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Software-as-a-Service ERP Versus

On-Premise ERP Through the Lens of
Total Cost of Ownership
WHITE PAPER
Sponsored by: Plex Systems
Si mon E l li s
May 20 10

IDC MANUFACTURING INSIGHTS

OPINION
Software as a service (SaaS), sometimes referred to as "software on
demand," is becoming an increasingly effective and popular way to
implement various business applications. While this implementation
approach has gained traction in application areas where there is value
to "network" interactions or large amounts of outsourcing, there have
also been a surprising number of hosted business intelligence
capabilities (sometimes including "analytics as a service") and a
growing recognition of the positive aspects of total cost of ownership
for companywide, enterprise-level applications particularly for
small and medium-sized companies.
There is little question that SaaS is becoming well established as a way
to deliver business applications. Based on our research, over 50% of
manufacturing companies are using some form of hosted application,
and another 35% are considering it. There has tended to be the view,
primarily among large manufacturing companies, that a hosted
application is functionally limited; however, this view is changing. The
most popular application areas for hosted applications are transportation
related (TMS, GTM), where the "network effect" (i.e., carrier pooling,
regulatory impact) can leverage both shared knowledge and existing
connectivity, with customer relationship management (CRM),
ecommerce, and business intelligence/analytics next. Enterprise-level
applications delivered as a service have been most appealing to small
and midsize manufacturing companies where tight IT budgets may
prevent an adequate level of IT support and infrastructure to manage
in-house application systems, but we are also seeing a growing interest
on the part of large enterprise manufacturers to at least understand the
various trade-offs inherent in proper SaaS options.
There is also little question that the total cost of ownership (TCO) can
favor SaaS for even large companies. In fact, for many companies, the
"pay as you go" nature of SaaS avoids many overt as well as hidden costs,
resulting in an attractive ROI versus more traditional forms of application
use. Even beyond that, there is a growing interest on the part of
May 2010, IDC Manufacturing Insights #MI223417

Based on our
research, over 50% of
manufacturing
companies are using
some form of hosted
application, and
another 35% are
considering it.

manufacturers to build variable-cost operations versus fixed-cost

operations (at least until the longer-term effects of the global recession are
better known) as a way to respond to market and sales uncertainty. For
many companies, this uncertainty is creating the need to hedge at a design
level, in terms of both physical supply chain capabilities (outsourced
versus owned manufacturing facilities) and IT capabilities (on premise
versus as a service). This trend clearly favors SaaS in the short term. In
fact, IDC has raised its IT forecast for SaaS-related applications as a result
of the global recession. Current projections are for an annual growth rate
of 7% from 2009 to 2013, versus 4.8% prior to the recession.
This white paper looks at the growing applicability of SaaS for
enterprise-level business applications and analyzes the adoption rate
and TCO of this technological approach. According to the anecdotal
experiences of our client organizations that have deployed SaaS, a
hosted option can drive significant cost savings, reduce initial
implementation times, and bring new functionality with relative ease
and convenience.
SITUATION OVERVIEW
Issues and Pain Points Faced by
Manufacturing Organizations

Manufacturing companies have done a generally good job of adopting

ERP tools across their enterprise. Large enterprise companies have led
their small and medium-sized counterparts in implementations, but
overall adoption has been strong. On the heels of the global recession
of the past 18 months, IDC Manufacturing Insights certainly sees less
of an appetite among CIOs for replatforming and for major ERP
upgrades, even where applications may be close to the end of their
anticipated useful life. In this context, SaaS alternatives certainly are
growing in their appeal.

IDC Manufacturing
Insights certainly sees
less of an appetite
among CIOs for
replatforming and for
major ERP upgrades,
even where
applications may be
close to the end of
their anticipated
useful life.

Manufacturing organizations currently face a number of pain points in

terms of their current ERP implementations. Based on our
conversations with both CIOs and line-of-business executives, we see
issues related to the following areas:
1. Cost is a huge issue for CIOs and IT organizations. Reduced IT
budgets, along with climbing maintenance costs for traditional
ERP implementations, certainly are causing manufacturing
companies to look for alternatives. In addition to these "obvious"
costs, there are less obvious costs such as the cost of the staff
necessary to manage information systems and datacenter, the
energy and space required for a modern datacenter, and the capital
investment in physical hardware and communications equipment.
Companies also need to consider the opportunity cost tied to all of
their expenses and especially to capital expenditures.
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2. The ability to add new functionality as customizations to

on-premise software implementations has also been a common
problem for IT organizations. After paying for the customization, IT
organizations pay the software vendor extra maintenance costs or
have to rewrite the customization when upgrading. In a SaaS model,
the software vendor is responsible for all system enhancements,
necessary upgrades, and maintenance. Not all can support
customizations, but those that can will typically handle upgrades and
maintenance as part of the subscription fee.
3. Accessibility is another issue that IT organizations struggle with,
particularly in organizations with increasingly virtual workplaces
and remote employees.
4. IT organizations also worry about ease of use, as application users
almost universally decry the complexity of use of most enterprise
applications, in terms of both the levels of training required and the
lack of intuitive user interface capabilities. In this context, the
multiple add-ons to ERP can also create a cumbersome interface
for many users.
5. IT organizations are having a hard time not only getting their arms
around the issue of scalability but also responding quickly to
changes in demand. Particularly in the current business climate,
where many manufacturers are struggling to understand the new
baseline for their business, the obligation on IT to provide the
correct level of bandwidth and services is difficult.
6. Lastly, business continuity/disaster recovery capabilities are
always on the minds of CIOs. If some kind of event occurs and the
system goes down, is there an adequate level of redundancy, or
failover, to ensure business continuity?
The Maturing of SaaS

We thought it would be useful to be clear about our definition of SaaS.

A number of terms are used in the software industry to describe as-aservice offerings, and sometimes these terms create confusion. For the
purposes of this paper, we would like to make some distinctions,
detailed in Table 1, and recognize that as SaaS matures in the
marketplace, so do the definitions.
TABLE 1
As-a-Service Definitions
Hosted

An application that sits on an external server in a single-tenant environment

Software as a service

An application that is hosted, but in a multitenant environment

Cloud computing

Delivery of infrastructure or IT platform

Source: IDC Manufacturing Insights, 2010

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The delivery of either hosted or SaaS applications may use the cloud,
but they are not, in and of themselves, the cloud. It is also important to
point out that as-a-service offerings exist in two distinct forms: single
tenant and multitenant. In a single-tenant approach, what we refer to as
"hosted," the software vendor maintains an independent version of its
application for each manufacturing client. In a multitenant approach,
multiple clients can be hosted on a single instance of the application
and on a single logical database. Early hosting was single-tenant
because it appeared to be easier for the hosting company to manage;
however, it is error-prone when applying fixes and upgrades to tens
(or worse, hundreds) of independent hosted versions of the software.
Multitenant is an emerging best practice for SaaS that reduces
operational and upgrade costs and enables the application provider to
better scale to demand without interruptions to service levels. These
translate to potential savings that can be passed to the customer. The
multitenant approach must be designed from the ground up to provide,
among other things, appropriate levels of security and data protection.
In a traditional, "on-premise" software implementation, the software
vendor sells a packaged license that the manufacturer installs and
maintains on servers within an owned datacenter. The manufacturing
company is responsible for paying the initial license fee, some level of
installation/integration cost, and an annual maintenance fee. Within the
owned datacenter, there are the regular cycles of buy and replace for
hardware, along with the software infrastructure (e.g., DBMS and OS)
and personnel costs. There may be variations of this basic model in
which the software vendor (or third-party service provider) runs/hosts
the application on its own servers within its datacenter and provides
access via a secure subscription process.
In a SaaS deployment, the application is built from the ground up to be
hosted and, furthermore, to allow a single instance of the database and
software to be used by all manufacturers using the software. Whether
hosted, or pure SaaS, the nature of the subscription pricing can vary. In
some instances, it is based on the size of the user company (typically
revenue based); in other cases, it may be based on the number of users
or on transaction volumes. In either case, SaaS would be viewed as a
primarily variable-cost approach, whereas traditional installations are
more fixed cost. This becomes an important distinction as we note in
detail later in this paper.
There is little question that SaaS is well established as a way to deliver
business applications. Based on our research, over 50% of
manufacturing companies are using hosted applications, and another
35% are considering it. The most popular application areas for SaaS are
transportation related (TMS, GTM), where the "network effect" (i.e.,
carrier pooling, regulatory impact) can leverage both shared knowledge
and existing connectivity, with CRM, ecommerce, and business
intelligence/analytics next. Enterprise-level applications delivered as a
service are most appealing to small and midsize manufacturing
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companies where tight IT budgets may prevent an adequate level of IT

support and infrastructure to manage in-house application systems, but
we are also seeing a growing interest on the part of large enterprise
manufacturers to at least understand the various trade-offs inherent in
hosted options, particularly where the ROI may be less clear or speed of
deployment is particularly urgent.
Although there has tended to be the perspective that ERP delivered
through SaaS is "ERP lite" and most appropriate for small and
medium-sized enterprise manufacturers, this view is increasingly being
dispelled among large enterprise CIOs. As CIOs wrestle with lower IT
budgets and pressure to deliver capabilities more quickly, they are
considering SaaS alternatives and realizing that SaaS offerings are as
robust as traditional vendor offerings. As a result, SaaS alternatives are
become quite appealing. A SaaS alternative fits nicely within the
changing view among manufacturing supply chain organizations of
moving toward a variable-cost rather than a fixed-cost structure as a
way to respond to market and sales uncertainty where capabilities
can be easily scaled (both expansion and contraction) based on
business changes. This notion of market uncertainty creating the
need to have flexibility at a design level, in terms of both physical
supply chain capabilities (outsourced versus owned manufacturing
facilities) and IT capabilities (on premise versus hosted) makes
SaaS a very compelling alternative.

As CIOs wrestle with

lower IT budgets and
pressure to deliver
capabilities more
quickly, they are
considering SaaS
alternatives and
realizing that SaaS
offerings are as
robust as traditional
vendor offerings.

Benefits of the SaaS ERP Model

As SaaS applications mature in the marketplace, the benefits and

trade-offs have become clearer. Yet, a number of misconceptions and
"half-truths" continue to pervade the marketplace and bias
potentially to its detriment the ultimate decision to purchase a
"behind-the-firewall" ERP application. In an effort to set the record
straight, we'd like to discuss each of the areas that technology buyers
should be considering as they look to build business capabilities
through investments in applications and IT tools.
SaaS Is More than Just Cost

Although the cost of an ERP implementation is not, and should not be,
the sole consideration, it is often the starting consideration and the
place where a conversation can come to a quick end. Table 2
summarizes many of the costs associated with an ERP implementation,
the periodicity of the costs, and some examples of magnitude.

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TABLE 2
TCO Comparison Between Software-as-a-Service ERP and On-Premise ERP
SaaS ERP

On-Premise ERP

License fee initial

One-time

None

$$$ variable

License fee upgrades

Periodic

None

$$ variable

Subscription fee

Annual/recurring

Charged by user,
volume/usage or company
size

None

Maintenance cost (plus extra for

customization)

Annual/recurring

Included in subscription fee

1525% of license annually

Support costs

Annual/recurring

Included in subscription fee

May be part of or in addition

to maintenance fee

Hardware costs

Periodic

Minimal (browser)

Extensive

IT infrastructure costs

Recurring

Minimal (Internet
connection)

Extensive

IT personnel/support costs

Recurring

Minimal

Extensive

Implementation costs external

(based on timescale/duration of
install)

One-time

$$ variable

$$$ variable

Implementation costs internal

(based on timescale/duration of
install)

One-time

$$ variable

$$$ variable

Source: IDC Manufacturing Insights, 2010

It is also interesting to note that financial cost analyses of major

application installations consider the overt costs but often fail to
account for many of the "hidden" costs. One example is the cost (both
overt cost and opportunity cost replacement) of the additional
hardware required to host the application along with the personnel
required to maintain the equipment and the application. Another
example is the implementation process. Although the external cost of
implementation, typically a third-party systems integration company,
is easily identified in the cost equation, it is our experience that the
opportunity costs of contributing significant internal personnel to an
implementation team often are overlooked. It is important to point out
that the process of implementation for a SaaS ERP installation may be
very similar to the implementation process for an on-premise ERP
installation, just not as long. Because resources are tied up for less
time, the costs will also be less. In the second example, companies

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end up reallocating and/or stretching resources across the business,

reducing the ability to manage unexpected business conditions, or
utilize some level of outsourcing capability. In either instance, there is
a cost to the business that may go unaccounted for.
Another area of costs that can be avoided through the use of SaaS
includes security, backups, and disaster recovery. This is a major area
that IT organizations do not generally consider certainly not to the
degree that these are costs that can be avoided with a SaaS
implementation and that many small or medium-sized businesses
cannot afford.
Particularly in the current economic climate, where business
conditions are unparalleled in their unpredictability, SaaS can offer a
level of adaptability that is enormously helpful to companies that may
be looking for more flexible IT tools as we pointed out earlier
for both easier expansion and contraction.
Integration and upgrade coordination are also issues that SaaS can
ease. At IDC Manufacturing Insights, we have seen a pretty consistent
view on the part of technology buyers that they will sacrifice that final
little bit of functionality for an easier integration. There is little
question that especially large companies are delaying the refresh rates
of IT systems, certainly to postpone capital expenditures from up-front
licensing fees and replatforming but also to avoid the inevitable
business interruptions and risk from long implementations. The same
occurs on a smaller scale with version upgrades. Opportunity costs are
associated with extending refresh cycles, and while these costs can be
difficult to quantify, they may manifest in terms of lagging
capabilities, poor agility, and inability to react quickly to changing
business conditions.
We see this as a particularly acute problem in the current business climate
where application modernization has enabled companies to react
quickly to changing business conditions. In this recession, IT has really
proven itself as companies with more sophisticated and comprehensive
tools have been able to respond more quickly to marketplace changes and
protect cash and profits. To the extent that "no good idea goes uncopied,"
we expect to see application modernization accelerate out of the recession
and, along with the desire to move to a more variable-cost approach,
bring SaaS front and center as an alternative.
As we discussed earlier in this white paper, there is a persistent view on
the part of many technology buyers that a SaaS ERP installation is "ERP
lite" and that functionality will be sacrificed. While this may have been
true, and may still be in some cases, particularly for newer players, IDC
Manufacturing Insights believes that it is no longer the case. Vendors in
the marketplace are offering ERP applications via a SaaS model that
give very little, if any, functional ground to the on-premise alternatives
while providing the inherent advantages of SaaS.
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The last point we would like to discuss is the notion of accessibility or

"ease of use." As manufacturing companies outsource operations and
move to supply networks that are increasingly distributed, the
challenges of system access for remote or virtual office employees
become more acute. To date, these issues have been at the forefront for
sales, marketing, and supplier system tools, but the problem also
looms for enterprise-level tools such as ERP. The need for easier
access, reduced training, and reduced support times can be a
fundamental advantage for SaaS delivery.
Evaluating the ROI

Given the benefits of ERP in a SaaS model, how should companies

proceed? Certainly we have seen adoption of SaaS applications driven
by company size and IT sophistication. Midsize companies have been
the most enthusiastic consumers of SaaS applications to date. In the
past, these companies had to overextend their budgets with a big
capital investment in on-premise software, or they would buy an
inexpensive, no-frills solution that allowed them to get by. The SaaS
delivery model is a new alternative that is making robust ERP systems
affordable to midsize companies. We are also seeing growing interest
from large companies that are now forced to reconsider the capital
investment paradigm and are discovering a broadening range of
applications available as a service.

We are also seeing

growing interest from
large companies that
are now forced to
reconsider the capital
investment paradigm
and are discovering a
broadening range of
applications available
as a service.

Indeed, based on IDC spending data, we see opportunities for ERP via
SaaS across a broad range of company size and IT sophistication. At
the low end of company size (below $100 million), where businesses
are often living without capabilities such as disaster recovery or
adequate security measures, ERP delivery via SaaS can offer a reduced
TCO versus on-premise ERP and valuable additional capabilities.
Midmarket companies ($100999 million), while likely to have more
extensive internal IT resources, may still be living without some of the
capabilities that larger companies have, and given their business
complexities, they are ideal candidates for ERP via SaaS. At the high
end of the market, large companies ($1 billion and up) may not lack
for IT capabilities, but given the size and breadth of their IT
infrastructure, they will see significant reductions in TCO. We
illustrate this situation in Figure 1, although certainly there may be
outliers (i.e., small companies with comprehensive IT capabilities or
large companies with more limited IT capabilities). The compelling
value proposition for ERP via SaaS is that regardless of where
companies may sit relative to the cost and capability axes, a SaaS ERP
deployment can put a company on the path to the top right corner.

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FIGURE 1
IT Cost/Capability by Company Size

Large
Enterprise

2.1%

IT Cost
(% Rev)

MediumSized
Enterprise

2.8%

3.5%

Small
Enterprise

Comprehensive

Limited

IT Capability
Source: IDC Manufacturing Insights, 2010

Given the potential benefits of an ERP via SaaS deployment in both

cost and capability, we sense that these benefits may in fact be
understated. In discussions with manufacturing CIOs, we found that
ROI or net present value calculations are based on less mature
economic cost models that do not factor in all of the costs associated
with on-premise ERP implementations when they make the
comparison. Most of the companies IDC Manufacturing Insights has
spoken to on this topic still use a fairly basic approach:
(# of users * subscription fee) >=< (annualized cost of license fees + maintenance)

As we point out in Table 2, a number of less obvious costs are

associated with on-premise ERP implementations that can easily fly
under the radar. Including these costs in the above calculation can
dramatically increase the savings. The other important point to note is
that this less mature view of economics is based on a prerecession
paradigm. Although we expect a shift to variable-cost structures as a
response to market uncertainty, we do not yet know how it will change
the perspective on SaaS. It is entirely likely, as SaaS continues to
mature and the benefits that accrue become clearer and more
comprehensive, that this shift to variable-cost structures will drive
higher levels of SaaS adoption and also increase the potential savings.
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It is also important to point out that sometimes the underlying ROI for
an ERP implementation can be unclear. The business rationale of
moving to a newer, on-premise ERP implementation can be difficult to
justify versus the existing state (i.e., doing nothing). In such cases, a
SaaS alternative can be appealing as a way to "kick the tires" on new
functionality and modernized capabilities.
FUTURE OUTLOOK
Clearly SaaS applications are maturing. Companies that either are
using or plan to use SaaS applications in the next year have grown
considerably over the past few years, suggesting that the barriers to
adoption either real or perceived are being overcome. At IDC
Manufacturing Insights, we see a bright future for SaaS across a broad
range of application areas and for companies ranging from small to
large. We see both SaaS offerings from an increasing number of small
and medium-sized software vendors and hosted options from the wellknown, large industry players.

Companies that either

are using or plan to
use SaaS applications
in the next year have
grown considerably
over the past few
years, suggesting that
the barriers to
adoption either real
or perceived are
being overcome.

But not all SaaS vendors are created equal. We talked earlier in this
paper about the difference between single-tenant and multitenant
implementations of SaaS and how the latter are able to more easily scale
to demand without interruptions in service. As SaaS grows in popularity,
and postrecession demand stabilizes, the ability to scale seamlessly is a
critical consideration. Even considering the scale economies, a poor
implementation of SaaS will deliver neither the expected savings nor the
required capabilities. The other point to consider is one of risk in
terms of both disaster recovery and security breaches. There are
immature SaaS vendors in the marketplace, and thus, particularly when
one considers an enterprise application such as ERP, the level of security
and maintenance of business continuity should not be compromised.
There is no doubt that manufacturing companies are much more open
now to considering SaaS as a delivery option, and technology buyers
view it as an increasingly competitive and viable option. Table 3
illustrates the changing perceptions.
TABLE 3
Technology Buyers Consider SaaS Alternative
SaaS as an Option

On Premise Only

2010

75%

25%

2008

45%

55%

2006

15%

85%

Source: IDC Manufacturing Insights Client Discussions, 20062010

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The numbers are not suggesting that in 2010, for example, we expect
75% of applications to be hosted; rather, they suggest that in 2010,
we expect SaaS to be considered as a viable alternative in 75% of
the evaluations. TCO is driving many of these perceptions. As we
have outlined, in the right circumstances, SaaS can drive significant
savings.
SaaS is not without its problems, however. Limited functionality and
security concerns linger, and while these concerns are more perception
than reality, it is important when considering ERP from a SaaS vendor
that appropriate due diligence be applied to ensure the functionality
meets critical business needs. But then, this is really no different from
the evaluation done on an on-premise application, at least not with
regard to functional requirements. With regard to security concerns,
one can make the argument that there are bigger internal threats than
external threats. Small and medium-sized companies cannot afford a
full-time security officer. Overworked employees, a lack of
appropriate diligence, or poor internal security policies can expose
internal applications. Leading SaaS vendors with clear and
documented practices focus significant effort on maintaining high
levels of security; indeed, their very livelihoods depend on a stellar
reputation. But, beware, not all SaaS vendors are as thorough.
Pay close attention and make sure the SaaS vendor has the
infrastructure and business practices in place to ensure that your
business systems are in reliable hands.
Perhaps the more problematic view of SaaS is its role in perpetuating
"shadow IT." SaaS has proven popular in large companies,
particularly, when functions or business units have trouble getting
systems approved through traditional IT channels. Implementing
software in this "go around" way can result in fragmented systems and
inconsistent business processes. This kind of "shadow IT" is less likely
in the case of enterprise applications such ERP, but it is something to
watch out for regardless.
ESSENTIAL GUIDANCE
Application delivery via SaaS is maturing rapidly and is now a wellestablished alternative to delivering business applications and IT tools.
Beyond early-adoption categories such as transportation, global trade,
and CRM, manufacturing companies are increasingly willing to
consider enterprise-level applications such as ERP. Implementation
costs and timescales may be improved and ease of use facilitated.
Based on our conversations with CIOs and technology buyers,
economic results are positive. While we caution users to look broadly
at benefits, the pure cost associated with SaaS is generally very
positive, and most companies report either meeting or even exceeding
expected savings. SaaS is particularly compelling where:
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1. Business or transaction volume is either variable or unpredictable.

2. Speed of deployment is critical.
3. The ROI of an ERP implementation may be difficult to calculate.
4. Capital expenditure budgets are constrained.
5. In-house IT staff/skills are either limited or required for alternate tasks.
As technology buyers investigate SaaS options versus on-premise
options, IDC Manufacturing Insights recommends keeping five key
points in mind:
1. Clarity around key functionality. While ERP SaaS offerings
have closed the functionality gap versus ERP on-premise offerings,
it is important to ensure that the selected application is adequately
robust and scalable and that it offers capabilities that meet your
business needs.
2. Understand the economics. How are the usage fees generated,
and what is the length of the contract? Can I easily scale usage up
and down without any assessment of penalty fees?
3. Implementation/integration capability. What is the duration of
the initial implementation process, and to what degree can the
SaaS ERP integrate with systems I might still have on premise?
4. How secure is my data? We've talked about the expectations for
appropriate security measures; however, doing due diligence is
critical to ensuring the robustness of the security provisions and
disaster recovery capabilities.
5. How are new capabilities added to the product, and will they be
available to my business as I need them?
Lastly, and in many ways most importantly, remember that not all SaaS
vendors are created equal. As we have pointed out, SaaS is a maturing
capability. Make sure to select a vendor that brings experience and a good
reputation for working effectively with manufacturing companies to
ensure business benefits, scalable growth, and business continuity.
Copyright Notice

Copyright 2010 IDC Manufacturing Insights. Reproduction without

written permission is completely forbidden. External Publication of
IDC Manufacturing Insights Information and Data: Any IDC
Manufacturing Insights information that is to be used in advertising,
press releases, or promotional materials requires prior written approval
from the appropriate IDC Manufacturing Insights Vice President. A
draft of the proposed document should accompany any such request.
IDC Manufacturing Insights reserves the right to deny approval of
external usage for any reason.
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