SaaS vs Licensed Software: Factors to Consider in your Cost Analysis

Is your company shopping for a new information system? Once you’ve identified the features you need, you’ll also have to figure out whether to select a licensed, on-premise solution or go with the cloud and subscribe to a Software as a Service (SaaS) model.

In our recent whitepaper, "SaaS Supply Chain Management Systems", and blogs we've looked at several of the issues you need to consider in making this important decision. Security is one area you need to consider (see our blog "Insecure About SaaS Security?"), as is the depth of your organization's IT resources, which we explored in "Cloud Supply Chain Systems: 5 Benefits for your IT Department".

Not an easy calculation

This time around we're going to tackle the question of cost. There is no cut-and-dried way to determine the relative costs of licensed versus SaaS software. It's certainly not as simple as looking at the upfront cost of the license versus the subscription cost for the SaaS.

And, depending on the scope of the system you are planning to acquire, you could be  looking at a considerable chunk of your budget.

But there are numerous angles from which to examine the question that will help you decide.

Costs to consider

Let's assume you know the difference between the cost of the license versus the cost of the SaaS subscription.

Now factor in the cost of all the ancillary people and things you need to make the software run. That includes servers, the space to house them, power and cooling systems, backups, operating systems, and staffing costs for project management and help desk, as examples.

These physical assets also require upgrades or replacement every few years—say five—so take that into account as well.

With SaaS all those costs are borne by the provider who is able to amortize them across all their clients. You'll end up paying only a fraction of the infrastructure cost thanks to economies of scale.

You'll still need internal IT resources to mediate between the company and the SaaS provider, but you can do away with a lot by adopting the cloud-based model.

Opportunity cost

Another piece of the puzzle is what you might have to give up by opting to buy the license. If the software requires a substantial upfront investment, say in the range of $100k or more, what does that mean you'll have to sacrifice?

Subtract from that upfront investment the amount you'd spend for the SaaS in the first year, and consider what the remainder could be invested in right now. That's budget for research and development, customer acquisition, additional supply chain upgrades, more staff, or whatever additional area of your business with immediate needs.

Lost time

Another aspect of opportunity cost is the amount of staff time that can be required as your IT department struggles to keep licensed software operating properly. You must factor in the resources that group will need to ensure that the software gets the updates it needs, along with the necessary maintenance of the hardware required to run it. Think about overtime pay for emergency fixes.

This is hard to do, as IT issues can be unpredictable and shifts in the market, consumer preferences or supply chain issues can require rapid changes that may make the in-house solution resource intensive.

And if you don’t manage to keep up by allocating resources to the problem, there will be additional opportunity costs in terms of business lost because your system is down or not operating properly.

Other factors

You also need to think about where your business is going.

What is the external environment doing? Is your industry in flux to the point that you may need a completely different software system in a couple years?

If so, opting for a licensed solution might end up costing even more if you have to dump it, or spring for a major upgrade in the short term.

Also, over the lifetime of the software license, will you be growing? Can the licensed product accommodate that growth? At what cost?

The scalability of SaaS may permit a less expensive expansion than buying more seats of an on-premise solution.

Real world research

A study conducted several years ago by Hurwitz & Associates ("The Compelling TCO Case for Cloud Computing in SMB and Mid-Market Enterprises" [i]) looked at SaaS versus licensed applications for small and medium sized businesses.

They found that the SaaS total cost of ownership was 55% lower for 52 users, dropping to 35% less with 200 users.

They also learned that IT infrastructure accounted for 11 percent of the cost of the on-premise solution, and zero percent for the cloud-based system.

The predictability of SaaS also meant lower costs, with 65 percent going towards the subscription itself. For the licensed software, only 26 percent went towards the license, with 41 percent going to IT resources, 7 percent to hardware and 4 percent to infrastructure software. By contrast, in the SaaS model, IT resources only accounted for 16 percent of costs.

Both models were similar, with 5 percent allocated to training and consulting taking 14 percent for SaaS and 17 percent for the licensed software.

Draw your own conclusions

These numbers are undoubtedly persuasive in the one example studied by Hurwitz & Associates. And the breakdown they provided for cost categories is helpful in assessing your own options.

But you still need to do your homework, get good forecasts and build a spreadsheet with the data you have and your best estimates.

As with all planning, taking the time to think it through will yield the most valuable results, guiding you to the most cost-effective decision for your company on SaaS versus licensed software.

We invite you to download our white paper ‘SaaS Supply Chain Management Systems’ for more information on the subject.