When considering a Software-as-a-Service (SaaS) solution versus a traditional on-premise software application, one needs to keep in mind several factors when calculating total cost of ownership and ROI. These variables come into play when determining the real bottom line, as in most cases initial out-of-pocket expenses represent only a fraction of the true dollar amount spent on the software over an extended period of time. Because significant costs are hidden in the details over the life of a traditional, on-premise deployment, SaaS solutions represent the best value in terms of true TCO. Both software providers and customers stand to benefit the most from the efficiency of the cloud’s economic model.

Pitfalls of Painting by Numbers

Consider the following comparison of a traditional software package versus a SaaS solution over a 3-year period.

The cost of the on-premise application consists of:

– A one-time $10,000 license fee to accommodate 5 users
– A 20% maintenance fee per year, which amounts to $6,000 ($2,000 x 3 years)

The total cost for using the on-premise solution for 3 years is $16,000 ($10,000 + $6,000)

In contrast, let’s assume a similar SaaS application would consist of:

– A flat $100 a month fee per user, or $1,200 a year ($100 x 12 months)
– For 5 users, the cost comes out to $6,000 a year (5 users x $1,200 = $6,000)

The total out-of-pocket cost for 5 users of the SaaS solution over a 3-year period is $18,000 ( $6,000 x 3 years)

Based on the figures above, the SaaS application seems to present a costlier solution to the customer. But let the buyer beware: the numbers do not paint the big picture in terms of overall expenditures over the life of the on-premise software application.

A Superior Value Proposition

Consider a typical IT department’s scenario in acquiring a traditional software package to be installed and managed in-house:

– The appropriate software licensing schema must be calculated and purchased per the organization’s needs.
– The application must then be installed on the proper hardware—which in turn must also be acquired and maintained.
– IT staff must be delegated to handle the above tasks. Furthermore, post-installation upgrades and patches will be required over the life of the application.

The TCO for the software is a sum of the licensing costs, hardware costs to host the application, as well as the cost of the staff associated with supporting the said ownership. A SaaS solution shifts all of the above to the service provider, leaving the customer with a flat, monthly usage fee. This operating model enables businesses to effectively trade fixed and/or sunk costs for a variable cost, allowing them to focus on core business processes such as delivering a better product or service to their own customers.

For the software provider, the migration of their traditional applications to the cloud results in similar, parallel benefits. By enabling their applications for cloud deployment, software providers eliminate the need to account for unique infrastructure considerations per customer. The SaaS provider controls hardware and operating environment, delivering the application in a multi-tenant, hosted model—with patch and upgrade delivery occurs across all customers simultaneously.

For this article, I have not considered the financial aspects like cash flow and IRR but I agree that they play an important role in the calculating the TCO.

Additional Benefits to Cloud Deployment

Aside from the aforementioned lower cost of acquisition, deployment and maintenance, various unique attributes of the SaaS delivery model benefit both consumers and software providers alike. A service-oriented architecture (SOA) allows users to build unique interfaces with the SaaS through web service APIs, resulting in greater flexibility and extensibility. By deploying to the cloud, software providers enable clients to customize the integration of the application as they see fit. This often results in an ecosystem and community built around a software provider’s application, which in turn translates to greater exposure and awareness around their product offering.

In short, both enterprise consumers and personal users have been migrating in droves to SaaS—and for good reason: by trading capital expenditures for operating expenditures, businesses and individuals realize a substantially greater cost savings. SaaS providers can justify the per user and per month subscription cost of their product by providing a lower TCO over the lifespan of the application’s usage. Customers stand to benefit greatly from adopting the cloud-based model of software delivery and consumption by trading fixed or sunk costs for variable costs, eliminating the overhead of traditional, on-premise software applications.

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Read more: The 8 Metrics I Use to Run My SaaS Company