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Total Cost of Ownership: SaaS vs On-Premise


Software as a Service (SaaS) is often touted as a software licensing model that saves organisations costs. This is mostly true, however, it’s not always as straight forward as it first seems. In this article I intend to highlight all of the considerations when considering the cost of ownership of SaaS vs On-Premise.

I recently discovered a great organisation called Software Advice. What they do is help organisations who are buying enterprise software to research and compare applications. They have created a tool that allows buyers to compare the total cost of ownership (TCO) of software as a service versus On-Premise. They model both the annual and cumulative costs of each deployment over a 10 year period.

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I think their TCO tool is brilliant. It makes comparing the types of licensing very straight forward. However, there are some important aspects of both license deployments that should be considered when trying to calculate TCO. I’ve listed them below:

1. To be able to make a fair comparison SaaS pricing must be assimilated over time.

One major benefit of SaaS is that the capital expenditure is much lower than traditional on-premise perpetual licensing. This allows the customer to spread the cost over time.

What is often overlooked however is the net present value (NPV) of a SaaS subscription; that is, in today’s money, what will be the total cost of all future subscription payments. By overlooking NPV, buyers misunderstand the actual costs of their software investment.

For example: You could buy a £100,000 on-premise license, with additional licensing costs of £7,500 per year. Or, you could purchase a SaaS subscription for £40,000 per year.

SaaS seem much cheaper – but while you may pay less on a yearly basis, these costs quickly add up. By year three, your annual SaaS subscription cost will already total £120,000. By comparison the on-premise license costs come to £125,000 and by year 4 the SaaS license costs have exceeded the On-Premise. As this example shows, forgetting to account for the NPV of your SaaS investment can give you the mistaken impression that your total license costs are significantly less than they would be with an on-premise system.

There is more to SaaS than just a cost saving, a major benefit is the lower financial risk due to lower amount of up front investment SaaS systems require to setup. But, for the purpose of fair price comparison it is important to always consider the NPV.

2. SaaS does offer an infrastructure saving versus On-Premise, but quantifying it is not easy.

Whilst there are obvious cost savings with SaaS you have to scratch beneath the surface to fully quantify the costs. This is because the saving associated with SaaS stem from organisations not having to invest as many resources into internal I.T. With a SaaS based system, the vendor takes on the majority of the I.T. responsibility such as hosting and the maintenance of the software as well as ensuring the systems remain secure. This majorly lowers an organisations I.T. costs, but, it doesn’t eliminate them entirely. The systems will most likely still require some level of configuration, testing and maintaining internal links to other systems may require attention.

By comparison organisations that run On-Premise software systems are wholly responsible for the infrastructure (servers, database, linking) that runs the software. They are also responsible for maintaining security and ensuring the system remains running effectively.

It is therefore easy to see why SaaS offers a cost saving, but quantifying it in terms of infrastructure versus On-Premise is very difficult to do accurately.

3. It is very hard to predict future On-Premise costs.

Whilst the traditional perpetual On-Premise software licenses usually mean there isn’t any future licensing cost the same cannot be said for the relating infrastructure costs associated with managing an On-Premise environment.

Hardware is the obvious cost that springs to mind. Maintaining servers, replacing and improving infrastructure is a cost that is difficult to predict. On top of this as SaaS becomes more and more popular will expertise surrounding infrastructure become rarer and subsequently more expensive? Just like point 2 it is hard to quantify the future costs of the I.T. department.

4. Customisations mean extra costs, but they are not limited to On-Premise systems.

In the early days of SaaS customising your SaaS system was not an easy process. As the systems have developed  they are becoming more customisable. The lack of flexibility with customisations has lead to a false perception of the TCO of SaaS, and as the systems become more flexible to customisation the associated cost will naturally rise.

Whilst On-Premise systems are currently more customisable than SaaS systems the cost of customisation is a double edged sword as customisations costs both at the point of implementation and when the time comes for a system to be upgraded to a newer version. By comparison SaaS systems are part of a new wave of software which appear to have been developed with easier upgrade processes in mind. Hopefully this will result in lower costs relating to customisations but it is still too early in SaaS systems lifecycle to tell.

5. Upgrades are expensive. Updates aren’t.

On-Premise systems require upgrades. Generally organisations will make upgrades within periods of 2-4 years of their last upgrade, although of course some organisations upgrade more regularly and others less so.

Often the upgrade process with On-Premise systems brings new costs such as new hardware that is required. On top of this as with point 4 if organisations have made customisations to their system then this will also increase the cost of an upgrade.

Another cost associated with the upgrades of On-Premise systems is that it may attract the attention of the software vendor who requires you to buy additional licenses to be compliant. With a SaaS model this isn’t the case as the licenses are often required to be purchased up front before they can be used.

By comparison SaaS systems have been developed to be much less intensive on the upgrade front. Some vendors even have dropped the ‘upgrade’ term and replaced it with ‘update’. Depending on the vendor and the type of system updates can often occur over night without any associated costs.

6. Business growth/shrinkage.

One area that is difficult to gauge the On-Premise TCO is in the event of business growth or shrinkage. If the business is to grow then new licences will be required regardless of whether the system is SaaS or On-Premise. This is normally the case with either SaaS or On-Premise regardless of your license type as turnover growth and employee count usually go hand in hand. However, forecasting for growth with SaaS is easier to work out the TCO whilst On-Premise depends on infrastructure costs.

With business shrinkage SaaS is the winner as most vendors will allow for the shrinkage to be reflected in the subscription fees. On-Premise on the other hand will not be so easy to recoup costs as a majority of the cost will have already been sunk in the initial capital expenditure and often ongoing support costs will reflect the initial expenditure.

 

There are of course many other elements that effect TCO within an organisation. Many of these elements will revolve around particular licensing deals available from vendors. Such as price holds, unlimited license agreements (ULA’s), enterprise license agreements (ELA’s) etc. This article is intended to give a high level overview of 6 areas that should be considered when trying to evaluate the TCO of both types of software deployment.

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