Hosted Software Is Shifting Ground

Years after most companies kissed their COBOL-based systems goodbye, C&H Sugar Co. was still entering data on green screens. By 2002, the $400 million refinery needed a modern-day enterprise resource planning (ERP) system that would enable it to integrate warehouse, order-entry and other systems to create real-time tracking of its sugar shipments. But running these critical applications 24x7 was out of its reach.

Vendor Vetting, Tough Negotiating Make ERP Affordable

Hosted software was the only approach that made any sense when C&H Sugar decided to implement an ERP system. The $400 million sugar processor knew that when it upgraded its systems from ancient green screens to SAP's mySAP.com Solution Suite, including warehouse, order-entry, human resources and other modules, it couldn't handle the job in-house.

Twenty-four hours a day, 10 out of every 14 days, the company refines and ships sugar to industrial and consumer customers, filling 26 different-sized packages -- small boxes on a supermarket shelf, 2,500-pound industrial containers and everything in between -- for a total of 700,000 pounds a year. That meant it would need a continuously operating system. But its 125-year-old brick building wouldn't support the infrastructure required for such an operation, nor could the company's 17-person IT staff. "We just didn't have the right staff to afford a 24x7 operation," says CIO Gary Walden.

Walden worked closely with controller Stephen Cottrell and a steering committee of top managers to vet vendors and negotiate contracts. The company began with 11 vendors and quickly whittled the group down to three, which it then pitted against one another. When it finally selected SAP, it worked hard to simplify the contract. "We spent a lot of time negotiating," Walden says. In the end, C&H spent $5 million to $6 million on the project. It pays 17% of that amount in yearly maintenance.

Once it had selected SAP, C&H began looking at companies to host the application. One important factor was making sure potential partners were financially stable because there had been so much bankruptcy in the ASP market. After considering various options, it chose Hewlett-Packard, which is SAP's hosting partner. It uses HP's Atlanta data center.

Walden says the project would have cost twice as much to bring in-house as it did to undertake using a hoster. (SAP's current hosted arrangement wasn't available at the time of C&H's project.) C&H was also able to negotiate with HP for the future use of applications such as a business warehouse, plant maintenance, CRM and advanced planning modules. It will pay for those applications and the hosting service as they come online.

Despite the desire to use a service provider, many of the business managers were concerned about application response times, especially because the data center was located across the country. However, C&H negotiated a service-level agreement with SAP that's based on uptime and response time. SAP faces penalties if those requirements aren't met. In addition, C&H leased a T1 line.

Involving so many managers in the process helped to allay their fears, Cottrell says. "It was important to involve business users in the decision so that they became comfortable with the decisions we were making." -- J.R.

"It was easy to make the business case that we shouldn't support that kind of application locally," CIO Gary Walden says. His 17-person IT operation didn't have the necessary skills, and the company's facilities didn't have generators or other pieces of infrastructure needed for continuous operations.

So once Walden, with a steering committee of top-level managers and controller Stephen Cottrell, spent between $5 million and $6 million to purchase nine modules of SAP AG software, the company went shopping for a third party to host and maintain it. In the end, Crockett, Calif.-based C&H signed on with an SAP partner, a Hewlett-Packard Co. data center in Atlanta, to which it pays a per-user monthly fee.

Today, SAP, like an increasing number of purveyors of corporate software and point products, offers that hosted model itself, charging as little as $325 per user per month.

Call it a disruptive technology: Hosted software is changing the dynamics of the software industry. Vendors avoid it at their peril -- and many hope to use it for competitive advantage as they wrestle for new customers in the largely untapped midmarket. For companies like C&H Sugar, making the leap to on-demand software means more choices, no upfront fees and, often, cheaper prices than investments in traditional perpetual licensing. That old model involves not only a hefty fee upfront, but also annual maintenance fees often approaching 20%.

Indeed, even the software giants that have relied on the perpetual model are coming to terms with the sea change. Oracle Corp., for instance, now offers much of its software as an on-demand service and last fall brought in a top HP executive to run its on-demand division. Siebel Systems Inc., in the customer relationship management (CRM) market, launched a hosted service in 2003; SAP launched its hosted service last year.

CRM, in fact, is a leader in the hosted space, largely because the application doesn't require integration with legacy systems. The loudest voice behind hosted software may be Marc Benioff, CEO of CRM provider Salesforce.com Inc. in San Francisco. Benioff, a former Oracle executive, is rarely seen without one of his company's anti-software buttons tacked to his lapel. He's not opposed to software itself, just the expense and complication of companies having to deploy it.

Nick Gall, principal analyst for technology research services at Meta Group Inc. in Stamford, Conn., credits Benioff with leading the hosted software charge. "Software as a Service in the Salesforce.com model is one of the biggest long-term disruptors," Gall says. Market projections bear that out. Framingham, Mass.-based research firm IDC expects usage of hosted software to grow by 25% a year, from $3.7 billion last year to $9 billion in 2008. By then, IDC predicts, subscription-based licenses (which include both hosted and on-premise software) will account for 34% of all software license revenue, bringing in a total of $38 billion industrywide.

Subscriptions make sense for industries whose software needs -- particularly with desktop and security applications -- change from year to year. Microsoft Corp. has created special subscription programs in education and government, for example, where the number of PCs and related software grows and contracts periodically. Microsoft also offers subscriptions on many products, including Office, Microsoft CRM and SQL Server. "A subscription licensing model helps ensure that they are covered, but not over-licensed," says Cori Hartje, a Microsoft marketing executive. Oracle and SAP also offer subscription-based pricing, and Sun Microsystems Inc. charges a flat subscriber fee of $140 per user for its Java Enterprise System. Computer Associates International Inc. already reports that about 15% of its customers are taking advantage of nontraditional metrics for buying software.

Observers say the subscription model is cheaper than traditional perpetual licenses at the outset, but those savings can peter out after a few years. In the end, a subscription can be more expensive than a perpetual license, especially if the vendor doesn't frequently update the product. "Subscription pricing has you paying full price for software every three or four years, which is actually faster than Microsoft is updating much of its software," notes Paul DeGroot, an analyst with Directions on Microsoft, a Kirkland, Wash.-based research firm that focuses exclusively on Microsoft.

Nevertheless, many businesses prefer subscription pricing to perpetual licenses. "Businesses are trading higher long-term costs for flexibility" and lower startup costs, says Amy Konary, director of software pricing and licensing at IDC. Tactical applications, compared with long-term strategic software such as supply chain management, are particularly well-suited for subscription and/or hosted models because they can be deployed relatively quickly, she says.

New Wave Complexity

Of course, there are risks in riding the new wave. Choosing the wrong model or pricing metric can land a business with unpredictable bills -- and perhaps even higher costs than before. Models with complex metrics can be hard to understand and make costs tough to predict over the long term, says Jim Shepard, a senior vice president at Boston-based research firm AMR Research Inc.

Businesses that opt for a usage-based model need to make sure they have a solid understanding of their usage pattern before entering into a deal, advises IDC's Konary. For example, sales reps can fluctuate greatly in their usage of sales force automation tools, leading to unpleasant spikes in monthly software "utility" bills. "With software you deploy throughout an enterprise around the world, how do you control that?" she asks. "It could be a management nightmare."

Alex Lang knows what that's like. As administration manager and security officer at $750 million Oceaneering International Inc. in Houston, Lang keeps an eye on contracts that not only use different models and metrics but also vary from country to country. He's in a constant scramble to ensure that his contracts are up to date and that he's not overpaying for licenses he won't use. He's often mired in legalese. "It is horrible," he says.

Access and, critically, security are other aspects of the hosted model that IT executives must consider before signing on the dotted line. Austin Energy, a $1 billion municipal utility in Texas, chose a hosted system for its billing software (see "Texas Utility Gets Extra Benefit: Data Analysis") but kept its financial system on site. CIO Andres Carvallo says the organization's chief financial officer didn't want to find out that the Internet connection was down and that he was suddenly left without access to financial data.

This was first published in March 2005

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