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Tip of the Iceberg: The real cost of on-premise software

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Sanjay Srivastava

Chief Digital Officer

December 3, 2012 - I have built or sold software applications most of my working life. These days I am often asked how Software as a Service (SaaS) compares in price to similar on-premise software. In reality, the cost of the license for on-premise software is only the tip of the iceberg. Comparisons between the two need to be much more comprehensive to be useful.

The real cost of on-premise software only starts with the cost of the software license. In order to compare it to true SaaS – which typically includes ongoing support – we need to add the annual cost of support and maintenance, typically another 20% of the on-premise license cost. Most companies also add the incremental cost of implementation services, as most on-premise software is complex to integrate into an enterprise environment. SaaS implementations can be simpler and less expensive, since they are designed to operate from a network and integrate through standard interfaces. The differences in the cost of implementation can be substantial and should be considered.

Next comes cost associated with the application infrastructure. SaaS doesn’t require acquisition of a computer environment or services to run it. When purchasing on-premise software, however, most companies will need to acquire hardware (computer, networking switches and disk storage) and software (database, application servers, middleware, client access licenses, etc). These costs can be significant, and traditionally are duplicated in at least two instances: production, and a development/test environment.

The ongoing costs of power and utilities allocated from the data center, as well as the costs of data replication and disaster recovery, also need to be added. Most data center hardware is updated on a 3 to 5 year cycle, so a long-term total cost comparison should factor in the cost of replacements and upgrades to hardware and software.

The allocated cost for IT staff required to manage and run the application in the data center is often higher for on-premise software, for two reasons. One, SaaS vendors obtain economies of scale that would be difficult for most IT teams to replicate. Two, since SaaS vendors can see what’s going on directly in the software, their support costs can be much lower.

Added together, all these pieces – license, support and maintenance, implementation, infrastructure purchases, data center costs, and allocated cost of IT services – represent the true hard costs of the on-premise application when compared with SaaS alternatives.

It is also important to capture some of the soft issues. SaaS implementations have a shorter implementation window, making SaaS faster to market than on-premise applications. Longer integration windows increase operational and financial risk around the implementation project. It is also easy to miss the largest soft cost: slow user adoption. Most SaaS applications, by virtue of the fact that they were designed recently with more current technologies and user-interface approaches, are easier to use and thus have much faster adoption. Equally, SaaS is new and evolving and not all application areas may have qualified available alternatives. Whether or not these considerations are actually converted into financial costs, they should be part of the overall comparison.

Actual calculations and comparisons will differ by situation. In many cases, on-premise software may still be the better solution. It is not my intent to suggest one is better than the other, but it is important to note that a true economic comparison can only be done by adding all the pieces required to deliver a complete service.