This article presents costs associated with different ERP software deployment scenarios. The numbers presented in this article have been gathered by averaging quotes provided by 2-3 different ERP and hosting service providers.
ERP Software Purchasing and Deployment Options
The Cloud has inspired a new way of thinking about ERP software deployments. Companies have the option to purchase a license or purchase a SaaS solution. When purchasing a license you own the software and have the ability to deploy it in your datacenter (on-premise) or outsource operations to an external provider (hosting). 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.
This article will examine the financial ramifications of these three models on your business.
Small Customer Licensing
With a very small deployment scenario, the cost of licensing the software is $20,000 and the cost of one year of SaaS is $16,000. The resulting chart (on the left below) shows that a SaaS deployment can provide lower costs in year one, but after 2-3 years of service, the hosted model can be less expensive in terms of total out-of-pocket money.
By looking at the graph, you would conclude that you should never purchase a software license and try to build your own infrastructure. However, in some scenarios (for example you are are running a point-of-sale terminal that needs to connect to your server) an on-premise deployment makes sense because you may not want to rely on an external Internet connection.
Mid-Sized Customer Licensing
For mid-sized businesses, we increased the cost of the license to $50,000 and the cost of SaaS to $40,000 per year. The resulting chart (above on the left) shows that the break even point for SaaS versus hosting occurs sooner (around year 2). In year 5 the cost of SaaS approaches the cost of a license plus internal infrastructure. These changes occured because the cost of the fixed license and recurring SaaS payments increased proportionately while the infrastructure cost remained relatively fixed. We observed a proportionate increase in SaaS and license pricing by comparing specific customer proposals from SaaS and license vendors.
Even though we increased the cost of hosting to $500/month, the cost of paying for 1/5 of an IT person to maintain the server, operating system, and software application caused the on-premise deployment to be more expensive than hosting over the long run.
Review of Assumptions
Cloud-based and Web-based Software
As previously reported, there has been significant discussion judging the merits of hosted ERP versus SaaS. In this comparison, we assume that the same software can be run as SaaS or deployed on-premise. This means that we are not considering the scenario where legacy client-server software is being hosted on the web along with VPN software, hosted desktops, etc.
We assumed that the software was web-based so client upgrades are not required.
Relationship between SaaS and License Pricing
The cost of the SaaS annual fee compared to the cost of the software license is critical to the analysis. For this analysis we used the following rule-of-thumb:
SaaS annual price = (2/3) x (Cost of license + One year maintenance)
This approximation accurately represents actual market data provided by SaaS providers and on-premise license providers. 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.
- 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 hosting scenario, maintenance covers only the application, 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 three 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 do not have IT resources to dedicate to installing and managing applications. Even in the hosted scenario, some level of IT expertise is required to install application upgrades. We assumed upgrades occur two times per year and require approximately 5 hours to install. As a result of this assumption, we budgeted $1,000/year for application upgrades in the hosting scenario. In all cases we assumed that the application was web-based so no client software upgrades were required.
Break Even for Mid-Sized Businesses
By lowering the SaaS cost by changing the SaaS rule of thumb (discussed earlier), we computed a break even point over a sever 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 + hosting + maintenance is roughly equivalent to a $20,000/year SaaS license.
Adding Cost of Capital
** section added May 2 **
After publishing this article, I received several requests to include the cost of capital in my calculations. Adding a cost of capital has the following impact on the different models:
- SaaS – expenses are deferred, so the model becomes more attractive as the cost of capital goes up.
- Hosted – the license cost is paid upfront, but some costs are deferred, so the benefits are less than with SaaS
- On-Premise – the on premise model contains the most upfront expenses as well as significant ongoing IT expenses that 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 higher than hosted but less than SaaS.
Cost of Capital Impact on ERP Analysis
With ERP software there is a significant amount of upfront analysis, consulting, configuration, testing, and training, so the impact of the cost of capital is less than it would be for simple software applications. The graphs below show the impact of making adding a 3% and a 15% cost of capital to the analysis. This was done by discounting the future payments to reflect the time value of money.
The analysis doesn’t change dramatically for the 3% case, but when the cost of capital is assumed to be 15% and higher, the SaaS solution will always be less expensive than an on-premise solution. At 15%, the breakeven between SaaS and hosted shifts by a few months in favor of SaaS.
** end of May 2 section **
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 as your requirements change.
Contact us if you would like to receive a copy of the spreadsheet used to generate these graphs.