SaaS May Loose Steam Without the Fire from Managed Services Market

Implications: SaaS continue to grow at a staggering 30% CAGR, but will remain to be a small drip in the worldwide software market.

Pure-play SaaS will be limited to a few segments of the software spectrum and the collective share of that will be less than 5% of the overall software market in next five years

Evolution of the Managed Services to include more business centric services, focus of the industry on SMB and convergence of Managed Services, SaaS and Systems Integration segments will help in wider adoption of SaaS and hence larger indirect revenue for the SaaS players in general

Analysis:

Buzz around Software-as-a-Service has been heating up for the past three years. Whether that is the Wall Street Journal talking about the SaaS as a savior, KM World Magazine listing SaaS applications as trend setters of the year, Google (GOOG) acquiring Postini to augment their expanding SaaS portfolio, or Microsoft (MSFT) going against Salesforce.com for the small & medium business (SMB) market with the Live CRM product, the trend is undoubtedly gaining momentum. Will it rock the packaged software industry and bring its closely guarded perpetual licensing based revenue model upside down? Will it drive the flexibility and agility (and not to mention, cost efficiency) that businesses have been striving to attain from IT in general and software in particular?

The world-wide packaged software market is huge, about $230B in 2006, with a healthy Compound Average Growth Rate (CAGR) of about 8% for next five years.  At the same time, the SaaS (or software-on-demand, as some categorize) market is expected to grow from $3.9B to $14.5B,  a CAGR of about 30% (source: IDC). Whether the buzz stays or not, the SaaS market is not expected to be more than 5% of the overall software market in five years. Even if it is assumed that the same high growth rate will continue for next ten years – which is an over optimistic assumption by any means - expected dent on overall software market from SaaS will not be more than 10%.

Why? Firstly, pure-play SaaS will be restricted to a few areas of software for foreseeable future. Examples of these areas are payroll, Customer Relationship Management (CRM), gateway security, like email filtering, and Supply Chain Management (SCM). Even in these areas, there are fundamental architectural issues like multi-tenancy and security that the SaaS vendors have to address. As many of them have learned the hard way SaaS enabling of an existing software product is often time consuming, costly and in many cases technically impossible. As can be imagined, SaaS has limited play in software segments like systems software, infrastructure management or end-point security (about 65 -70% of the overall market), each of which are difficult to centralize and provided over a network in a hosted environment, unless looked at as part of an outsourced IT infrastructure (not just software) framework.

Which takes us to the second point, that is, a more comprehensive value proposition, with flexibility, agility and efficiency as critical drivers, can be provided to a customer - whether they are large enterprises or SMB - when SaaS is delivered as part of a larger outsourced IT infrastructure framework; a framework that includes network, systems, applications, security and business processes. Whether this is called Managed Services or Infrastructure as a Service (Iaas),  centrally hosted, shared software becomes a critical component of the overall business service that the provider is offering.

The subscription based pricing and customer friendly contract models already in existence in managed services setup for a decade or more now, aligns well with the SaaS pricing and revenue model. As a managed services setup can have a mix of SaaS and other shared/unshared infrastructure if architectured well (whether it is through Service Oriented Architecture or Service Delivery Platform framework), can provide an excellent vehicle for transitioning internal enterprise IT infrastructure (including software) to an outsourced external infrastructure backed by Service Level Agreements (SLA). In other words, Saas becomes part of a larger IT journey that the enterprises have been taking for a number of years.  Of course, on a number of fronts on the IT value chain, technologies, service delivery frameworks and business processes have to continue to mature for reaping full benefits from that journey.

As MSPs have started to focus more and more (finally!) on the SMB IT market (which is as big as the large enterprise market per Forrester), the synergies between SaaS and managed services are more than ever before. From the SaaS vendors’ perspective, the MSPs, if they cannot be one themselves, become a new channel to push their products into the market. Note that MSP market has large pull through power, in terms of size and growth (worldwide:  $145B in 2006; 13-15% CAGR for next five years; sources: TelecomWeb, Gartner, IDC). The SaaS vendors have much to gain from aligning well with that market.  And, without that alignment SaaS will continue to be a fringe play in the software marketplace.

P.S.  If SaaS is less disruptive than as predicted by the pundits, why are a number of software vendors, especially the large ones, paranoid? It is quite evident that their revenue streams are not going to dry out overnight and there are no compelling market forces overturning their revenue model that is built on perpetual licensing and maintenance contracts. The answer is that most of them have a learned a lesson from the past – the emergence of Web 2.0 dominants who came from nowhere and started to deliver on a business model that is more customer centric than any of them could imagine. The last thing they want to do is playing a second fiddle to the next Google. There are parallels here. Look how legacy telecom service providers have been struggling in the Internet era to be more than dump pipe providers to Amazons, eBays and Yahoos of the world.