For the past few years, the technology press has been eulogizing desktop and server-based software while proclaiming that the era of Software as a Service (SaaS) is now upon us. According to the lessons of the Innovator's Dilemma the cheaper and more flexible SaaS solutions will eventually replace traditional installed software and the current crop of software vendors will turn out to be dinosaurs in a world that belongs to the warm blooded mammals who have conquered cloud based services.

So it seems the answer is obvious, software vendors should rush to provide Web-based services and extricate themselves from their "legacy" shrinkwrapped software business before it is too late. What could possibly go wrong with this plan?

Sarah Lacy wrote an informative article for Business Week about the problems facing software vendors who have rushed into the world of SaaS. The Business Week article is entitled On-Demand Computing: A Brutal Slog and contains the following excerpt

On-demand represented a welcome break from the traditional way of doing things in the 1990s, when swaggering, elephant hunter-style salesmen would drive up in their gleaming BMWs to close massive orders in the waning days of the quarter. It was a time when representatives of Oracle (ORCL), Siebel, Sybase (SY), PeopleSoft, BEA Systems, or SAP (SAP) would extol the latest enterprise software revolution, be it for management of inventory, supply chain, customer relationships, or some other area of business. Then there were the billions of dollars spent on consultants to make it all work together—you couldn't just rip everything out and start over if it didn't. There was too much invested already, and chances are the alternatives weren't much better. Funny thing about the Web, though. It's just as good at displacing revenue as it is in generating sources of it. Just ask the music industry or, ahem, print media. Think Robin Hood, taking riches from the elite and distributing them to everyone else, including the customers who get to keep more of their money and the upstarts that can more easily build competing alternatives. But are these upstarts viable? On-demand software has turned out to be a brutal slog. Software sold "as a service" over the Web doesn't sell itself, even when it's cheaper and actually works. Each sale closed by these new Web-based software companies has a much smaller price tag. And vendors are continually tweaking their software, fixing bugs, and pushing out incremental improvements. Great news for the user, but the software makers miss out on the once-lucrative massive upgrade every few years and seemingly endless maintenance fees for supporting old versions of the software.

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Nowhere was this more clear than on Oracle's most recent earnings call (BusinessWeek.com, 6/26/08). Why isn't Oracle a bigger player in on-demand software? It doesn't want to be, Ellison told the analysts and investors. "We've been in this business 10 years, and we've only now turned a profit," he said. "The last thing we want to do is have a very large business that's not profitable and drags our margins down." No, Ellison would rather enjoy the bounty of an acquisition spree that handed Oracle a bevy of software companies, hordes of customers, and associated maintenance fees that trickle straight to the bottom line.

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SAP isn't having much more luck with Business by Design, its foray into the on-demand world, I'm told. SAP said for years it would never get into the on-demand game. Then when it sensed a potential threat from NetSuite, SAP decided to embrace on-demand. Results have been less than stellar so far. "SAP thought customers would go to a Web site, configure it themselves, and found the first hundred or so implementations required a lot of time and a lot of tremendous costs," Richardson says. "Small businesses are calling for support, calling SAP because they don't have IT departments. SAP is spending a lot of resources to configure and troubleshoot the problem."

In some ways, SaaS vendors have been misled by the consumer Web and have failed to realize that they still need to spend money on sales and support when servicing business customers. Just because Google doesn't advertise it's search features and Yahoo! Mail doesn't seem to have a huge support staff that hand holds customers as it uses their product doesn't mean that SaaS vendors can expect to cut their sales and support calls. The dynamics of running a free, advertising based service aimed at end users is completely different from running a service where you expect to charge business tens of thousands to hundreds of thousands to use your product.

In traditional business software development you have three major cycles with their own attendant costs; you have to write the software, you have to market the software and then you have to support the software. Becoming a SaaS vendor does not eliminate any of these costs. Instead it adds new costs and complexities such as managing data centers and worrying about hackers. In addition, thanks to free advertising based consumer services and the fact that companies like Google that have subsidized their SaaS offerings using their monopoly profits in other areas, business customers expect Web-based software to be cheaper than its desktop or server-based alternatives. Talk about being stuck between a rock and a hard place as a vendor.

Finally, software vendors that have existing ecosystems of partners that benefit from supporting and enhancing their shrinkwrapped products also have to worry about where these partners fit in a SaaS world. For an example of the kinds of problems these vendors now face, below is an excerpt from a rant by Vladimer Mazek, a system administrator at ExchangeDefender, entitled Houston… we have a problem which he wrote after attending one of Microsoft's partner conferences

Lack of Partner Direction: By far the biggest disappointment of the show. All of Microsoft’s executives failed to clearly communicate the partnership benefits. That is why partners pack the keynotes, to find a way to partner up with Microsoft. If you want to gloat about how fabulous you are and talk about exciting commission schedules as a brand recommender and a sales agent you might want to go work for Mary Kay. This is the biggest quagmire for Microsoft – it’s competitors are more agile because they do not have to work with partners to go to market. Infrastructure solutions are easy enough to offer and both Google and Apple and Amazon are beating Microsoft to the market, with far simpler and less convoluted solutions. How can Microsoft compete with its partners in a solution ecosystem that doesn’t require partners to begin with?

This is another example of the kind of problems established software vendors will have to solve as they try to ride the Software as a Service wave instead of being flattened by it. Truly successful SaaS vendors will eventually have to deliver platforms that can sustain a healthy partner ecosystems to succeed in the long term. We have seen this in the consumer space with the Facebook platform and in the enterprise space with SalesForce.com's AppExchange. Here is one area where the upstarts that don't have a preexisting shrinkwrap software businesses can turn a disadvantage (lack of an established partner ecosystem) into an advantage since it is easier to start from scratch than to retool.

The bottom line is that creating a Web-based version of a popular desktop or server-based product is just part of the battle if you plan to play in the enterprise space. You will have to deal with the sales and support that go with selling to businesses as well as all the other headaches of shipping "cloud based services" which don't exist in the shrinkwrap software world. After you get that figured out, you will want to consider how you can leverage various ISVs and startups to enhance the stickiness of your service and turn it into a platform before one of your competitor's does.

I suspect we still have a few years before any of the above happens. In the meantime we will see lots more software companies complaining about the paradox of embracing the Web when it clearly cannibalizes their other revenue streams and is less lucrative than what they've been accustomed to seeing. Interesting times indeed.

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