The Economist
Software: Universal Service?
By Tom Standage
4/20/06

SOMETHING momentous is happening in the software business. Bill Gates of Microsoft calls it "the next sea change". Analysts call it a "tectonic shift" in the industry. Trade publications hail it as "the next big thing". It is software-as-a-service (SaaS)--the delivery of software as an internet-based service via a web browser, rather than as a product that must be purchased, installed and maintained. The appeal is obvious: SaaS is quicker, easier and cheaper to deploy than traditional software, which means technology budgets can be focused on providing competitive advantage, rather than maintenance.

This has prompted an outbreak of iconoclasm. "Traditional software is dead," says Jason Maynard, an analyst at Credit Suisse. Just as most firms do not own generators, but buy electricity from the grid, so in future they will buy software on the hoof, he says. "It's the end of software as we know it. All software is becoming a service," declares Marc Benioff of salesforce.com, the best-known proponent of the idea. But while SaaS is growing fast, it still represents only a tiny fraction of the overall software industry--a mere $3.35 billion last year, estimates Mr Maynard. Most observers expect it to be worth around $12 billion by 2010--but even that is equal only to Microsoft's quarterly sales today. There is no denying that SaaS is coming. But there is much debate, even among its advocates, about how quickly it will grow, and how widely it will be adopted.

At the moment, small and medium-sized businesses are the most enthusiastic adopters of SaaS, since it is cheaper and simpler than maintaining rooms of server computers and employing staff to keep them running. Unlike the market for desktop software, which is dominated by Microsoft, or for high-end enterprise software, which is dominated by SAP and Oracle, the middle ground is still highly fragmented, which presents an opportunity. "This is the last great software market left--the last unconsolidated market," says Zach Nelson of NetSuite, which provides a suite of software services including accounting, sales-force automation and customer service. His firm is targeting small and medium-sized businesses by providing "verticalised" services--that is, versions of its software adapted to particular types of company, such as professional-service firms, wholesale distributors and software firms.

Large companies, says Mr Nelson, have already made big investments in traditional software. "They've already been through the pain," he says. So they will not be in a hurry to ditch their existing investments in traditional software from the likes of SAP and Oracle. "I have no fantasy of replacing those guys," says Mr Nelson. But Mr Benioff of salesforce.com disagrees. His firm provides customer-relationship management (CRM) software as a service, which is already used by many big firms including Cisco, Sprint and Merrill Lynch. "The world's largest companies are now using salesforce.com for the world's largest CRM implementations," he says. "It's the future of our industry that everything will be a service."

Even so, Mr Maynard reckons it will be some time before large companies fully embrace the service model. However, lingering concerns over security, reliability, archiving and regulatory compliance will eventually go away, he believes, and basic functions--such as accounting, expense-management and human resources--will be switched over within five years. "How you handle accounts-payable doesn't determine your competitiveness," he says. Eventually, only the bespoke software that provides competitive advantage to a firm will be left; everything else will be a service.

SaaS is fast becoming sophisticated and flexible enough to meet the needs of large companies, says Sheryl Kingstone of the Yankee Group, a consultancy, but "for the next five to ten years we will continue to have a mixture." In a survey, she found that 81% of respondents leaned towards a "hybrid" model, combining traditional software with SaaS. Microsoft, Oracle and SAP are all belatedly moving into SaaS, but they understandably prefer to characterise it as a new model that will exist alongside the traditional way of doing things, and will appeal to some, but not all, customers.

So it is too soon to write the obituary for traditional software, even if its eclipse by SaaS seems to be only a matter of time. The SaaS market is growing by about 50% a year, compared with single-digit growth for traditional software, notes Mr Maynard. "It doesn't mean the big guys are going to die overnight," he says, "but this is where the market is heading."