SAP: Big Businesses Won't Be Interested In On-Demand ERPSAP: Big Businesses Won't Be Interested In On-Demand ERP

With momentum surging behind on-demand business software, SAP delivered its response last week. Business ByDesign, a software service for business functions such as order management, customer relations, and analytics, will be available early next year for $149 a month per user. But the new offering came with one shocking caveat: It's appropriate only for companies with 100 to 500 employees.

"I'm now 25 years in this company, and I can say it's the most important announcement I've made in my career," SAP CEO Henning Kagermann said during a launch event in a midtown Manhattan theater. Kagermann was just as emphatic, however, that the new product won't interest the current customers of its high-margin on-premises software. "It's not a solution for larger enterprises," he said. "It's not a solution for midmarket companies who have high demand, deep demand for vertical solutions."

In contrast, other software-as-a-service vendors are starting to land some big customers. Chiquita Brands just signed up to put 25,000 employees on the on-demand human resources software from startup Workday. Merrill Lynch has 25,000 people using Salesforce .com's CRM software. ConAgra Foods, Domino's Pizza, Eastman Kodak, JetBlue Airways, and Toyota Motor Sales use Procuri's on-demand supply chain management software. (Ariba last week announced a deal to acquire Procuri for $93 million.)

None of those deployments is as complicated as full-scale ERP, but that's part of the story. Companies are looking for simpler IT, and increasing numbers think software as a service is part of the answer.

To get an idea of the momentum behind SaaS, consider that 7,000 people attended Salesforce's Dreamforce user conference in San Francisco last week. That's half the number that attended SAP's Sapphire user conference in Atlanta in April. SAP is the world's largest business application vendor, with annual revenue of about $13 billion and a massive worldwide developer ecosystem. Salesforce is tiny by comparison but growing at 49% a year, projecting revenue this year of more than $700 million, most of it from on-demand CRM software.

Salesforce is trying to expand beyond CRM. Last week it announced a new development environment for the platform it offers developers that lets them build apps based on its Apex language. The new environment, due next year and called Visualforce, is for creating user interfaces with HTML, Ajax, and Adobe Flex, so developers won't be restricted to Salesforce's look and feel. Salesforce also lets other vendors sell on-demand software to Salesforce customers through its AppExchange marketplace, in exchange for a cut of the monthly subscription.

SAP's correct that on-demand software isn't right for every company or application. Most companies' software infrastructure will evolve into a hybrid of the two models. Applications that need to support a high number of transactions, for example, will probably continue to work best on premises, since on-demand vendors generally put some limit on database access in a given time period, says Marc Friedman, CRM manager at Acumen Solutions, an IT services firm that has deployed Salesforce and other on-demand products for clients. But companies under pressure to deploy quickly should consider on-demand software, he says.

PROFITABLE STATUS QUOConventional software companies such as SAP have good reason to want to keep on-demand software tucked in the small-business segment: They want to avoid cannibalizing highly profitable existing customers. Instead of a customer paying thousands or even millions up front for a software license, SaaS buyers pay around $25 to $250 per month per user, depending on the application. An unhappy customer can turn the service off and go elsewhere. SaaS vendors face high marketing and infrastructure costs, explaining why some of them have limped along for years without a profit.

For vendors of on-premises software, creating a separate on-demand product can lead to internal strife, especially among salespeople who risk losing juicy commissions to lower-price subscriptions. Credit Suisse software analyst Jason Maynard says most vendors won't be able to make the two models co-exist. "On demand is like a virus in an on-premises software company," said Maynard, speaking at the information 500 conference last week.

Ken Rudin, CEO at on-demand business intelligence vendor LucidEra, knows firsthand what can happen, having served as general manager of Siebel Systems' OnDemand unit. Part of the problem was that Siebel tried to take code developed for on-premises software and transform it into a service. The bigger problem, though, was the resistance from Siebel's sales force. He recalls briefing a top sales executive about Siebel OnDemand a month before its launch: "As I got up to leave, he said, 'By the way, stay the hell away from my accounts.'" Rudin describes it as "civil war."

Not at SAP, promises deputy CEO Leo Apotheker. The company has spent four years developing the model while building the code from scratch to work as a service. "We feel very comfortable that this will not create a civil war but will create peace, harmony, and lots of revenues," Apotheker says.

Oracle CEO Larry Ellison doesn't see the profit potential in small businesses or software as a service, saying during a conference call last week that the added product development, marketing, and customer support costs make the margins unattractive for Oracle. Specific to SaaS, he said, "We think it's very interesting, but so far no one has figured out how to make any money at it."

SAP estimates there's a potential $15 billion market of small companies looking to automate their business processes for the first time, and its goal is to have 10,000 companies signed up for Business ByDesign by 2010. Kevin Flanagan, CEO of Compass Pharma Services, an early user of Business ByDesign, chose it partly for the "comfort level" of working with a company the size of SAP. Peter Novak, CEO of Sunflower, a startup focused on alternative lighting technology, says his company has Business ByDesign almost ready to handle its manufacturing, purchasing, and supply chain processes, after eight weeks of part-time work implementing it.

SAP will spend 300 million to 400 million euros this year and next developing Business ByDesign, including building the support infrastructure. It has one data center to run the service at its headquarters in Waldorf, Germany, and plans to build or partner for additional data centers as needed.

Rivals Oracle and Microsoft offer some applications as hosted services, but neither has rewritten their software to fit the model. With a pure on-demand model, customers don't worry about the staff and support costs for upgrades, for example, since new features are added to the service by the vendor.

SAP needed to do something if it's serious about the small-business market. Textile maker Asahi Kasei Spandex America, with 170 employees, recently moved off SAP and onto NetSuite's on-demand software for accounting, inventory management, procurement, order management, and financial reporting. "We didn't want to pay for that high-powered in-house programming staff" to keep SAP running, says Asahi CFO David Stover.

SAP is treating software as a service as a chance to expand into a new market without disrupting its licensing model. Businesses, however, are looking to SaaS for more choices in how software is delivered--and that includes businesses of all sizes, even if SAP and its on-premises software peers try to convince them otherwise.