Key Trends in SaaS: 2008 and Beyond by SMARTLINE SYSTEMS

RESEARCH ALERT RA-417 December 20, 2007 B. McNee, M. West, B. Guptill, M. Koenig Title

Key Trends in SaaS: 2008 and Beyond

What is Happening?

Software-as-a-Service is poised for continued strong growth over the next few years, as it moves well beyond its initial focus on providing low-cost and “fringe” islands of automation in the cloud, to richly configurable and customizable “core” business solutions leveraging next-gen workflow.

Browse Related Research: • Emerging Trends / Technologies • IT Management • Software-as-a-Service (SaaS) • The IT Utility

Why is it Happening? The authors invite your comments and inquiries on this Research Alert. Please contact Bill McNee at bill.mcnee@saugatech.com. Mike West, Bruce Guptill and Mark Koenig helped support the development of this RA. Note 1 Three Waves of SaaS Evolution Wave I: Early Adoption (‘01-‘06) • Characterized by cost-effective software delivery (TCO, rapid deployment) • Stand-alone apps, multitenancy, limited configurability Wave II: Mainstream Adoption (’05-’10) • Characterized by the growth of integrated business solutions – and integration of SaaS apps with on-premise apps and data • SaaS Integration Platforms (SIPs), Business Marketplaces and SaaS ecosystems, early customization capabilities Wave III: Ubiquitous Adoption (’08-’14) • Characterized by the growth of workflow-enabled business transformation • Optimized business and ITtargeted ecosystems, interenterprise collaboration, IT utility / SaaS infrast., personalized / customized workflow Source: Saugatuck Technology

This extended year-end Research Alert highlights five key trends in SaaS for 2008 and beyond: 1. 2. 3. 4. 5.

SaaS Marketplaces and Platforms Proliferate SaaS Goes International SaaS Merger & Acquisition Activity Explodes Traditional ISVs Take Off Their Gloves – and Begin to do Battle SaaS Development Platforms Evolve

As recent Saugatuck research has explored, SaaS is now entering Wave III of user adoption (see Note 1). Whereas Wave II focused on the emergence of SaaS Marketplaces and integrating SaaS applications and business services with onpremise data and applications – Wave III will be all about optimizing SaaS ecosystems, inter-enterprise collaboration and personalized and customizable workflow capabilities (see Strategic Perspective SaaS’ Third Wave: On the Road to Personalized Workflows, MKT-337, 18Apr07, and Research Alert SaaS Beyond the Tipping Point: Three Waves, Four Key Challenges, Five Planning Positions, RA-343, 03May07). As we look forward to the New Year, Saugatuck has identified five important trends for 2008 and beyond that it believes will help shape how the SaaS applications and business services sector will evolve – including changes to how vendors will increasingly go to market, as well as how customers will gain value from SaaS solutions. 1. SaaS Marketplaces and Platforms Proliferate Although SaaS Marketplaces and Platforms began to emerge in 2005-2006 (to great hype and fanfare), early players such as Salesforce have yet to significantly monetize their investments in initiatives such as AppExchange thus far. Given this, many industry watchers (as well as AppExchange partners) have begun to question how real and important SaaS Marketplaces will be longer-term to the growth of the SaaS market. With the onset of the Wave III, Saugatuck firmly believes that SaaS Platforms and Marketplaces will begin to proliferate – becoming a significant channel opportunity for vendors, as well as a key means by which users will gain access to SaaS solution capabilities. No doubt other routes to market will also increasingly bear fruit, including a growing role for traditional VARs and SIs, as well as next-generation SaaS Integration Services Providers (e.g., Astadia, Bluewolf). And clearly there will be a growing appetite for solution suites packaged and sold direct by either a single provider, or via tightly integrated multi-vendor bundles positioned and sold by strategic partners. However, Saugatuck forecasts that by 2012, as much as 15 percent of total SaaS solution revenues will be accessed via SaaS Marketplaces. During the past several years, SaaS Marketplaces and Platforms have evolved well beyond their initial capabilities, offering customization, integration, data pipes

SAUGATUCK RESEARCH ALERT for BI or data sharing, data storage, content management, workflow, and development tools and APIs. In fact, we are starting to see specializations of SaaS Platforms that offer storage, raw compute power, and development and production environments in the cloud (such as Amazon's Elastic Compute Cloud or EC2 – and IBMs emerging 'blue cloud' initiative). Ecosystems have formed around these Platforms to enrich the value of their offerings, often through Marketplaces, always through the synergy of functionality brought together on the Platform. Beyond the pure-play SaaS Master Brands who have emerged (e.g., Salesforce, Cisco/Webex), established Master Brands such as IBM, Microsoft, Oracle and SAP are now clearly deepening their SaaS commitments – as are upstart Master Brands such as Amazon (see above) and Google who are getting into the game with serious commitments of their own. Expect a variety of different styles and flavors – but most of all, expect SaaS Platforms and Marketplaces to be dominated by well financed vendors who are in it for the long haul. SaaS Platforms now express a wide range of capabilities that are driven by the business model of the Ecosystem and the needs and characteristics of the Marketplaces they enable: no two are or will be alike. In that regard, we point the reader to a recently published Strategic Perspective (see On the Outskirts of Wave III: SaaS Platforms Proliferate in 2008, MKT-415, 18Dec07), where Saugatuck identifies and profiles six types of SaaS Ecosystems and Marketplaces forming around SaaS Platforms: Transaction Services, Collaboration Services, Corporate-Consumer Business Services, AggregationDistribution Services, SaaS Enablement/Infrastructure Services and IT infrastructure Services. Strategic Planning Position(s): • •

By 2012, 15 percent of SaaS solution revenue will be accessed through SaaS Marketplaces. By 2012, at least 75 percent of the revenue generated by SaaS Marketplaces will be driven by five or fewer SaaS Platform providers – who will both directly provide Marketplace services, as well as power vertical initiatives led by large and established business and consumer brands.

2. SaaS Goes International Throughout the planning horizon, Saugatuck anticipates continued strong growth in customer demand across all application and solution segments, as well as across a variety of on demand infrastructure and IT management services. Similar to other leading industry and Wall Street analysts who track the SaaS market (i.e., IDC, CSFB), Saugatuck believes that worldwide SaaS revenues will exceed $20 billion by 2012 (up from approximately $6.5 billion in 2007), which translates into a 35 percent compound average growth (CAGR) over this time period. What is important to recognize is that SaaS is now becoming an international phenomenon – driven by both local demand as well as large multi-nationals who are adopting SaaS business solutions on a global basis. While US SaaS adoption is clearly going “mainstream” (with deeper penetration by both SME and large enterprise accounts – and shifting from a “fringe” phenomenon to focusing increasingly on core business processes and systems of record) – Europe and Asia are only now beginning to experience the steep adoption ramp that the US has witnessed over the past two years. In fact, Saugatuck research suggests that Europe is beginning to go through a very similar adoption profile that the US has – albeit with an 18 month lag. In fact, we

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SAUGATUCK RESEARCH ALERT anticipate very strong European growth for both US-based SaaS giants aggressively expanding into this region (e.g., Salesforce, OpSource) – as well regional and country-specific players who are seeing very strong growth (see SaaS Adoption in Europe: A Closer Look at Rapid Growth, MKT-349, 25May07). Similar to adoption in the US in the 2005-2007 timeframe, demand is being primarily driven by Wave I and II market attributes, although greater emphasis is being placed on issues of security and data privacy in Europe. A great example of a fast growing regional European player is Stepstone, a UKbased provider of talent management solutions. One Wall Streeter that we recently spoke to described them as a cross between Monster.com and Taleo (who likewise is aggressively moving into this region). Whereas average US market growth rates will likely slow into the 35-40 percent range for public company SaaS vendors in 2008, European market growth rates should exceed 60-70 percent next year. Springboard Research projects similarly strong SaaS growth in Asia through 2010. Strategic Planning Position(s): • •

By YE2008, greater than 55 percent of North American-based businesses will have deployed at least one SaaS application, with Western European close behind at greater than 40 percent . By 2012, 30 percent or more of all new business software will be deployed and delivered as SaaS.

3. SaaS Merger & Acquisition Activity Explodes The tough housing market combined with high oil prices and sagging consumer confidence suggests that US GDP growth will likely slow to 1.5-2.0 percent in 2008. This environment should only benefit SaaS providers vis-à-vis traditional onpremise alternatives for companies making new investment decisions, as one of its core value propositions is a much more attractive up-front investment profile. This will likely also accelerate the necessity for ISVs to step up their SaaS transition strategies (see below). A slowing US economy will also only reinforce the core enterprise software consolidation trend, with the “Big Four” (e.g., IBM, Microsoft, SAP, Oracle) and a host of mid-market aggregators (e.g., Infor, Epicor) likely to continue gobbling up unprofitable enterprise software assets. Where that leaves existing enterprise software customers can often be a huge question mark as it concerns ongoing investment spending to keep those assets current. While worldwide economic growth will likely remain strong – especially in Asia – another important impact of the US slowdown may be fewer SaaS IPOs that come to market, which could have a significant impact on the balance of power in enterprise software. While the IPO window will likely remain open for the next two years, the quality and size of the companies that can exit via this method will likely change dramatically – with Wall Street increasingly looking to more traditional metrics and measurements (such as profitability) rather than exclusively focusing on top line revenue and cash flow growth. In fact, we would anticipate that average public company SaaS valuations have a strong possibility of falling over the next 12-18 months, from 6-7 times trailing 12months revenue toward a still high but more down-to-earth 4.5-5X ratio. If a narrower and higher-quality IPO market emerges later in 2008 and into 2009, combined with a valuation contraction scenario, Saugatuck would anticipate that a

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SAUGATUCK RESEARCH ALERT large number of venture-backed start-ups and emerging SaaS companies in the $5 million - $20 million range would be put up for sale by their venture backers over the next 12-18 months – and acquired by either SaaS pure-plays, ISVs hungry to enter the SaaS fray, and/or on-shore and off-shore IT services and BPO providers who are eager to leverage a SaaS model (e.g., Infosys, Wipro). We see this time period as an important one where next-generation horizontal and vertical franchises will be cemented. We see no reason why the services arms of IBM, Accenture, EDS or CSC won’t ultimately play very big in SaaS as well, as they increasingly package up some of their intellectual capital. No doubt a serious feeding frenzy is about to unfold. No wonder NetSuite got out when it could (given its’ spending on sales and marketing, and profitability profile) – although we are mystified by the 15X trailing 12-month multiple that the recent NetSuite IPO commanded. The recent SuccessFactors IPO is another (even more surprising) example. Strategic Planning Position(s): •

•

While SaaS-based start-ups will continue to get the lion’s share of new VC investment in the enterprise software space, 60 percent or more of SaaS firms funded prior to 2005 will either be acquired or go out of business by 2010. By 2012, all bets are off as it concerns traditional on-premise licensing schemas.

4. Traditional ISVs Take Off Their Gloves – and Attempt to do Battle Saugatuck believes that 2008 will be the year that the traditional ISVs earnestly begin to fight back. Whether it is SAPs SME-targeted launch of its’ (SOA-based) Business ByDesign offering, or Lawson’s new Talent and Performance Management line-extension initiative – traditional application ISVs are on the march. Saugatuck believes that approximately 15-20 percent of application ISVs have already either begun new skunk works initiatives or gained access to SaaS assets and development experience through M&A activity. However, over the next 12-24 months we anticipate this number to rise dramatically, as a tougher economic climate will only exacerbate an already challenged on-premise and traditional perpetual license model. To be successful, ISVs need to fully understand the journey that they will be on across five key dimensions – economic, technological, operational, organizational and cultural – as well as to take advantage of the many best practices that are available based on the hard-fought experience of early adopters (see ISVs Transitioning to SaaS: Common Threads and Best Practices, RA-402, 31Oct07). Among the most important technological issues is the decision over how best to implement multi-tenancy, and whether to take a more evolutionary approach (by leveraging virtualization technologies from vendors such as Parallels or rPath), or whether to truly start from scratch in building new single-instance multi-tenant applications. While almost all the same basic functionality can be delivered via either a virtualization or via a multi-tenant approach – in our opinion, most ISVs should view virtualization as merely an interim step along the journey to SaaS, rather than an end-game in itself (see Traditional ISV Transition to SaaS: Reinvent or Virtualize?, RA-413, 12Dec07). When starting from scratch, our experience in working with dozens of ISVs is that the most successful ISVs are those that target adjacent market opportunities, rather than trying to replicate existing on-premise

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SAUGATUCK RESEARCH ALERT application functionality in the cloud (unless it is with a substantially broader footprint, or with a dramatically updated business process workflow). One of the biggest battlegrounds over the next three years will be among the large application and platform providers with large partner networks, who will do everything that they can to incent their partner networks to repurpose and rearchitect their solutions using their development and integration tools, methodologies and roadmaps. Significant investment by firms such as Microsoft, IBM, SAP and Progress are already underway. If you are a vendor going down this path and you want or need the help – this is a good time to act, as creative deals are being structured NOW. Strategic Planning Position(s): •

•

By 2010, 40 percent of traditional on-premise application ISVs will bring to market SaaS solution offerings, either via acquisition, development of new single-instance multi-tenant applications, or through virtualized (multitenant) versions of their traditional on-premise offerings. Less than half of the ISVs in transition will succeed – especially large multi-divisional publicly-traded vendors who have unique organizational, cultural, sales and marketing, and installed customer base (transition / cannibalization) challenges.

5. SaaS Development Platforms Evolve 2008 will see explosive growth in the adoption and use of SaaS-based software development platforms and services for user enterprises, beginning with significant growth in the use of vendor-specific, application-specific, and marketplace/ecosystem-specific development platforms and services. SaaS platforms (and ecosystems) offer a secure, managed environment and tools for software development, by customers and by SaaS partners. Some are growing around specific SaaS applications and marketplaces (e.g., Salesforce’s force.com). But not all of the development on force.com is related to the Salesforce ecosystem, as the 6000-seat HR application developed and deployed by Japan Post indicates. Others platforms are growing around aspects of traditional software development and management (e.g., version control, component development and re-use) that can be delivered and managed in a SaaS environment (e.g., CollabNet). Advantages of SaaS-based development include an ability to tap into worldwide base of developers, skills, tools, and technologies suited to specific applications, platforms, and communities. This represents somewhat of a shift for user enterprises in the traditional "build versus buy" debates. In fact, the powerful growth, presence and influence of SaaS within user enterprises are driving the growth of "build in a SaaS environment" – and shifting the argument well beyond the early configuration messaging prevalent over the past few years. The broad and easy availability of customizable SaaS will become a rising tide that lifts SaaS use along with customer and partner development within SaaS applications and ecosystems. And the increasing presence of SaaS-based (but non-SaaS-vendor-focused) software development platforms will increase the pace of change in traditional software development and customization, especially when combined with open, standards-based technologies. Wide availability of open, standardized tools and technologies in subscription-based, on-demand environments will help streamline

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SAUGATUCK RESEARCH ALERT and reduce the costs of software development and customization. It will also foster use and growth of services-oriented architecture development strategies. Finally, such SaaS development platforms help to promote "green IT". Fewer development resources are required and utilized within both user and vendor enterprises, with the collaborative nature of such environments helping to improve efficiencies. Fewer development resources working in a more efficient environment reduces staff sizes, reduces facilities needs, reduces overall resources used, overall and delivers positive "carbon footprint" impacts. Strategic Planning Position(s): • •

•

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By YE2008, the number of user enterprises taking advantage of SaaSbased software development platforms, services and offerings will number in the tens of millions worldwide. By YE2008, SaaS-based development platforms will increasingly be found at the center of Open Source development communities; these development communities will create code that enterprise IT will subscribe to and mine for use in production systems. By YE2008, the convergence of service-oriented architecture (SOA), Open Source and SaaS will enable SaaS-based development platforms to attract developers across geographies, industries and company size to collaborate on not-for-profit skunk-works projects.

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