Software-As-A-Service Faces Its Next Big Test

Dave Duffield, founder and former CEO of PeopleSoft who lost a takeover fight with Oracle, is about to take another run at the software market, this time without the software. His startup, Workday, will offer ERP applications as pay-as-you-go services. The pitch: ERP, fast and easy.

Any professional who has experience with these financial, HR, manufacturing, and other business apps will be intrigued--and suspicious. ERP is notoriously complicated, so the prospect of no-hassle implementation and management is hard to ignore. Then reality sets in. What about data security, scalability, regulatory compliance, systems integration, and customization?

Starting this week, Workday will offer human capital management applications, including services for staffing (recruiting and hiring, leave management), compensation (benefits management and employee enrollment), and employee performance assessment. Next year, the company will expand into accounts payable and receivable, procurement tracking, and other financial applications. Supply chain and resource management apps will follow. Duffield describes Workday's offerings as a "modern day ERP system."

But businesses may not be ready to run their most critical processes on software managed by a third party. "There is an element of risk, since you're letting part of your business out the door," says Bernie Sims, project director for KP SalesConnect, Kaiser Permanente's sales force automation system, which is based on Salesforce.com's software services. Given the Health Insurance Portability and Accountability Act restrictions under which the health care industry operates, the HMO forbids the 650 sales reps and account managers who use SalesConnect from putting clients' personal data into that system. The data stays in Kaiser Permanente's "highly, highly protected" legacy membership and underwriting systems, Sims says.

Medical device maker Biosite has been testing Workday's human capital management service for several months and is close to switching its legacy HR systems over. During testing, the company asked Workday to bulk up certain security features, such as improving how passwords are structured and how the service's user "roles" provide access to employee data, says Suzy Zoumaras, Biosite's head of worldwide human resources. No data is more sensitive than employee information, she says.

Biosite will likely replace its on-premises Pivotal CRM system with on-demand apps within two years. But echoing others we talked to, she expects that it will take longer--at least five years--for Biosite's management to warm to the idea of replacing the company's core JD Edwards financial system with a software-as-a-service alternative. "Financials are very different. They're very integrated with the business," she says.

SLOW TO DEVELOP

Software as a service is starting to gain favor for several reasons: It's relatively easy and inexpensive to implement; it's flexible; it doesn't require as much infrastructure; and its costs are more predictable. Gartner predicts that 25% of new business software will be delivered as services by 2011, up from 5% last year.

CRM services have set the pace, led by Salesforce, whose sales grew 64%, to $118 million, in its second fiscal quarter. Gartner estimates that software services accounted for 8% of CRM revenue last year and will jump to 12% this year. Many Salesforce customers are salespeople and department managers who got tired of waiting for their IT departments to implement company-wide CRM systems, so they acted on their own.

Demand for software as a service beyond CRM has been slow to develop. An InformationWeek cover story titled "The End Of Software," a slogan later adopted by Salesforce, predicted the rise of software services as far back as October 1999. By Gartner's estimate, however, a mere 4% of ERP and supply chain management software revenues last year were generated by services.

Workday, Silicon Valley's worst-kept secret, will at least raise the profile of on-demand business software beyond CRM. Duffield, 66, started the company 18 months ago with Aneel Bhusri, who guided PeopleSoft's product strategy and business development. Today the Walnut Creek, Calif., company has 65 employees and $15 million in venture funding, plus an undisclosed stake by Duffield.

Not everyone's convinced there's a big market here, including conventional software rivals. Infor, which acquired ERP vendors Baan, Extensity, and SSA Global, offers on-demand CRM and asset management services. But CEO Jim Schaper says the company doesn't see demand for software-as-a-service versions of its financial and logistics applications.

SAP will host any of its applications for customers. But the CRM On-Demand service SAP debuted earlier this year--widely seen as an effort to head off defections to Salesforce--is the vendor's only software-as-a-service offering. Executive VP Doug Merritt won't detail SAP's plans for additional on-demand apps, saying only that the vendor is experimenting with delivery mechanisms for its products as customers ask for them.

Oracle is more aggressive, last month rolling out a new on-demand Siebel CRM app and adding on-demand versions of PeopleSoft Enterprise (HR, finance, procurement, marketing, and sales applications) to its software-as-a-service portfolio. Next week, Microsoft's Office Live service for small businesses will debut, and hosted versions of Microsoft CRM and ERP apps are in the pipeline. Ariba this week will unveil a new release of its spend management application offered in on-demand and on-premises versions.

CUSTOMIZE AND INTEGRATE

Vendors have addressed some of the limitations of software as a service, including the inability to customize the apps and integrate them with other on-demand or on-premises software. Forty-five percent of the 3.1 billion transactions Salesforce processed in the second quarter were conducted through Web services APIs, meaning they involved systems external to the vendor, says George Hu, Salesforce's chief marketing officer.

Salesforce and rival NetSuite recently introduced programming languages that help with customization and application integration. Kaiser Permanente plans to use Salesforce's Apex language and Web services links to integrate the Salesforce apps with its core membership, underwriting, and health care plan pricing systems over the next few months.

Software as a service "no longer means isolated data, because companies are beginning to successfully integrate on-premises data sources and software applications with data and applications hosted by their SaaS providers," according to a Gartner report. More mature integration middleware and greater use of service-oriented architectures help.

Customers have come to regard software as a service as reliable, or at least reliable enough, despite several service outages at Salesforce that spooked some companies. "None of us has 100% uptime and availability, across the board, 24-by-7," says Jeff Guillot, executive VP of product and technology at Hoover's, a business information company that has 350 sales reps using Salesforce applications. Of Salesforce, he adds, "Their track record is pretty solid."

FOLLOW THE LEADER

Workday is following the Salesforce business model, Duffield admits, including plans to charge annual subscriptions on a per-user basis, though prices haven't been set. Applications will be hosted on a multi-tenant basis in a third-party data center managed by Workday. The basic technology for the applications was acquired from former PeopleSoft chief architect John Malatesta, who began developing the software after leaving PeopleSoft in 2000. The software incorporates objects that represent, for example, the category "employee" and business services such as "hire," which are managed by an object management server. Object-oriented applications are more flexible and easier to customize than hard-wired code. Companies also will be able to integrate Workday apps with other IT systems, such as an SAP application, using XML and Web services. Built-in data encryption will ensure privacy and security. And an Ajax-based user interface will make Workday more interactive than other on-demand apps, Duffield promises.

The bulk of the market for on-demand applications has been small companies or divisions of bigger ones. But that's changing, at least for CRM. Salesforce lists Cisco, Citizens Bank, and Staples among its nearly 25,000 customers. Two-thirds of RightNow Technologies' third-quarter sales of on-demand CRM and customer service apps were to companies with sales of more than $1 billion, CEO Greg Gianforte says. But he doesn't think many companies are ready to rip out the millions of dollars of Oracle and SAP ERP applications they installed in the Y2K rush. "Those apps must get to be 10 or 12 years old before the economic benefits become so compelling they have to replace them," Gianforte says.

Workday is initially targeting midsize companies running outdated homegrown applications or small companies that have outgrown their systems. It will compete with NetSuite, which has grown rapidly selling on-demand ERP, CRM, and e-commerce apps, as well as Employease (acquired by ADP last month) and Taleo, which offer on-demand HR applications.

As ERP applications installed at big companies age and IT managers become more comfortable with the software-as-a-service model, Duffield wants to be there. "The smart IT guys will support what we're doing," he says. "I don't think there is much standing in the way of big companies adopting the on-demand model."

Some applications will always remain in-house, including those that are custom-built or contain highly sensitive data. And, fearful of losing control over their company's data, some IT executives may never embrace the on-demand model.

But adoption of on-demand CRM, HR, and other software is growing and, over time, will expand to a wider range of critical business applications. Central IT organizations that have watched from the sidelines are getting more involved as they realize that software as a service is here to stay, Gartner says.

Adventurous companies such as Biosite are leading the way. "We were looking for a system that allows us a lot of flexibility," HR head Zoumaras says of the decision to give Workday a try. "Two years from now, there's going to be completely new technology." When that day comes, she adds, "I don't want to be chained to a decision I made two years ago."

With Laurie Sullivan

Photograph by Eric Millette