SaaS A Guide to Pricing, Terms & Savings Overview There is no shortage of SaaS buyers guides that focus on how to select the best vendor for your IT and business needs. However, there are very few resources that closely examine the unique considerations and pitfalls surrounding SaaS pricing and terms. This white paper will discuss considerations and tactics IT and procurement executives can use to ensure they achieve the fairest pricing and terms for their SaaS purchases.
SaaS A Guide to Pricing, Terms & Savings Executive Summary Software as a Service (SaaS) is a seismic shift in the delivery model for enterprise software. Pundits have sung its praises, and its critics have spoken. For many organizations, SaaS has the potential to offer valuable operational and financial payback. This white paper focuses on the costing and contracting pitfalls that often impede, even negate, the benefits that SaaS delivers. Software as a Service (SaaS) is a software delivery model where multi-tenant application functionality is run in the cloud by a third party and provided remotely to the user through a subscription-based pay-per-user or pay-per-usage model. The buyer does not take ownership of the software. Rather, it is owned, delivered and managed remotely by the vendor/software provider. The benefits of SaaS have long attracted corporate IT and executives. First and foremost, SaaS enables companies to keep up with the rapid pace of software s technological advancements in a cost-effective way. There is no need to go through a cumbersome software upgrade every time a new feature is added Gartner expects the enterprise SaaS or install a new patch each time a specific vulnerability is uncovered, because market will total $10.7 billion in 2011, the vendor maintains the software off-premise. Because the software is stored a 16.2% increase from 2010. and maintained externally, SaaS requires fewer IT resources. (Source: Gartner, Inc. December 2010) On the surface, SaaS sounds perfect and, for many companies, the decision is a no-brainer. For others, the value of SaaS is harder to determine. The problem goes deeper than just evaluating benefits. Most companies are unaware of the precautions they should take as they select and contract with SaaS vendors. For that reason, NPI has created a new kind of buyer s guide. This paper aims to arm companies with the insight that will help them understand long-term cost and benefit comparisons between SaaS and traditional software delivery models, as well as insight that will navigate buyers around costing and contract pitfalls. An Inside Look at SaaS versus Traditional Software Model Pricing, Contracts and Delivery The differences between SaaS versus traditional software models (TSM) go well beyond who hosts the application. The pricing models, the contract terms and conditions, and how software updates are delivered are also fundamentally different. Pricing Traditional Software Model The traditional model involves several pricing layers. First, the software application is purchased in the form of a perpetual or term license. Then, companies pay an additional annual cost for maintenance and support. In this situation, the vendor s long-term revenue strategy is to make as much money as possible from ongoing annual maintenance and support, which typically represent 17-22 percent of the upfront license cost. In addition to paying for annual maintenance costs, which tend to rise year over year, companies may also pay extra for upgrades and patches. Professional services (either through the vendor or through a third party) may also be required to successfully customize, implement and/or deploy these product updates. www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 1
The last layer of cost in the TSM pricing model is the hardware and software infrastructure to run the applications. This includes servers, security, power, operating system support, as well as the IT staff resources required to administer this infrastructure, maintain the software and provide support to end users. SaaS SaaS offers a less complex, and often more affordable, operations and cost model. Typically, the price includes a small upfront fee to set up users in the application. From there, costs are comprised of a subscription-based pricing model based on the number of users or usage. While pay-per-user is by far the most common pricing model, pay-per-use (e.g. per transaction) and pay-per-functionality are also common. With SaaS, the buyer purchases the right to use the software rather than a license to the actual software. The software is stored and run off-premise at a third party location. Therefore, the infrastructure costs to the buyer are not very high as these are borne by the vendor. Upgrades and patches are not purchased separately and usually occur automatically, thereby eliminating the need for professional services or costly maintenance and support agreements, and eliminating IT staff overhead. The SaaS pricing model can also be tiered by functionality. Today, many SaaS providers have various editions of their product ranging from premium versions with added functionality to freemium versions with only limited functionality. As with TSM, SaaS costs do accumulate over time. The difference is that they accumulate in a more linear fashion under the SaaS model, as opposed to the spiky costs inherent in TSM. Hybrid Model Recently, a hybrid software delivery model has emerged. In this model, vendors combine the best of TSM ownership and support with the flexibility, accessibility and cost efficiency of SaaS. There are many variations of this model, driven by companies desire to experience the cost benefits of SaaS, while having access to the customization capabilities and security offered by a pure TSM model. Contract Duration In SaaS, a company has the right to use the software for as long as the subscription is current. If the contract or subscription is not renewed, the buyer forfeits access to the application. This is in sharp contrast to TSM, where the buyer purchases a (typically perpetual) license to the software and can use the software beyond the duration of any maintenance and support contract. However, it is important to note that upgrades and patches cost much less to install while a company is under a maintenance and support contract for their TSM investment. An upgrade or patch outside of a traditional maintenance and support agreement will most likely require an upfront cost to access the update(s), as well as the cost of IT resources to implement and deploy the update. The transition to SaaS was much more complex than we realized. If we hadn t known how to properly navigate and negotiate our vendor contrac t, we could have easily overbought licenses and had less than satisfactory SLAs. CIO, Major Retail Organization The contract duration for SaaS and TSM can vary. In both models, the buyer www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 2
can typically leverage a longer contract duration for a lower price. This is achieved through effective negotiations. However, companies should have clarity around how long they want to invest in the software before entering these negotiations. Depending on your business model and strategic planning, committing to a 10-year contract may not make sense even if the cost savings look substantial on paper. Time to Deployment One of the clear advantages of SaaS is the quick deployment of the application. The same goes for product updates, upgrades and patches. In a SaaS application, companies get access to new functionality or product fixes automatically. All updates occur behind the scenes as opposed to having to be upgraded/updated on premise (and subject to infrastructure and IT staff availability). SaaS Costing Pitfalls For some, the cost benefits of SaaS far outweigh any sacrifice in customization and flexibility. But, there are many pitfalls within the SaaS costing and contracting models about which companies should be aware. These pitfalls can often negate or at the very least, lessen the cost benefits of SaaS. Therefore, companies should consider the following as they evaluate and procure SaaS solutions: Switching Costs: One commonly stated advantage of SaaS is the reduced switching costs or the cost for a company to switch from a legacy application to a new application (regardless of whether it is SaaS or TSM). While this is true, there are still associated switching costs, which need to be taken into consideration while investing in a SaaS application. These costs range from direct costs to indirect costs. On the indirect side, the switch to a SaaS application from a legacy traditional software application can give rise to cost redundancies, such as investments in servers and data center infrastructure that will no longer be used. While this does not represent an immediate cost to the enterprise, the fact that these IT infrastructure components will now be underutilized represents wasteful spending. For example, how will a move to SaaS impact a company s existing data center investments? Will the data center s space and power costs still be justified? It may be worth simply scaling your on-premise solution versus creating investment redundancies through a move to SaaS. Direct costs include data transfer and customizations, as well as integration costs and data cleansing. Moving data from one application to another is no easy feat, especially as the functionality and structure varies between software vendors. Total Cost of Ownership (TCO): While it is generally believed that SaaS is cheaper than TSM, this is not necessarily true. To calculate and compare the actual costs over a period of time, it s important to know the time period (e.g. 1 year, 3 years, 5 years, 10 years, etc.) for which the application will be used. TCO over the course of a predetermined time should be calculated for both models, then compared. Remember maintenance, upgrades and patches should always be factored into TSM costs as they represent a major portion of long-term costs. For large enterprises with a large number of users, SaaS may not deliver as much value in the long term. The bigger an organization is, the more complex the requirements are for any software application. That typically translates into more customizations and integration issues all of which increase spending. www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 3
As mentioned earlier, the TCO of SaaS increases in a consistently linear fashion, versus a TSM cost structure that requires heavy upfront investment, but levels out over time. In fact, the compounded per-user costs of SaaS for a large enterprise can easily outweigh the total cost of ownership for TSM. Industry research from experts such as Forrester Research has pointed out that SaaS cost benefits become null within five years (for large enterprises). After five years, on-premise software becomes the cheaper option. Companies should do their own cost comparisons, while factoring in the indirect costs of administration and management as well as their unique business scenarios, to determine which software model is the best fit. In a survey of 1,000 businesses, 44% of companies claim to have at least one business application on the cloud, and more than 70% indicate they will move more applications over in the next 12 months. (Source: MarketBridge, January 2011) SaaS Contract Pitfalls There are many areas in SaaS contracting where buyers should be wary. These areas are prone to hidden costs and can often lead to minimal recourse in the event of poor performance, security and service levels. At a minimum, buyers should ensure the following areas of their contract are ironclad: Users & Functionality: Get rid of minimum purchase clauses. Buyers should not fall prey to requirements to buy a minimum number of licenses (or have a minimum number of users) over the term of the contract. This will prevent you from reducing the number of users in the event you have to downsize business operations, cut staff, etc. Many companies ended up overpaying SaaS vendors in the most recent economic recession (2008/2009) when they had to downsize. For example, a company in 2007 may have needed 500 users while the economy was strong only to cut its user base to 150 in 2009. Today s economic climate is still unpredictable with many industries still teetering between recovery and recession, and without a clause that protects your right to reduce your number of users, usage and/or functionality, you can easily be locked into inflexible spending negating one of the most highly touted SaaS benefits. On the flip side, many companies expect solid growth in 2011. With that in mind, they should require vendors to specify their ability to ramp up new users/usage quickly. What happens if your company takes on a major client or acquires another company? How quickly can your SaaS-based business application adapt? If a vendor can t support a major increase in users, then a company needs to evaluate other vendors. This must be specified in the contract not just in sales talk. Data Protection: One of the first things a company should do when procuring a SaaS solution is establish data ownership. This includes who owns the data as well as the data migration procedures and costs. Many companies subscribe to a SaaS solution assuming the data migration and ownership costs will be incurred by the vendor. That s not always the case and, depending on how the vendor works, can add another cost and complexity layer to your SaaS purchase. Another facet of data protection is disaster recovery and backup. How a vendor stores, backs up and continues service in the event of a crisis/disaster is extremely important. Your contract should include a service level agreement that clearly specifies performance metrics such as server uptime. Additionally, because your data will reside in a data center versus within your business, your contract should clearly communicate the vendor s disaster recovery and business continuity capabilities. This includes specifying how often data is backed up, where backup is stored and so on. Lastly, companies should make sure data confidentiality is addressed in their SaaS vendor contract. SaaS is based on a www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 4
multi-tenant architecture where a vendor stores multiple clients data within a single location. Ensuring this data is protected and kept confidential is key. Upgrades & Renewals: Many companies assume upgrades and renewals are a non-issue in SaaS contracting. While most SaaS vendors don t charge for upgrades, don t assume they re free. Confirm the cost in your contract. Additionally, be sure to address renewal rates in your contract by inserting language that limits or prevents renewal rate increases. Not doing this empowers your vendor to enact unreasonable rate increases once your contract is up for renewal. Performance: When transitioning from a TSM application to a SaaS model, you are consequently outsourcing performance quality assurance. Therefore, you need to determine service level guarantees and performance metrics in your contract. These should address application availability uptime, performance monitoring, security, support response time and help desk accessibility (among others). Buyers should also define grounds for termination for unacceptable performance. If there is a failure to meet certain service level agreement (SLA) requirements, buyers should specify the solution (e.g. SLA credits). This is of increased importance for security performance metrics, where compliance and brand trust is on the line. Finally, buyers should specify termination costs and data transfer guidelines. Should you choose to terminate your vendor agreement, you need to understand the costs of doing so beforehand. Specify these costs, as well as data transfer costs and procedures, up front in the contract. Vendor Health, Risk Assessment & Auditing: Demand and perform due diligence on vendor health. Companies should conduct a diligence check on the vendor to determine financial health, use of subcontractors/third-parties, etc. This includes conducting reference checks of other clients who are in the same industry. Given the young nature of the SaaS industry and its players, companies should select vendors that understand not only the challenges of SaaS delivery, but the challenges and key business processes of their specific industry. As part of your due diligence, you should ensure that your vendor can meet any legal and e-discovery requirements set forth by your clients, partners or industry. Certain industries have specific regulations about data, email, what should be stored, for what period of time, etc. Include a right to audit clause in your contract that allows you to audit the vendor s facility. Due to multi-tenancy, the usual forms of audits may not be possible; therefore, these requirements should be established beforehand. For some companies, it may be important to require that the vendor be compliant with SAS 70 Type II reporting. Service risk management has become increasingly important as companies further understand the business continuity risks associated with the SaaS delivery model. For this reason, thorough risk assessment and analysis should be carried out as companies evaluate vendors. For example, what is your risk tolerance to down time? What would happen to your operations if Complex implementation projects, multi-year contracts with payment upfront, deal sizes that run to six- or seven-figure sums, alliances with the established global SIs, and account management teams recruited from the ranks of old-guard vendors such as Oracle, IBM and HP. Meet the new boss, same as the old boss. (Source: ZDNET, Loosely coupled crowd development, February 2011) www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 5
you were down one day a week? One day a quarter? How can you mitigate those risks? The combination of contractual requirements (such as SLAs) and smart vendor selection will best serve your business operations. Managing Your SaaS Vendor for Long-Term Savings & Protection Saving opportunities go beyond the contract phase of any vendor agreement. How you manage your SaaS vendor is directly related to your overall spend. There are three key areas that you should focus on to calibrate your vendor relationship for long-term savings and data protection: Have a transition assistance clause: At some point in time, you will switch vendors. Save yourself the cost and headache of a painful switching experience by including a transition assistance clause in your agreement. Ask your vendor to provide support to export data, document interfaces and customizations that you will need to share with a new vendor. Negotiate renewal rates: Renewal rates should always be negotiable no exceptions. Demand that any rate increases be negotiable as part of your contract specifications. Enforce SLAs: As with all software, SLAs should be measurable and enforceable. Stay on top of your vendor and make sure they are meeting all performance metrics and service level requirements. When performance is subpar, enact the penalties specified in your contract. You ve outsourced a lot of control to your vendor don t let them abuse or misuse it. Conclusion Buyers should create and execute a targeted cost management strategy for their SaaS investments. This involves arming themselves with protection against the cost, contractual and performance-related pitfalls that have haunted many SaaS buyers. Through a long-term cost comparison before the purchase, contract-driven cost management tactics and post-contract spend management, companies can improve the performance of their SaaS investment and optimize total cost of ownership. In some ways, SaaS procurement represents the Wild West of IT spending where transparency, standards and visibility have yet to be normalized. Insight into market pricing data, contract pitfalls and vendor flexibility will ensure that a company s next SaaS investment is optimized for performance and savings. About NPI NPI is a spend management consulting firm that protects companies from overspending in specific cost categories information technology, telecommunications, transportation and energy. The savings we deliver are used to fund other investments and to increase profits. Using a combination of market experts, proprietary methodologies and extensive data, NPI ensures that prices and terms are in line with best-in-class benchmarks. Reviewing more than 14,000 purchases annually, we provide objective oversight for billions of dollars of strategic spend for our clients. NPI s commitment to seeing recommendations through to execution is reflected in our resultsbased fee structure. Our services are self-funding, and we guarantee at least 100% ROI. This combination of expertise, savings and value is why NPI is an advisor to IT, finance, procurement and supply chain executives for some of the world s most recognized brands. To learn more about how NPI can help your company start saving today, visit us at www.npifinancial.com or call 404-591-7500. www.npifinancial.com 404 591 7500 2011 NPI, LLC All rights reserved. V0311.1 page 6