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Cloud vs On-Premises Software: Know Your Total Cost of Ownership

Cloud Versus On-premisesLike nature versus nurture—the debate over on-premises versus cloud software wages on. Today, more enterprise companies choose cloud software-as-a-service (SaaS) offerings because they can speed time to deployment and adoption, “pay as they go” with customer support and regular enhancements, and eliminate long-term capital expenses associated with on-premises software.

Still, some companies prefer the in-house on-premises option offered by traditional software vendors, which normally requires annual maintenance fees (averaging 22% of the software licensing costs per year). Maintenance fees enable access to technical support as well as enable your IT department to solve issues by downloading and installing hotfixes and service packs.

So, if cloud software costs less in subscription costs per year than on-premises software maintenance, then the Cloud should be a clear choice. However, if the cloud option is more than the annual on-premises maintenance costs, would on-premises be the better option?

Not necessarily.

How Do You Calculate Software TCO?
In addition to the original upfront licensing fee, companies must consider the total cost of ownership (TCO) of their on-premises investment, including hardware, network, backup, and development systems. The TCO includes the cost of human capital, such as project management, database, server, firewall, security, backup, and help desk resource—not to mention the overtime pay for weekend work to install emergency hotfixes, make hardware repairs, or address security issues.

And don’t take our word for it. Analyst Derek Singleton at Software Advice created a TCO calculator designed to allow companies to compare cloud cost versus on-premises.

According to Singleton, buying a cloud SaaS system lowers your sunk costs by allowing you to minimize your upfront investment. By spreading out your costs over time via a subscription license, you can better manage your financial risk.

“Many people focus on the subscription license as the true cost savings but your licensing costs for a SaaS and on-premises system, in my model, will catch up to each other by year 3 if you factor in the net present value (NPV) of a SaaS license,” says Singleton. “The true savings of a SaaS system come from not having to manage your own IT infrastructure to manage hosting, data security, hardware maintenance.”

The numbers don’t lie.

Is Cloud Cheaper Than On-Premises?Cloud Costs Less
TCO is one angle for comparison. What about the economic term “opportunity cost”?
When a business pays a large upfront cost for a software solution, it no longer has that cash available to grow the business. There are simply fewer funds to devote to their core competency.

Consider this scenario: Is there an opportunity cost to your business if you buy on-premises software for $250,000 plus 22% for maintenance for a total of $305,000 in the first year (and $55,000 each year thereafter) versus an annual cloud-based subscription cost of just $70,000 for SaaS for the same number of users?

The SaaS option saves you $235,000 in the first year. That money could be spent on engineers to build more products or salespeople to help grow revenue.

What if those engineers or salespeople brought in well over $1 million of additional revenue to your company? That is the opportunity cost. In this scenario, the opportunity cost of on-premises is $930,000 just for the first year. And it just keeps getting bigger every year thereafter—often dwarfing the financial TCO model.

The scenario above shows a gross benefit to on-premises of $15K for years 2 and beyond. In reality, $15K per year doesn’t begin to cover the annual IT costs for on-premises. The net benefit in TCO terms still favors SaaS.

SaaS vs. On-Premises: It Pays to Dig Deeper
Advancements in technology give product companies more options than ever when selecting enterprise software. It’s important to make informed decisions when evaluating SaaS versus on-premises solutions. Savvy product companies know to compare the TCO between SaaS and on-premises and look at the opportunity cost difference as well. The numbers will typically point in favor of a SaaS solution, but it’s important to do your due diligence.

To learn how cloud-based solutions can further drive ROI beyond initial investment, try out our cost calculator to find out what your product development mistakes cost and how you can reduce or eliminate those costs with a single source of truth in the Cloud.