On Demand for Practitioners
Many businesses are now looking for delivery and payment models that are more in line with their demands relative to rapid return on investment (ROI) and low ongoing cost of ownership. One of the most popular new alternatives is the on demand model. On demand applications are priced using a utility-like model, with the costs spread over time based on usage. They are also accessible via the Internet, and upgrades, support and other operational services are included by default instead of being treated as extras.
The on demand model originally grew to prominence in the customer relationship management (CRM) space and has spread to other application categories, including payroll, expense reporting and spend management. This pattern is indicative of the fact that use of on demand solutions makes sense for supporting "mission critical/non-core" areas — the processes that need to occur in order to effectively run a business but are not directly related to a company's core business.
Because companies pay only for what they use and don't have to install software, there is no need to invest in internal or external resources to implement the application. Additionally, applications are deployed in weeks, not months or years, and ongoing ownership costs are typically five to 10 times less than the enterprise software option, according to a 2002 study from Industry Analysts.
A good example of this is the experience of Kennametal, a $1.8 billion manufacturer of tools and supplies for the metals industry. Kennametal wanted applications that would help the company to better control and manage its spending. The company was looking for a solution that would provide a positive ROI within a year, a low ongoing cost of ownership and ensured that scarce IT and business resources were not invested on a lengthy implementation project. The company spent two years reviewing solutions before it ultimately decided on an on demand service. The project was live within 45 days and delivered more than 150 percent ROI within one year. Just one manager from the company is running the project.
The Vendor Side of On Demand
As the on demand model gains momentum, old and new vendors may be required by default to adopt this way of doing business. Due to the fundamental differences between the license and on demand model, many of the larger software vendors will struggle to make the transition.
To understand the challenge, it is important to understand how software companies run their internal operations. High margins from upfront fees are dictated by how a vendor spends its income and how its employees are compensated. Most software companies spend more than 50 percent of their income on sales- and marketing-related expenses. Sales teams are paid on a commission rate based on quotas, and they are given an increased commission rate when they exceed their quota.
Marketing departments are provided with significant budgets that equate to 10 percent or more of annual revenue in order to woo new customers to pay for the company's products.
Once sales and marketing are underway, companies must invest in research and development (R&D) to continually develop new products and features. An average R&D budget costs 25 percent of revenue. Essentially, software companies have to have high margins for every new customer they sign simply in order to keep the business running.
In contrast, on demand providers' margins are earned over the lifetime of a contract rather than when a contract is signed. Sales teams are rewarded based on the customer's usage of the system over time rather than being paid based on upfront license fees. With the need to sustain ongoing value, an on demand vendor will spend proportionately more on R&D than it's software counterpart. These operational changes may take time for enterprise software vendors that have not traditionally provided on demand services.