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Include Management Costs When Calculating Software as a Service Benefits

Here's why total cost of ownership calculations for software as a service contracts are tricky.

By Galen Gruman

May 21, 2007 — CIO — Software as a service (SaaS) applications are typically rented on a per-user-per-month basis. There are no up-front licensing costs, and no need for up-front equipment and development resources. The subscription fee covers software maintenance and operational costs as well as any upgrades.

CIOs like that model. In fact, “I would like to convert traditional applications to pay-as-you-go,” says Peter Young, vice president of IT at pharmaceutical firm MedImmune—something he’s begun to discuss with his traditional vendors come upgrading time. (“There’s no requirement to link subscription pricing to on-demand,” notes Rebecca Wettemann, an analyst at Nucleus Research.)

Perhaps the toughest aspect of SaaS pricing is figuring out whether the subscription pricing leads to a higher total cost of ownership (TCO) than deploying the software internally. While enterprises know how much the licenses cost and what the annual maintenance fees are, most don’t know the operational costs—those for the operations and support staff, the hardware, the network resources and so on—so they can’t compare in-house TCOs to SaaS costs. Those that can make the calculations also have to estimate how often they expect to upgrade and what the upgrade would actually cost—not just the new licenses, but also the integration, training and operations, notes Rick Milazzo, CIO of retailer American Eagle Outfitters.

Similarly, predicting usage of SaaS applications is inexact. “The costs are not perfectly predictable either way,” says AMR Research analyst Rob Bois.

But for many, it doesn’t matter what the TCO is for SaaS. Enterprises make a rough calculation that if a SaaS application costs no more than a traditional license amortized over five years, plus the maintenance costs, it’s worth buying. Even if it costs a little more up front, not having to manage the software is often worth the price.

Other stories by Galen Gruman

 

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