Much has been written to date about why businesses are purchasing SaaS. If you like to spend time on the Linked In systems and peruse the various SaaS and Cloud groups, you’ll often read references to Capex vs. Opex (capital expenditures vs. operating expenditures) as the primary driver of SaaS purchases. (For some reason, we’ve noted that commentators from India seem to focus heavily on this metric, a reflection, perhaps, of their local market conditions. I’d be interested in hearing more on this topic from Indian SaaS companies.) The idea behind this is that by shifting software expenditures from capital budgets to operating ones, the flinty hearts of CFOs everywhere will be warmed and SaaS expenditures are more likely to be approved.

If you spend time reading through the various IT publications, you’ll certainly develop the impression that it’s the CIOs and their attendant geek squads that hold the fate of SaaS in their hands. Over the last several years there’s been an unending stream of articles with headlines such as “SaaS adoption in IT,” “What do CIO’s think of SaaS?” “CIO’s embrace SaaS” “CIOs fear SaaS” “CIOs Believe SaaS is Evil Plot,” “CIOs Believe SaaS Presages the Rapture” and so on. Perhaps the best example of this dynamic in action was The Gartner Group’s June 14th announcement on its newsroom site that:

“Software as a service (SaaS) will have a role in the future of IT, but not the dominant future that was first thought, according to Gartner, Inc. Organizations should carefully assess their software needs in light of the current promises delivered on by SaaS.

‘In 2009, within enterprise applications, SaaS represented 3.4 percent of total enterprise spending, slightly up from 2008 at 2.8 percent,” said David Cearley, vice president and fellow at Gartner. The research firm predicts that this market will reach $8.8 billion in 2010.”

This sounds rather gloomy, especially when compared to this 2008 observation:

“Worldwide software-as-a-service (SaaS) revenue in the enterprise application markets* is on pace to surpass $6.4 billion in 2008, a 27% from 2007 revenue of $5.1 billion, according to Gartner, Inc. The market is expected to more than double with SaaS revenue reaching $14.8 billion in 2012.”

But no matter. By July 27th, thinks were looking better than ever for SaaS according to Gartner as it told us that the:

“SaaS Market Growing by Leaps and Bounds.”

But, again, no matter. The fact is that the growth of SaaS has not been driven by either IT enterprise acceptance or Capex vs. Opex, though both of these do a play a part in the model’s expansion. Since 2006, Softletter has been surveying SaaS companies and incorporating them into our SaaS Report,  asking them what we regard as the most important question in the survey. This question is:

What do you believe is the primary reason your customers choose to subscribe to a SaaS system?

Here are the answers from 2012:

 Customers can quickly gain access to new capabilities and functions that they cannot obtain by purchasing existing software products and services 40%
Customers wish to replace existing licensed and/or client/server applications with SaaS applications to reduce overall IT operations and complexity at their company or business unit 19%
 Customers wish to replace existing licensed and/or client/server applications with SaaS applications to reduce the overall cost of software at their company or business unit 13%
SaaS applications are counted as an operating expense, not as a capital investment 16%
Other (Almost all “Other answers were a mix of A or B and some other factor) 11%

As you can see, “Quickly gain access to new capabilities” is the response leader by a strong plurality. In fact, in the previous three reports, this answer was always the majority response (last year” Quickly gain” came in at just over 50%). What accounts for the shift in numbers this year?

Before we answer this question, let’s look at these responses in greater depth. In the Softletter SaaS Report, we drill down into our survey questions by various criteria, including years in business, revenue size of the company, and development state. Below are the crosstabs for development state of the company.

What do you believe is the primary reason your customers choose to subscribe to a SaaS system? (By company development stage)

Customers can quickly gain access to new capabilities and functions… Start-Up Privately Owned & Funded Privately Owned / Venture Public
Reduce overall IT operations and complexity at their company or business unit… 43% 40% 40% 33%
Reduce the overall cost.. 14% 13% 20% 11%
Capex vs. Opex… 29% 14% 13% 33%
Other (Almost all “Other answers were a mix of A or B and some other factor) 14% 7%

Note that across the four categories in this breakdown “Quickly gain access” maintains its lead in three of them and ties in “Public,” with “Reduce IT complexity” fairly stable across all cohorts. It’s not surprising that “Capex vs Opex” is strong in “Public,” as most of the companies in this category are dealing with larger companies in established and successful SaaS application categories (CRM, project management, HR, etc.). In these markets, Capex vs Opex is more compelling.

One answer to why the shift in numbers is that the uptake of SaaS in the enterprise is indeed increasing, driven by the recession and the consequent need of companies to continue to modernize their business operations and increase flexibility while also conserving cash. But note that the Capex vs. Opex answer comes in at 16%; last year, this response came at 19%. Over the four years of the survey and report, the response to this question has ranged from 15% to 19%, with a mean of 16%.

Another factor driving the change is that for the 2010 Report, we added a new question to the survey on which the SaaS Report is primarily based, “Reduce overall IT operations and complexity….” The introduction of client/server technology in the 90s gave businesses the ability to build and maintain internal datacenters of amazing complexity and flexibility. But as more and more applications have been poured onto corporate servers, these environments have become increasingly fragile and difficult to maintain, leading to a counter movement in IT to simplify their computing environments.

Today, increasing numbers of companies believe that existing client/server applications that work, are paid for, and address key element’s of a company’s business operations should stay in place for many years into the future, in much the same fashion as COBOL applications devised for the financial and insurance industries in the 50s are still chugging away in back offices all over the world. A working application in place bothering no one tends not to be bothered and no one wants to bother it, as Microsoft, Oracle, and other companies built around desktop/retail and client/server models are finding.

Within software categories that have existed for over forty years, customer resistance to change is steadily increasing as the perception grows that everything these applications can do they’re doing and it’s cheaper and best to just leave them alone to keep on doing what they do best. And it’s also probably best to leave the server’s on which these applications in states that are stable and easily maintainable, something that becomes increasingly difficult to do as more programs take up residence next to these placid, domesticated chunks of code.

This point is driven home by the next question we asked in our survey, which was:

What do you believe is the main secondary reason your customers choose a SaaS system?

 Customers can quickly gain access to new capabilities and functions that they cannot obtain by purchasing existing software products and services 31%
Customers wish to replace existing licensed and/or client/server applications with SaaS applications to reduce overall IT operations and complexity at their company or business unit 24%
 Customers wish to replace existing licensed and/or client/server applications with SaaS applications to reduce the overall cost of software at their company or business unit 11%
SaaS applications are counted as an operating expense, not as a capital investment 18%
There is no secondary reason 11%
Other (Almost all “Other answers were a mix of A or B and some other factor) 6%

“Quickly gain access” maintains its number one standing but loses ground to “Reduce IT complexity.” “Capex” stays stable; clearly, it’s important to a significant segment of customers, but it’s never the main driving factor.

But the world is not standing still and the need for new applications to address new needs is not going away. And herein lies the primary reason for the growth of SaaS over the last seven years, since the market began to recover from the ASP meltdown of 1999-2001. The on-demand model inherently opens up new markets and opportunities that simply can’t be adequately serviced by existing client/server applications.

Let me provide you with a practical example of what we mean. At our recent SaaS University conference in Austin, we met a representative of a company that provides a service that enables states to meet the requirements established by the various state “Megan’s Law” requirements to track the locations of released sex offenders. These laws have been passed with a great deal of acclaim and fanfare over the years but the reality has been their effectiveness is sharply limited in client/server computing environment.

For these systems to work, a wide variety of state municipalities, locations, and regions must have access to the software in order to provide up-to-date information on an offender’s status and location. However, many town, counties, villages, etc, etc, are simply incapable or unable to install and maintain client/server applications in their locales (and may not have the hardware on which to load the software or the ability to maintain once they do). However, even the smallest village will have governmental resources that can access a web browser on a PC. In a SaaS-based world, implementing a sex offender tracking database, or elections management system, or wide area emergency notification to a college campus all become viable markets.

Salesforce.com, the current SaaS poster child, grew to its current $1b+ status via a related dynamic. What is now called CRM began in the late 80s as a series of desktop/retail class products with names such as Telemagic, Act, Maximizer, and Goldmine. To sales and marketing departments and CSOs/CMOs, these applications were as compelling as VisiCalc and Lotus 123 had been to finance groups and CFOs years earlier.

By the 90s, there were few heads of sales or marketing who weren’t aware of how useful desktop CRM packages were and didn’t want them in their departments, but it was often impractical. While client/server versions of these products were available, installing them on departmental computers (their usual destination) was a painful process and didn’t scale well. If you were a big company, you could spend millions on a Siebel installation but that obviously wasn’t practical for most firms. Salesforce.com saw the opportunity and ran with it.

This dual dynamic remains in place today and will only accelerate, with each element reinforcing the other. As companies find new needs to be met and require solutions for the business problems they face, they will look to the software industry. But they will not be looking to increase IT expenditures or disturb smoothly running back office operations with new desktop or client/server products. Only after SaaS becomes the default solution for a software purchase do we expect Capex vs. Opex to become a dominant driver in SaaS purchasing.

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