On-Demand Computing: A Brutal Slog

The tough reality of the on-demand game is taking its toll on software companies hoping to make a mint distributing their wares via the Web

by Sarah Lacy

The Internet revolutionized the distribution of software—perhaps a bit too much. The Web brought a new, cheaper method for getting software into the hands of users, but in doing so may have killed one of the best models in Silicon Valley history.

At the outset, the Internet ushered in an exciting new era of corporate software. On-demand computing—its poster child Salesforce.com's grinning, rosy-cheeked Marc Benioff sporting his once trademark "No Software" button—promised low-priced, convenient delivery of applications. Buyers would save on consultants, because vendors would host the applications and just rent access via the Web. No more obnoxious upgrade cycles, because software would be improved and tweaked daily. And if the software didn't live up to expectations? Just cancel. Businesses didn't invest in installing and configuring the software, so there was no lock-in.

Traditional Software Marketing

On-demand represented a welcome break from the traditional way of doing things in the 1990s, when swaggering, elephant hunter-style salesmen would drive up in their gleaming BMWs to close massive orders in the waning days of the quarter. It was a time when representatives of Oracle (ORCL), Siebel, Sybase (SY), PeopleSoft, BEA Systems, or SAP (SAP) would extol the latest enterprise software revolution, be it for management of inventory, supply chain, customer relationships, or some other area of business. Then there were the billions of dollars spent on consultants to make it all work together—you couldn't just rip everything out and start over if it didn't. There was too much invested already, and chances are the alternatives weren't much better.

Funny thing about the Web, though. It's just as good at displacing revenue as it is in generating sources of it. Just ask the music industry or, ahem, print media. Think Robin Hood, taking riches from the elite and distributing them to everyone else, including the customers who get to keep more of their money and the upstarts that can more easily build competing alternatives.

But are these upstarts viable? On-demand software has turned out to be a brutal slog. Software sold "as a service" over the Web doesn't sell itself, even when it's cheaper and actually works. Each sale closed by these new Web-based software companies has a much smaller price tag. And vendors are continually tweaking their software, fixing bugs, and pushing out incremental improvements. Great news for the user, but the software makers miss out on the once-lucrative massive upgrade every few years and seemingly endless maintenance fees for supporting old versions of the software.

Software as a Service

AMR Research's Bruce Richardson calls it the "hidden cost" of software as a service (SAAS) and says Silicon Valley is uncovering it the hard way. "The challenge is you have to spend 50% to 100% plus of revenue in sales and marketing cost," he says. "You need this [limitless] amount of cash to forever feed the growth machine."