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March 8, 2007

The software-as-a-service (SaaS) ship has sailed with a boatload of customers, while many traditional vendors of on-premise software have been left behind.

According to Gartner, the market for SaaS applications grew by 26 percent last year, from $5 billion in 2005 to $6.3 billion in 2006. The consulting firm expects demand for SaaS to continue growing at a 25 percent compound annual rate over the next five years, to $19.3 billion by 2011. Most of those dollars are going to new entrants rather than established software vendors like Oracle (Quote), SAP  and Microsoft (Quote).

The reason for this boom in demand, says Gartner analyst Ben Pring, is that customers are rejecting the business model for on-premise software. "Customers were frustrated with the client-server, on-premise, $1 on software, $10 dollars on services model that SAP and Accenture (Quote) have been flogging since the late 1990s," he told internetnews.com. "The way technology has been sold, every piece of software is the most mission-critical, must-have piece of software, whereas the truth is that 80 percent of business technology makes no contribution to the business whatsoever," said Pring.

SaaS "represents a more sane approach coming into the marketplace."

The big software vendors have thus far made only half-hearted attempts at developing their own SaaS offerings because, said Pring, "they didn't want to see disruption in their enterprise space."

He cited the notable lack of traction for the on-demand CRM applications offered by Microsoft, SAP and Oracle. These offerings have failed to inspire the market because of a lack of a true commitment from leadership, resulting in a self-fulfilling prophesy.

"It was almost implicitly set up to fail — 'we tried but the customers didn't want it.' "This has left the door open for smaller, newer players who are now pouring into this gap," said Pring.

Plenty of SaaS Waves Still Out There

But it's still early. Eighty percent of the value of the market is in companies with more than $1 billion in revenues, and SaaS has only penetrated 6 percent or 7 percent of that segment. "The big space is where the real revenue opportunity lies," Pring said.

This means that those software vendors still have a significant opportunity within their installed base of customers.

Moreover, with SaaS no longer a novelty, customers are becoming more demanding of SaaS applications, giving the laggards a chance to catch up. As SaaS matures, customers will also stand to benefit from better customization options on the front end and interoperability with their legacy software systems.

SaaS applications won't replace all on-premise software. They will replace certain applications where less functionality is good enough and will have to interact with some legacy applications that customers will want to maintain on-premise.

"It's about getting a more useable solution at a better price-performance ratio."

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