Like nature versus nurture – the debate over on-premise versus cloud wages on.
Today, more enterprise software purchasers choose software as a service (SaaS) offerings because companies can “pay-as you-go” with customer support and upgrades usually a free part of the package.
Still some companies still prefer the in-house option offered by traditional on-premise enterprise software, which are typically purchased with a required annual maintenance fee (22% upfront) to have customer support as well as enable your IT department to solve issues by downloading and installing hot fixes and service packs.
So, if cloud is less than on-premise’s 22% maintenance, then cloud is the simple choice. But if cloud was more than the 22% maintenance fee, would on-premise be a better deal?
First consider the original upfront licensing fee. In addition, many companies forget to consider the total cost of ownership (TCO) of their on-premise 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 hot fixes, hardware repairs, or 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 or SaaS, versus on-premise: http://www.softwareadvice.com/tco/.
According to Singleton, buying a 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-premise 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.
Ok. So 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’s simply fewer funds to devote to their core competency. Consider this scenario: is there an opportunity cost to your business if you buy on-premise software for $250,000 plus 22% for maintenance which equals $305,000 first year (and $55,000 each year thereafter) versus an annual cost of just $70,000 for SaaS for the same number of users?
The SaaS option saves you $235,000 the first year. That money could be spent on engineers to build more products or sales people to help grow revenue.
What if those engineers or sales people brought in well over $1,000,000 of additional revenue to your company? That is the opportunity cost. In this scenario, the opportunity cost of on-premise 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-premise of $15K for years 2 and beyond. In reality, $15K per year doesn’t begin to cover the annual IT costs for on-premise. The net benefit in TCO terms still favors SaaS.
Enterprise software buyers know to compare the total cost of ownership (TCO) between SaaS and on-premise, and the savvy ones are looking at the opportunity cost difference as well.