Cloud Computing Experts

Slashing Costs and Driving

Capacity for SaaS Providers
The Business Case for Moving SaaS into the Cloud

Febuary 9, 2009.
By Mark Hadfield & Kent Langley

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Slashing Costs and Driving Capacity for SaaS Providers

The Business Case for Moving SaaS into the Cloud

A 50% reduction in costs with an associated ten fold increase in available capacity has been
achieved by various SaaS vendors migrating their infrastructure to Amazon Web Services and
those of other cloud vendors. The competitive advantage of an impact of this magnitude on the
business model is ignored by SaaS providers at their peril. Moreover the barriers to entry for new
SaaS companies continues to drop, with new entrants finding significant efficiencies in not having
to invest in or manage their own infrastructure. They are instead able to focus all of their resources
on customer acquisition and solving business problems for their customers, while their more
established competition is spending precious resource on inflexible service contracts, legacy
infrastructure and additional personnel.

Many Software as a Service (SaaS) providers promote themselves as cloud service providers; and
from the perspective of their customers this is true. Less understood are the significant benefits
available to SaaS providers by moving their own infrastructure to that of cloud providers.

This white paper will explore the metrics and benefits of SaaS vendors migrating their own
infrastructures to those of cloud service providers.

A Brief History of SaaS

Early SaaS companies grew out of the Application Services Provider model around 1999. At the
time there were no cloud providers available of the sort we see today. (Amazon Web Services,
Rackspace Mosso, GoGrid, Joyent, Google App Engine and soon Microsoft Azure). Leaving aside
the challenges of every start-up business, like identifying customer needs, designing and building
a compelling solution, marketing, financing and the like, the pioneers of SaaS had to invest very
significantly in infrastructure to support their new business models. Investments included
everything required to deliver highly available, scalable, multi-tenant services to clients from
physical hardware, networking equipment, custom management software, billing systems and
everything else in between.

New SaaS start-up companies have a very different set of business challenges to face in 2009.

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A Brief History of SaaS (continued)

There is no need to invest in physical servers or personnel to manage them. Many critical functions
which had to be written from scratch by predecessors are now available as services from a variety of
reliable vendors. There is little concern for issues of scale nor service reliability beyond the specific
functions of the product feature set. Indeed, the modern day SaaS start-up is free to spend the
majority of their resources on creating a compelling service which solves their customers business
problems, and getting their message out to the market. This resource reallocation provides
significant competitive advantage over more established predecessors who still maintain these
legacy systems and processes.

SaaS Market Dynamics

The razor thin margins of SaaS (sometimes around 3%) mean that any significant alteration of the
competitive landscape from a cost perspective is particularly disruptive when viewed from the
perspective of capital markets. New entrants with significantly advantageous cost structures
put downward pressure on pricing and margins.

Customer success is critical to SaaS companies because the barriers to customer adoption and
customer attrition are both lower than traditional software. Any SaaS company with annual attrition
rates of more than 5% is on the wrong side of this equation. When you compare the (similar)
costs of customer acquisition between SaaS and tradition models, with no perpetual upfront fee
for a SaaS customer, it becomes clear that attrition of existing customers can have a devastating
effect on the business.

Uptime is fundamental for customers who are relying on their SaaS provider for mission critical
business systems. Any prolonged or intermittent service outages can erode customer confidence
very rapidly.

Variations in demand for SaaS means that capacity provisioning is typically designed and built
to deliver more than the peak demand expected. The downside to this is that most often when
demand is not at peak levels, there is excess capacity being paid for, but not utilized.

These SaaS market dynamics work together to make the business case for SaaS in the cloud

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SaaS Market Dynamics (continued)

particularly compelling as discussed below.

Cloud Service Market Dynamics

With cloud services, there is no need to invest in excess capacity to meet peak demands as
service can be scaled up and down on demand as needed, literally in minutes if required.
This means the SaaS provider running on cloud based infrastructure could provision servers to
meet demand in North America as the business world comes online in the morning, and reduce
capacity during the night as it approaches. At the same time, the morning in Europe could bring
extra capacity online there and so on following the day. Since the SaaS provider is not paying for
capacity they don’t need, there are tremendous cost savings to be had from only providing enough
capacity to meet demand at that time, and no more.

Most public cloud providers do not require long term commitments or service contracts. For
SaaS providers that are experiencing rapid growth, this flexibility allows revenue to closely follow
costs. In a sense the SaaS provider becomes a ‘cost plus’ vendor; with variable hosting costs,
limited fixed costs and no capital costs.

Leading cloud providers (like Google, Amazon and Salesforce) have grown out of years of
investment and refinement of infrastructure to support their own similarly failure intolerant
business models. This has made them particularly good at what they do and are generally
considered to be amongst the most reliable services on the Internet. The likelihood of service
failure between any new start-up providing its own infrastructure, and mature, stable, market
tested platforms, is self apparent.

Cloud Service Market Dynamics

A cloud hosted SaaS architecture would include:

fully virtualized environment

enterprise class fabric management software
hosted with either a public, private or hybrid cloud services provider

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Cloud Service Market Dynamics (continued)

Moving to this type pf environment from more a traditional version is not trivial, however
there are no major barriers to adoption, given the state of things today. A properly coordinated
and planned migration could be executed in phases with little risk of disruption to the
organization.

Let’s Do the Numbers

Let’s start with some basic assumptions that we can run through various scenarios.

1. Our SaaS vendor is considering whether to invest either in a Collocation Facility, Managed
Services provider or a Cloud Services provider. (assuming that creating their own independent
datacenter was already eliminated as a viable option.)
2. The typical demand shows peaks from 6am EST to 6pm EST which are 400% greater than
demand experienced during the night and at weekends.

Co-Lo Managed Services Cloud Hosting

Capital Costs $550,328 $0 $0

50 servers $250,000 included included
Networking equip. $250,000 included included
Software licenses $25,000 included included
Cost of capital $25,328 included included
Operating Costs $575,000 $725,000 $337,560
Bandwidth $100,000 $100,000 $50,000
Salaries $300,000 $85,000 $100,000
Software maint. $5,000 included $6,000
Hardware maint. $50,000 included included
Power $120,000 included included
Service fee $0 $540,000 $350,400
Elastic Demand
Weekends N.A. N.A. -$74,880
Nights N.A. N.A. -$93,960
Total Over 3 Years $2,275,328 $2,175,000 $1,012,680
Cost Comparison 100% 96% 47%

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Let’s Do the Numbers (continued)

Notes and Assumptions

-Servers are Dell 2950 rack mounted, medium spec. @ $5,000 each
-O.S, database licenses etc. Cloud hosting uses enterprise class fabric management.
-Cost of capital calculated at 9%
-Cloud hosting has no committed pre-purchase. Bandwidth estimated at $0.1 per GB.
-Co-lo is 3 data center people, Man Svs. one SYS Admin and Cloud better skilled Sys. Admin
-10% equipment replacement every year
-Man. Svs. $900 per server / month. Cloud $0.8 per hour / server instance.
-Weekends 104 days at 25% capacity
-261 business nights excluding weekends at 25% capacity

Conclusion
The cost advantages to cloud services are compelling, given the assumed environment above.
While Managed Services provides a modest 4% cost saving over Co-Locating, the Cloud Hosting
option, before considering the ability to adjust capacity with demand, shows itself to be 33% cheaper
than Co-Locating. Once you add the ability to adjust capacity to meet fluctuating and repetitive
demand swings, the savings really start to become game changing at 53% over Co-Lo.

If two companies are competing head to head in the same industry, and one of them is able to
deliver the same technical service at 47% the cost, they will be able to channel the difference into
other business functions like R&D, marketing, customer service or channel sales margins with
partners. This reallocation of capital into more efficient areas is a disruptive force brought about
by cloud computing that will affect every company over the coming years.

The price differential of cloud services are not the only benefits. Under the cloud model,
new servers can be provisioned in a matter of hours (not days or weeks), there are few long term
commitments or pre-buy requirements and redundancy and resilience to failure is improved
(due to the distributed nature of large cloud providers).

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About nScaled
nScaled helps companies reduce costs and increase capacity through the adoption of flexible,
on-demand cloud computing services. Our products and services ease the adoption and
management of virtualized cloud services on platforms such as Amazon Web Services, Joyent,
Rackspace Slicehost, GoGrid and others.

Contact us at:

Tel 415 480 5720

info@nscaled.com
www.nscaled.com

email: info@nscaled.com contact: 415.408.5720 www.nscaled.com