The Cloud has inspired a new way of thinking about ERP software deployments, with companies having the option to purchase a license or obtain a SaaS solution. When purchasing a license you own the software and have the ability to deploy it in your data center (on-premise). When you purchase a SaaS solution (sometimes called an on-demand solution), you rent a complete turnkey package that includes software and the entire delivery mechanism.
There has been a lot of debate about the merits of on-premise vs. SaaS ERP solutions and many of the arguments have been based on assumptions about how much different solutions would cost. But what do the numbers say about the cost differences between the two options? With SaaS ERP solutions your business pays less upfront while on-premise requires you to buy the software outright. However, there are many of other factors beyond the initial investment that go into evaluating total cost of ownership (TCO). Based on numbers gathered by averaging quotes provided by 3 different ERP providers, we did a cost comparison between the two options.
With a very small deployment scenario, we pegged the initial cost of licensing the software on-premise at $20,000 and the cost of one year of SaaS is $16,000. So a SaaS deployment can provide lower costs in year one. On-premise ERP can also require acquiring additional internal infrastructure and may incur additional staff costs to maintain the solution. So, for small businesses SaaS may offer better ROI. Since costs remain rather constant, SaaS is also easier to budget for. However, in some scenarios an on-premise deployment makes more sense. For example your business might be running a point-of-sale terminal that needs to connect to your server. In this situation, you may not want to rely on an external Internet connection.
For mid-sized businesses, we obtained pricing information by comparing specific customer proposals from SaaS and license vendors. We ascertained an increase in the cost of the license to $50,000 and the cost of SaaS to $40,000 per year. In this scenario, in year five, the cost of SaaS comes close to equaling the on-premise costs of a license plus internal infrastructure. The numbers level out because the cost of both the fixed license and recurring SaaS payments increased proportionately while the infrastructure cost remained relatively fixed. However, you must also consider labor costs. We assumed the mid-sized business would have the cost of paying for 1/5 of an IT person to maintain the server, operating system, and software application; these costs may mean that the on-premise deployment would be more expensive.
For mid-sized businesses we computed a break-even point over a seven year deployment. Holding other assumptions steady, the break-even occurred when the cost of the SaaS annual fee is approximately 1/3 of the cost of the license plus one year of annual maintenance. So, if your only concern is out-of-pocket expenses, the option to purchase a $50,000 license + maintenance is roughly equivalent to a $20,000/year SaaS license.
Review of Assumptions and Methodology
The cost of the SaaS annual fee compared to the cost of the software license is critical to this analysis. Based on actual market data provided by SaaS providers and on-premise license providers, we devised a formula to approximate the cost disparities. In both cases, the cost per user (when applicable) is reduced as more users are added at approximately the same rate. Also in both cases, the addition of modules increases the cost.
For purposes of the comparison we assumed that the on-premise and SaaS systems deployed the same software. This means that we are not considering a scenario in which legacy client server software is being used. We also assumed that the software was web-based so client upgrades are not required. Doing this kind of comparison requires making a number of other assumptions:
- Calculations did not include NPV calculations.
- Hardware and software costs for an on-premise deployment are similar for small and mid-sized customers. This equals approximately $15,000 for the deployments shown. This does not include off-site backup storage.
- Maintenance fees are 20% per year of the license costs. In the on-premise scenario the maintenance costs cover the application, OS, and database software.
- Configuration, training, and data migration fees are equal across all deployment models. We used a 1:1 ratio of license cost to consulting fees for this analysis.
- Customization fees are not included, but would be equal across all models.
- Application support is not included, but would be equal across all models.
- For an on-premise deployment, power and replacement server parts were assumed to cost $1,000/year.
When is SaaS Better?
Businesses benefit from SaaS when they cannot dedicate IT resources to installing and managing applications. We assumed upgrades occur two times per year and require approximately five hours to install. In addition, with SaaS expenses are deferred, so the model becomes more attractive as the cost of capital goes up.
The on-premise model contains the most upfront expenses as well as significant ongoing IT expenses paid over time. As the cost of capital increases, the upfront costs are not impacted, but the impact of the ongoing IT costs is reduced, so that the overall benefit is less than with SaaS.
Also, with ERP software there is a significant amount of upfront analysis, consulting, configuration, testing, and training, so these costs should be figured into the calculations. When these expenses are relatively low, the two approaches are roughly equivalent, but if they reach 15% and higher, the SaaS solution will always be less expensive than an on-premise solution. Because all of these factors are different for every business, the best way to decide between SaaS and on-premise is to perform your own TCO evaluation. That way you can take into consideration your company’s unique needs.
This article addressed costs, but costs are only one part of the deployment equation. Your deployment model should be based on your level of IT expertise, your comfort level with outsourcing, the strength of your internet connection and tolerance for downtime, and the timing of expenses.
As your business changes, your business requirements change. Company size, IT expertise, legislation, risk, programming requirements, and other factors will influence your SaaS versus on-premise deployment over time. You should partner with a provider that offers a choice of license and SaaS deployments so you can switch your deployment if your requirements change.