Similar to Myspace or Beanie Babies, on-premises business applications are “out.” Cloud-based applications are “in.” Over the past few years, we have seen a fundamental shift in the business applications marketplace for small to medium sized enterprises. Companies are moving away from on-premises, best-of-suite applications to cloud-based, best-of-breed applications.
A survey by the Institute of Management Accountants found that lower Total Cost of Ownership (TCO), data access, and streamlined business processes were the main reasons why companies moved their business applications to the cloud.1 Another driver for this IT paradigm shift is that housing, maintaining, and continually updating a data room provides no strategic advantage to a business’s core strategy.
In fact, on-premises business applications often end up costing considerably more than a comparable cloud-based application due to multiple hidden expenses within the on-premises software pricing model.
To use an on-premises software application, a business needs to purchase hardware, software licenses, and implementation services. What is often not considered at the time of purchase (and often ends up ballooning the total cost of ownership) is the cost of hardware upkeep, license maintenance, and IT systems personnel.
The on-premises hardware needs to be stored in a secure, climate controlled environment to ensure optimal performance, limit downtime, and prevent unauthorized data access. If a business does not already have a modern data room, then this new facilities investment can end up costing hundreds of thousands of dollars. Additionally, the physical hardware needs to be replaced roughly every five to seven years to continue to meet the business’s performance and security needs.
In addition to the one-time license fee, on-premises software customers are charged annual maintenance (typically 15–20% of the one-time license fee). While customers are not obligated to pay the maintenance fees, customers cannot receive system updates or support in the event of a disruption if maintenance fees have not been paid. Lastly, the software user licenses often cannot be returned if an organization would like to reduce its number of system users.
Finally, on-premises systems often require technical specialists fluent in the application’s programming language and familiar with the architecture to troubleshoot issues, write reports, deploy patches, and maintain any customizations or integrations. Whether these specialists are internal staff or consultants, they need to be paid. These resources can also pose a business continuity risk if they and their undocumented system knowledge leave the organization.
On the other side of the spectrum, cloud-based systems are becoming more and more popular due to the cost saving advantages inherent to their product delivery model. The cloud-based pricing model shifts the financial responsibility for hardware and security upkeep from the end user to the vendor. Cloud-based applications such as Salesforce CRM and NetSuite ERP allow their users to use a browser to access the system from their laptop, mobile device, or even a tablet. Customers pay a monthly fee that covers licenses, maintenance, and updates for each user. Licenses can be added or removed on a monthly basis to scale up or down with the business’s needs.
While cloud-based applications are comparatively cheaper, there are some hidden costs that business should be aware of when building a systems business case or ROI analysis: support fee, development environment license, and new release testing.
For some applications, product support is not included in the monthly license cost and can be purchased separately. Typically the support fee is offered in multiple tiers priced at different percentages of the total license fees.
Another hidden cost of cloud-based applications is the fee for a development or sandbox environment. The sandbox environment mirrors the production environment and allows for a business to test new features or modify configuration without impacting the live production environment. We typically recommend purchasing a sandbox environment for the duration of the implementation to assist with design and testing; however, whether a business requires a sandbox environment on an ongoing basis varies on a case by case basis.
An additional cost consideration for cloud-based applications is the amount of resource time needed to test new releases. Cloud-based application vendors regularly update their applications (some as frequently as every quarter). If a business has significantly customized their application, then it will need to test and verify that its customizations still work following the release of new versions. Not every customer will incur this cost, but any business that decides to customize its cloud-based applications should be aware of this potential expense.
With the low implementation costs, lower TCO, and less capital investment, it is clear why many businesses are choosing to move to the cloud. The cloud allows business to focus on their core competencies rather than spending time and money on maintenance and support of their business applications. Although cloud-based applications have some hidden costs, the cloud provides a higher ROI than on-premises for most small to medium sized businesses.
1 Proformative.com – “The Buyer’s Guide to Financial Management Software”