, requiring significant investmentin R&D, outlays for data center operations and sharedcosts, incentives for the sales team that are competitivewith compensation offered by licensed software ven-dors, and investments in additional customer service,account management, and operations. All of these out-lays must be supported by a business model that sacri-fices large upfront cash inflows in favor of long-termand more predictable revenue streams & cash flow.Without meaning to overstate these challenges, we dobelieve it is important for new or transitioning SaaSfirms to move into this market with their eyes open.Depending on how fast one desires to grow the busi-ness, the subscription business model requires a certainlevel of capitalization to sustain operations until posi-tive cash flow is achieved and a highly efficient meansof customer acquisition becomes possible.

To drill down into the Salesforce.com example, since itsinception in 1999 the company has grown to annual rev-enues of $96 million and achieved positive operatingmargins. In that same period of time, however, it builtup an accumulated deficit in excess of $70 million.Granted that Salesforce.com invested in sales & market-ing more heavily than most of its peers and faced a moresubdued economic environment, attaining breakevenprofitability and positive net worth still remains a chal-lenge and requires patient investors (see Figure 10).

Lest we appear overly pessimistic, we should stress thatonce positive operating margins are achieved, the pic-ture changes considerably. The SaaS firm benefits fromeconomies of scale as application development andinfrastructure costs are shared across a growing customerbase. In addition, the recurring revenue model enablesthese companies to effectively manage cash flow, render-ing them well-positioned to address issues that stillplague ISVs: revenue visibility and predictability. Thelarge revenue backlog that SaaS firms build is highlyattractive to investors and, as these firms go public, willenable them to provide more accurate guidance to ana-lysts. However, the importance of deferred revenue as abarometer of health and viability is not yet well under-stood by the financial community (see Figure 11).

In the case of Salesforce.com, its deferred revenue on itsbalance sheet has increased appreciably over the pastthree years and also climbing as a relative comparisonto its subscription revenue recognized in the given peri-


Source: TripleTree & Salesforce.com company documents

Figure 10: Salesforce.com: Reaching “Critical Mass” to Positive EBIT

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Figure 11: Increased Revenue Visibility with Growth of Deferred Subscription-based Rvenue

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od. The end result is consistent and visible revenue &cash flow from a growing installed base going forward.

Salesnet

Privately held and venture-backed, Salesnet was one ofthe first wave of hosted CRM pure-plays along withSalesforce.com and Upshot.com. After launching itsfirst product in 2000, the company has become one ofthe leading service providers in the hosted CRM spaceand has played a significant role in driving the successof this market. Focused primarily on the sales forceautomation and marketing automation segments of theCRM market, Salenet's software platform providesfunctionality such as account management, contactmanagement, customer/prospect segmentation, analyt-ics & reporting, and lead management & tracking.

A number of differentiating factors have contributed toSalesnet's success. One interesting fact regardingSalesnet's product development is that prior to writingany code, the company interviewed over 200 sales pro-fessionals to ensure that their software was designed toserve rather than monitor the sales team. Althoughnaysayers could dismiss this as marketing hype, in reali-ty it illustrates an important principle related to cus-tomer retention - if a product is not designed aroundthe needs of the business personnel who will actually beusing it, many of its features and functions will gounused and become “shelfware,” which makes it diffi-cult for the vendor to maintain a profitable relationshipwith the customer in question. However, by tailoringits solution to the needs of the end-users, Salesnetensures its client relationship is “stickier” and thatretention/renewal rates remain high.

As a corollary, an important component of Salesnet'ssuccess is its product architecture. Specifically, theactivity-based workflow embedded within the softwareis a crucial differentiating factor for the company. Thisworkflow enables customers to leverage best practicesin order to increase the effectiveness of the current salesforce and quickly ramp new sales personnel up to fullproductivity. It also provides managers with trackingtools to link sales activities with quantifiable results and

identify weaknesses that need to be addressed. Finally,the high degree of configurability facilitated by Salesnetenables managers and sales representatives to modifyexisting workflows, design and build custom workflowsand dashboards, build custom reports, and set useraccess permissions. Salesnet's product is also built torapidly integrate with existing systems, using over 200pre-built application adapters and connectors as well asa Web service-based API.

RightNow Technologies

Representing the other end of the CRM spectrum,RightNow Technologies has emerged as the dominantSaaS player in the customer service & support market.With 2003 revenues of just under $36 million, thecompany has achieved 25 consecutive quarters of rev-enue growth and has been cash flow positive for eightquarters. RightNow has signed over 1,000 customers,split evenly between midmarket firms and large enter-prises. The company offers both hosted and non-host-ed versions of its products and reports that 90% of itsnew customers are opting for the service-based model,typically on a two-year basis. In May 2004, the compa-ny filed for its initial public offering.

RightNow Service™, the company's flagship product,is a contact center solution enabling customer interac-tion across multiple channels, including phone, fax,email, and Internet (chat & self-service). By offering asingle application to manage these channels,RightNow facilitates more effective responses to cus-tomer inquiries, resulting in 10% - 30% reductions ininbound calls and 50% - 70% reductions in inquiryemails. The solution's features include intelligentWeb- and voice-based self-service, inquiry tracking,service quality analytics, surveys, and SLA compliance,among others.

In many ways, RightNow's approach epitomizes theshift from a product sales model to a service-based rela-tionship model. RightNow's product design incorpo-rates a high degree of configurability and customiza-tion, which are highly valued particularly by enterprisecustomers. The company's “LifeCycle Solutions


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Methodology”™ is designed to facilitate long-termclient relationships by providing services related to cus-tomization/integration, optimization, and ongoingcustomer support. Customers are able to scheduletheir own upgrades, manage their applications asthough they resided onsite, and customize the applica-tions to address their specific needs. The companyalso provides customer activity monitoring in order toensure that customers are benefiting from the fullbreadth of its products and have implemented themost recent version.

RightNow's “Tune-Up” program, recently profiled inthe media, has also proven highly successful in drivingstrong customer relationships. Tune Ups consist of a90-minute phone call with a RightNow consultant,who compares the client's use of RightNow's solutionsto a set of best practices within the appropriate indus-try. The consultant then assists the company in opti-mizing its operations in accordance with this score-card. RightNow has found that clients participating inthis program are four times more likely to renew at theend of their contract period.


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We believe developments among proprietary SaaSproviders are fueling the bulk of the innovation andmomentum in this space. Emerging SaaS firms areoffering purely Web-architected applications designedto be deployed as services over the Internet, and offer-ing narrow solutions that are more “on-point” in termsof addressing very specific business processes whilemany traditional ISVs are going to market with scaled-back versions of their current products.

Although these services generally lack the breadth offunctionality offered by traditional enterprise softwarepackages, proprietary SaaS firms are competing effective-ly by positioning themselves as specialists offering easily-integrated, focused applications. Given the choicebetween a major enterprise package that takes monthsto integrate versus an on-demand service that directlyaddresses the relevant business process and can go livein a matter of days or weeks, both SMEs and large firmsare finding the SaaS value proposition compelling.

Positioning their products to address specific businessfunctions has proven effective for software as a servicecompanies. Since enterprise buyers are currentlyinclined to view major implementations with skepti-cism, their corresponding preference to deploy Web-based point solutions provides SaaS providers with amajor opening. Many of these firms have seized on thisopportunity, crafting sales strategies that emphasizeboth the technical advantages of software as a serviceas well as the lower total cost of ownership (TCO) andhigh return on investment (ROI) associated with thesesolutions.

CHALLENGES WITH THE ISV TRANSFORMATION TO SOFTWARE AS A SERVICE

While many traditional ISVs are transforming theirbusinesses in response to software as a service models,many of their go-to-market strategies are predicated onscaled-back versions of their products. However, asprior attempts have illustrated, the transformationprocess for the traditional ISV is not without its own setof challenges.

Cultural Barriers. As has been illustrated in earli-er sections, the software as a service model is philo-sophically different than traditional ISVs modelsincluding a redefinition of the relationshipbetween vendor, customer, and third-party serviceproviders, a different value proposition, andchanging roles for ongoing delivery. In fundamen-tal contradiction to traditional ISVs, the SaaS firmbecomes a service-based relationship rather than atechnology enabler.

Technical Hurdles. To prosper in a multi-tenantdelivery model, SaaS firms utilize purely Web-nativeapplications that are based on a single instance ofan application rather than multiple instances sup-ported across different delivery environments(client/server, mainframe, Web-based) with tradi-tional ISV models. This is not an insurmountableundertaking by an established ISV, but requires acommitment to Web-based delivery. Additionally,technical development becomes much more adap-tive, as SaaS firms provide continuous updates on aweekly, monthly, or quarterly basis rather thanmajor upgrades every several years.

Sales & Partnership Conflicts. With ISV salesteams earning commissions on large upfrontlicenses rather than earning over the term of theagreement, re-aligning proper sales incentives &cultures is perhaps the largest impediment thatISVs face in successfully making a quick transi-tion. Sales teams are rewarded based on the cus-tomer's usage of the system over time rather thanbeing based on upfront license fees.

Customer Service, Application Support &Management, & Network Operations. We havealready made passing reference to the implicationsof convergence between software and services. Asthis process occurs, several challenges arise.Customer service and technical engineeringbecome intertwined as the company relies on cus-tomer feedback and user adoption trends in the


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refinement of its solutions. Administrative issuessurrounding customer support, account manage-ment, and application support become ongoingrather than one-time processes, and essentiallybecome the lifeblood of the SaaS provider in build-ing long-term client relationships. Additionally,network operations take on an additional role andare viewed as essential contributors and a hub forcustomer service & ongoing support.

Shift in Business Model and Explanation toWall Street. Lastly, with Wall Street demandingmore revenue and cash flow predictability out ofpublic technology companies, these types of busi-ness models are ultimately attractive, but are notwithout their short-term sacrifices. An ISV isforced to forgo larger software licensing deals inreturn for longer-term visibility. This disruptionto short-term revenue growth and EPS resultscan be punishing to ISVs by unforgivinginvestors that perhaps do not fully appreciate thepositive long-term impact. As a result, we believethat those ISVs that make internal commitmentswill do so sparingly and with gradual steps orresort to more aggressive tactics through mergersand acquisitions.

SOFTWARE AS A SERVICE SUCCESS STORIES

The on-demand model began to accelerate originally inthe CRM sector and now has spread to other applica-tion sectors, including content management, e-com-merce, business intelligence / analytics, supply chainmanagement, human resources and professional servic-es, healthcare, among other areas. In the course of com-piling this report, we interacted with senior executives atover 25 SaaS firms that have continued to rationalizethis market from being thought of as merely hostedapplications, pushing the envelope in terms of what“software as a service” really means. As a means of pro-viding concrete examples of the points we have beenmaking, we thought it would be instructive to profile

several leading software as a service providers, across arange of different functional and vertical specialties.

Web Content Management

CrownPeakis a privately-held software as a service firmfocused on the $1 billion web content managementmarket. The company's Advantage CMS™ product isan enterprise-class content management system, provid-ing web publishing, asset management, document man-agement, and content versioning & syndication. Thecompany also offers modules for web site managementas well as SOAP and XML-based APIs for easy integra-tion with current systems.

Since commencing operations four years ago,CrownPeak has already completed 250 deploymentsand has started to make inroads against entrenched tra-ditional vendors like Documentum (now part of EMCCorp.) and Vignette. Serving primarily mid-marketfirms and large enterprises, CrownPeak has experi-enced a strong increase in demand since the middle of2003, with buyer attitudes more open toward IT invest-ments in general and displaying a high degree of inter-est in on-demand solutions in particular.

CrownPeak differentiates itself from its competitionalong several distinct lines. The company places a greatdeal of emphasis on the flexibility and ease-of-use of itsproducts, combining a sophisticated but user-friendlyapplication with a flexible development environmentand Web services-based connections for non-invasiveinstallations. CrownPeak's offering is also distinguishedby its focus on professional services. Reversing the logicof the traditional ASPs, which contended that applica-tion providers needed to minimize their investment inprofessional and support services in order to reap thenecessary economies of scale, CrownPeak dedicatesresources to working with end-users in order to cus-tomize and optimize the application according to theirspecific business needs. This approach has resulted in anextremely high customer renewal rate and strongmomentum in moving up-market into larger accounts.


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Commerce / Content / Search

Atomz is a privately-held software as a service firm thathas been in operation for approximately five and halfyears. Starting from the premise that 85% of allInternet purchases involve some level of searching,Atomz's hosted offering is designed to bridge the com-merce, search, content management, and marketingsectors by providing users with the ability to create tem-plates, workflows, business rules, and digital assets todrive online shoppers to relevant products. The compa-ny targets primarily large enterprises and currentlyserves over 1,400 such customers, including large enter-prises such as Sony, Time Warner, Verizon Wireless,GE, and CBS. The company has reported an impressive95% customer renewal rate, which is a crucial metric asSaaS firms scale their businesses.

Atomz's 100% hosted solution offerings - AtomzCommerce™, Atomz Media & Entertainment™, andAtomz Enterprise™ - are designed to drive greater trans-action activity across its clients' e-commerce systems andto facilitate higher customer retention and a greaterdegree of self-service and automation. The Commerce,Media & Entertainment, and Enterprise solutions arebased around the following applications:

Atomz Search™ is a search/browse applicationthat enables online retailers to utilize keyword-based promotions to provide their customers witha “guided shopping” experience and drive incre-mental sales via cross-selling and up-selling.

Atomz Publish™ is a Web content managementapplication with an intuitive user interface thatallows quick content editing and deployment atthe business user, rather than website administra-tor level. The application also provides workflow-enabled email that facilitates easy collaboration aswell as providing an audit trail.

Atomz Promote™ is an e-marketing applicationthat enables Atomz's clients to offer targeted pro-motions and content to their own customers. Theapplication provides online retailers with the

tools to design and manage campaigns and a busi-ness rules-based means of identifying related prod-ucts and cross-selling opportunities. Finally,Atomz Promote provides reporting functionalityto assess the impact of a campaign.

Atomz Connect™ enables retailers to provide target-ed, opt-in email content to customers based on spec-ified areas of interest. The application also providesthese firms with the ability to design and initiateemail campaigns.

Human Resources

The human resources sector is proving to be fertileground for software as a service vendors, as enterpriseshave become accustomed over the last 10-20 years tofarming out various HR functions to payroll processorsand HR outsourcers. Now a new generation of HR-focused SaaS companies is capitalizing on this trackrecord and experiencing strong receptivity for theirsolutions. One such company is Workscape, a privately-held provider of workforce management and benefitsadministration solutions. Cash flow positive andreporting consistent revenue growth, the company hasexperienced strong sales traction among mid-marketfirms and large enterprises and now counts over fiftyFortune 500 companies among its clients.

Workscape offers integrated applications and servicesin the following areas:

Outsourced Benefits Administration. Workscape'ssolutions provide automation for all facets of ben-efits administration, including enrollment & eligi-bility, regulatory administration (e.g. HIPAA,COBRA), and employee management.

Workforce Management. The company's work-force management offerings provide functionalityrelated to compensation planning, employee per-formance evaluation, and career development.

Employee Self-Service. A core component ofWorkscape's value-add is its ability to drive a high-er degree of employee self-service by providing a


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centralized, intuitive interface that enables employeesto manage their own benefits, thereby reducing theexpenses incurred by the client enterprise on adminis-trative tasks.

Since launching in 1999, the company has establisheditself not only as one of the leading HR outsourcingcompanies, but as one of a handful of SaaS firms thathave successfully executed upon a relatively aggressiveacquisition strategy. Most recently, Workscape acquiredTALX Corporation's benefits enrollment business, HRservice center operator CallConnect, and employee per-formance management software vendor Performaworks.These and other transactions served to broadenWorkscape's solutions portfolio and enabled the com-pany to capture an increasing percentage of enterprises'HR spend.

Employease is another SaaS provider that has estab-lished a strong position within the human resourcessector. Founded in 1996 to address the “disenfran-chised” small-to-medium enterprise market, privately-held Employease currently serves over 1,000 clientcompanies and has experienced 26 consecutive quar-ters of revenue growth. Although the bulk of theseclients are SMEs, the company reports increasing inter-est from large enterprises, driven by the high degree ofconfigurability and customization enabled byEmployease's purely Web-native applications. As ameans of maintaining its edge in product develop-ment, the firm introduces three major upgrades peryear in addition to minor updates every month.Offering such a high degree of product sophisticationand flexibility, particularly in implementing upgradeswithout disrupting customer operations, is proving tobe a vital ability for winning business from SMEs andlarge corporations alike.

Employease's applications and outsourcing servicesfocus on core HR and benefits functionality. The com-pany's HR applications address performance manage-ment, vacation/leave tracking, employee self-service,and reporting functionality, while the firm's benefitssolutions provide such features as administration soft-ware, employee enrollment and communication man-

agement, insurance carrier invoicing, and billing. Bothsets of applications are easily integrated with other par-ticipants in the HR value chain, such as payroll systemsand insurance carriers. Finally, Employease offers BPOservices including call center, enrollment, billing, andCOBRA & HIPAA administration.

Procurement & Supply Chain

The procurement and supply chain sector is also devel-oping into a strong market for on-demand solutions,attracting both pure-play SaaS firms and hybrid vendorsalike. SciQuest is one noteworthy firm that falls withinthe latter category, as a publicly-traded software vendorthat successfully built a significant SaaS offering withinprocurement and supplier relationship management.With ambitions toward launching a broad, horizontalplatform, SciQuest initially targeted the life science andhigher education verticals and achieved a high degreeof success. The company has witnessed its on-demandrevenues increase 100% year-over-year, fueled by clientssuch as GlaxoSmithKline, Schering-Plough, Pfizer, anda number of top-tier research universities.

SciQuest's solutions provide functionality related tosupplier enablement, procurement automation, andmaterials management. Within supplier enablement,the company's catalog tools enable users to search forand compare products, as well as allowing managers todirect spending toward preferred suppliers. SciQuest'sprocurement applications provide integration betweenenterprise and supplier systems, reducing the time andexpense associated with the ordering process. Finally,the materials management solution includes a central-ized database to facilitate improved inventory manage-ment and order fulfillment.

In April 2004, SciQuest announced an agreement underwhich it would be acquired by Trinity Ventures for over 3.5xtrailing revenue and a 50% premium over the previous day'sclose. This transaction was conceived primarily as a means ofeliminating the distractions of being a public company andenabling the firm to focus on building out its on-demand offer-ings and expanding its customer base.


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Finance & Accounting

Within the finance & accounting segment of the ERPmarket, privately-held Intacct is emerging as a leadingSaaS provider. Founded in 1999, Intacct has raised over$40 million in venture capital and currently serves over2,000 clients, primarily small businesses and mid-mar-ket companies. The company has experienced strongrevenue growth and is closing in on profitability.

Intacct offers three variations of its software. Eledger™provides general ledger, cash management, and accountspayable functionality for small businesses (sub-50employees), and add-on modules include professionalservices automation, retirement, and time & billing func-tionality. Intacct's Enterprise™ product offers a higherlevel of accounting functionality designed for mid-mar-ket companies, with more robust optional modules thataddress inventory and purchasing. Finally, the company'sfastest growing solution, MEGA™ (Multi-Entity GeneralAccounting) is designed to meet the needs of larger com-panies that operate multiple locations, franchises, or sub-sidiaries. MEGA offers high-level accounting and financefunctionality for these businesses, provides consolidatedfinancial information, enables reporting & analytics, andfacilitates either centralized or distributed transactionactivity. Intacct's solutions are also fully integrated withpayroll systems from Intuit and ADP.

Healthcare

Marked by aging, homegrown legacy computing sys-tems, an increasing need to improve payer andprovider efficiency, and a growing focus on cost con-tainment, the healthcare industry is proving to be fer-tile ground for outsourcing, and SaaS firms are benefit-ing from this macro-trend. SCI Systems and ThirdMillennium Healthcare Systems are two leading SaaSproviders targeting this vertical.

SCI Systems (formerly Scheduling.com) is a SaaS firmproviding access management and revenue cycle man-agement applications to healthcare providers such ashospitals, clinics, and physicians' offices as well as toconsumers. The company has over 60 current cus-

tomers, who generally sign up for contacts lastingbetween three and five years. SCI Systems has experi-enced strong revenue growth, with over 80% of rev-enues generated by recurring monthly fees, is cash flowpositive, and has attained “critical mass” to drive signif-icant profit margins.

SCI Systems' solutions improve efficiency withinhealthcare providers' scheduling and revenue cycle busi-ness processes. The company's offering includes the fol-lowing applications:

Patient Scheduling™ provides a rules-based work-flow that enables hospitals and other providers toschedule patient visits and procedures and to allo-cate staff and resources appropriately.

Patient Registration™ collects relevant patientand insurance data in order to facilitate a fasterbilling cycle.

Access Assurance™ provides a Web-based meansof gathering patient eligibility, referral, andauthorization information from insurers and ren-dering medical necessity decisions.

Patient Reminders™ provide multi-channelappointment notifications to consumers in orderto reduce the number of “no-shows” and theaccompanying misallocation of resources.

Consumer Appointments™ enables patients toschedule medical visits online and access relevantinformation, such as insurance data and appoint-ment history.

Provider Portal™ provides physicians with a net-worked means of scheduling appointments & pro-cedures and of coordinating the required resources.

To take another example, Third MillenniumHealthcare Systems provides solutions more directlytargeted at revenue cycle management (RCM) forhealthcare providers such as hospitals and clinics. Thecompany's core RCM offering facilitates more effectivemanagement of receivables in order to accelerate collec-


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tions and improve cash flow. The application auto-mates functions related to claims processing, billing,and the identification of problematic accounts. OtherThird Millennium applications address the correctionand reprocessing of denied/rejected claims, documentmanagement, and report generation.

Hybrid Models

As IT firms position themselves to respond to thethreats and opportunities presented by software as aservice, we expect to witness a proliferation of a num-ber of hybrid firms. We are aware of a number of com-panies pursuing such a model, such as eMeta (profiledbelow), Silver Oak Solutions, and SPS Commerce, that aregoing to market with some combination of profession-al services, licensed software, and on-demand solutions.

While initially predicated on an enterprise-class soft-ware model, privately-held eMeta has been making pos-itive inroads with a hosted, subscription-based offeringthat solves the challenges associated with online accesscontrol and e-commerce of digital assets and services.The company has effectively helped enable the onlinemarket and e-commerce opportunity for digital con-tent, data and intellectual property to mature. As aresult, the company has become mission-critical infra-structure in securing and commercializing the digitalassets and services for some of the world's most presti-gious corporations and most frequently visited web sites,including more than 100 web sites processing millionsof unique visitors each day. Originally targeting andsecuring enterprise license relationships with the world'slargest publishers and information providers such asThe McGraw-Hill Companies, The New York Times,Financial Times, Thomson, Reed Elsevier, among manyothers, eMeta has augmented its licensed offerings witha mid-market and SME hosted solution that is based onthe same feature-rich enterprise offering, but with theadded benefit of a service-based relationship thatensures optimal end-user application performance andtactical execution of e-commerce initiatives.

Its technology is based on an open-standards technolo-gy platform designed in Java and developed to be inter-

operable with numerous technology platforms andclient-side applications. The company's hosted andenterprise offerings consist of the following:

eRightsWEB™ is the hosted information accesscontrol and commerce service-based offering thatallows firms to sell digital assets and services,shorten the time-to-market and reduce up-frontcosts for executing upon its e-commerce strategy.This hosted offering leverages the capabilitiesoffered in eMeta's modular, enterprise softwarelicensing products:

RightAccess™ provides sophisticated accessprotection for digital assets and services,including rich user authentication and verygranular authorization and delegatedadministration for both consumer and busi-ness end customers.

RightCommerce™ a robust, fully integrat-ed commerce system with numerousbilling and payment options includingpromotions, dynamic pricing, pay-per-view, teleco, metering, rate-plan changesand progressions and full subscription life-cycle management.

RightsServices™ provides authentication,authorization, metering and completebilling features for software assets deliveredby Web Services.


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As a result of the challenges that incumbent ISVs face,we believe that SaaS firms that are competitively posi-tioned with successful models will make for very attrac-tive merger and acquisition targets. While several pri-vate companies are becoming public companies at thetime of this report, we believe that some of the moststrategic opportunities for SaaS firms will be the resultof M&A with ISVs replying to broader market condi-tions and competitive pressures. Throughout thecourse of this paper, we have made reference to the keysto success for SaaS firms to incorporate into their strate-gies. We thought it would be useful to briefly recap ourrecommendations for emerging companies looking tocreate long-term shareholder value in this regard:

Scalability and Critical Mass. Above all else,SaaS firms must maintain their focus on build-ing their customer base and scaling to profitabil-ity, since payment streams are considerablysmaller at the outset when compared to the tra-ditional licensing model. By comparison, whilesigning 20 clients in a quarter may result in $20million-plus in revenues for licensing firms, it isa much smaller fraction for the SaaS. Once athreshold is reached, the SaaS can enjoy the ben-efits of stable revenues and predictable cashflows but as we have stated, reaching criticalmass can be a significant challenge and take aninvestment of time and patient investors. All ofour other recommendations are predicated onthe importance of scalability.

Narrow Solutions with Quantifiable ROI thatAddresses Precise Business Needs. Due to theinvestment required to reach scalability, the SaaSfirm cannot afford to run the risk of being 'allthings to all people'. Traditional ISVs have a sig-nificant advantage in terms of R&D investmentand product functionality accumulated over theyears, making it difficult for SaaS firms to imme-diately “play catch-up” with regard to functionali-ty. As a result, many of the successful SaaS firmshave carved out niches in the market to address

particular 'pressure points'. We believe this nar-rowly focused approach that quantifies a ROI fora client is an effective go-forward strategy.

Client Acquisition & Retention. Strong cus-tomer acquisition and retention metrics are vitalto SaaS firms, as their business model requires arapidly growing customer base with minimalturnover. These firms must achieve contractrenewal rates of at least 90%, and probably higher,in order to achieve positive operating margins.This need for high retention in turn drives SaaSfirms to place a premium on effective customerservice. In addition, we believe many SaaS firmswill find a more lucrative customer base as theymove upstream into larger enterprise accounts.

Sales Channels & Partnerships. Many SaaS firmsfind traditional indirect sales channels with majorsystems integrators somewhat restricted, sincetheir rapid implementation cycles eliminate largesources of revenues for the service firms that usu-ally provide valuable solution selling competenciesto ISVs. As a result, effective direct sales or alter-native channels to the market are important forSaaS firms, while these firms learn to take advan-tage of the opportunity and ROI over the tradi-tional software model (high upfront fees, uncer-tain implementation timeframes, integration andsupport costs, etc.), as well as upgrade cycles, merg-ers & acquisitions, and other technology purchas-ing that trigger events to sell into customers. Inaddition to direct channels, numerous SaaS firmshave sought business alliances with mid-tier con-sulting firms, VARs / OEM relationships, andeven private labeled hosted offerings with thirdparties as a way to achieve more market visibility.In our eyes, this will continue to be one of themost challenging and critical factors impacting thelong-term success of SaaS firms as conventionalgo-to-market alliances are not as readily availableand require much more creative ways to drive mar-ket adoption.

R E C O M M E N D A T I O N S F O R S A A S F I R M S

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Move Upstream into Enterprise Accounts. Inthe earlier days of SaaS, the model was largelypredicated on providing hosted solutions forSME and mid-market accounts. This marketfocus has not changed, but growing evidence sug-gests that larger organizations are open to consid-ering the merit of hosted solutions. In looking tobuild long-term value, we believe that SaaS firmswill need to continue to demonstrate their abili-ty to migrate into the larger accounts while con-tinuing to service the SME market. This is animportant driver in terms of displacing incum-bent ISVs and expanding the SaaS market

Educating the Market. As we outlined earlier,current SaaS sales & marketing efforts representa new, more “value-added” means of conveyingthe software as a service value proposition.Moving beyond the “base case” for software as aservice, which brought the traditional argumentsfor IT outsourcing down to the application level,the new approach is centered upon replacing theusual software vendor relationship with a newrelationship that creates value in terms of bothtechnology and service. This new value proposi-tion is marked by the following characteristics:

High degree of customer service leading tostrong client relationships

Ongoing support and product upgrades

Emphasis on targeted solutions ratherthan broad horizontal applications

Support for open standards to alleviateintegration complexities

Focus on demonstrating rapid and signifi-cant return on investment

Vertical and business process specificfunctionality


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The enterprise software industry is undergoing a fun-damental shift in how technology is being deliveredand sold with new models changing the relationshipbetween vendor, client or end-user, and third-partyservice provider. The trend toward software as a servicerepresents a dramatic shift that has been broughtabout by an interest in lowering the total cost of appli-cation ownership, generating a faster return on tech-nology investments, sharing in the application execu-tion risks, and eliminating large, upfront and 'hidden'operational costs.

The on-demand model first grew into prominence inthe hosted CRM space where firms likeSalesforce.com, RightNow, and Salesnet have alldemonstrated the attractiveness of the model andintroduced it into the mainstream. Now, the softwareas a service model is spreading to other layers of theenterprise software infrastructure moving beyond anearly-adopter phase within certain sectors like contentmanagement, e-commerce, business intelligence / ana-lytics, human resources, supply chain management,etc. by validating the model with a growing list of satis-fied clients. As a result, in several years, certain appli-cation categories will witness software as a serviceassuming a very meaningful role where traditionalenterprise software once dominated. The success ofthe on-demand CRM firms as well as SaaS companiesin other application categories, combined with Siebel'sentry into the hosted market with its on-demand solu-tion and recent acquisitions, are combining to validatethe software as a service model.

However, due to the fundamental differences betweenthe license and software as a service model - cultural,technical, sales incentives, customer service and opera-tional, investor expectations, etc. - we believe thatmany of the large ISVs will slowly adapt or transitionon their own. Going forward, we believe that softwareas a service will be led by emerging, private companiesthat have addressed these challenges from the outset bydeveloping proprietary applications that are properlyarchitected for Internet delivery and an infrastructure

designed to support this new delivery mechanism. Asthese firms gain momentum, traditional ISVs will berequired to adapt or risk losing market share to a newgroup of competitors. These implications will be far-reaching, disrupting not only the role of traditionalISVs, but also other sectors such as consulting and ITservices firms who have relied on large, upfront soft-ware license deals to secure large implementation andintegration projects.

While software as a service is rapidly forcing change insome sectors, by all accounts, the model still consti-tutes just a small fraction of the overall software indus-try, a market IDC sizes at $190 billion in spending.However, its emergence is likely to impact some soft-ware sectors much sooner than others, which willrequire incumbent players to quickly re-define theirstrategies or risk losing market share to a new breed ofcompetition. A helpful analogy might be the consumerInternet commerce market led by the likes of eBay andAmazon, which dispelled the initial security and per-formance concerns and continue to gain market shareagainst their bricks & mortar competitors. Once SaaSfirms have proven themselves as worthy adversaries andconquered some of the challenges facing these models,we believe that enterprise ISVs will make strategicacquisitions to gain these competencies, acquire a newcompetitive advantage, and to ensure their ownsmooth transition to service-based delivery.Consequently, privately-held firms that have success-fully mastered the software as a service deliveryprocess, proven their business model, and overcomeindustry challenges are poised to prosper and buildlong-term shareholder value.

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A P P E N D I X : G E N E R A L R E F E R E N C E S

The following resources complemented the sources cited in the report as well as our executive discussions in providing valuable backgroundinformation on the SaaS market.

Aberdeen Group Research

n Hosted CRM Gains Momentum as salesforce.com Paces the Market, October 2003.

IDC Research

n 2004 AppSourcing Taxonomy & Research Guide (#28743)

n Model For Turning Information Assets into Hosted Web Services (#29595)

n New Foundations for Software Pricing & Licensing (#29569)

n Software Business Models Must Adapt to a New Era (#29229)

n U.S. Software as a Service Forecast by Delivery Model, 2004-2008 (#31267)

n Worldwide Enterprise ASP Competitive Analysis, 2003 (#29813)

n Worldwide Software as a Service Competitive Analysis, 2003: IDC's Top 10 Vendors for 2002 (#30131)

n Worldwide and U.S. Software as a Service 2004-2008 Forecast & Analysis (#31016)

Industry Resources

n ASPNews.com

n ASPStreet.com

n Information Week

n InfoWorld

n Outsourcing-Center.com

SEC Filings

n Salesforce.com S-1 & amendments

n RightNow Technologies S-1 & amendments

n Taleo S-1 & amendments

n WebSideStory S-1 & amendments

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Business Intelligence

WebSideStory www.hitbox.com

Content/Commerce/Search

Atomz www.atomz.com

Content Management

CrownPeak www.crownpeak.com

Communication/Collaboration

BlueTie www.bluetie.com

Intranets.com www.intranets.com

CRM

NetSuite www.netsuite.com

Motive www.motive.com

RightNow Technologies www.rightnow.com

Salesforce.com www.salesforce.com

SalesNet www.salesnet.com

Finance / Accounting / Expense Management

Concur www.concur.com

Intacct www.intacct.com

Ketera Technologies www.ketera.com

Outtask www.outtask.com

Paycycle www.paycycle.com

Healthcare

Third Millennium Healthcare Systems www.tmhsi.com

SCI Systems www.scisystems.com

Human Resources

Employease www.employease.com

PeopleClick www.peopleclick.com

Softscape www.softscape.com

Taleo www.taleo.com

Workscape www.workscape.com

Meeting Management

SeeUThere www.seeuthere.com

Procurement and Supply Chain

Nistevo www.nistevo.com

SciQuest www.sciquest.com

Professional Services Automation

OpenAir www.openair.com

Vertical Applications

ARC Systems www.arcsystems.com

Silver Oak Solutions www.silveroaksolutions.com

Sinex www.sinex.com


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