Where Is ERP Headed
(Or Better, Where Should It Be Headed)?
Part 4: ASP's and New Pricing Models
P.J. Jakovljevic - April 27, 2001
A typical ERP system now offers broad functional coverage nearing the best-of-breed capabilities; vertical industry extensions; a robust technical architecture; training, documentation, implementation and process design tools; product enhancements; global support and an extensive list of software, services and technology partners. While it is not a system-in-a-box yet, the gap between its desired and actual features is becoming smaller every day.
ERP vendors, on the other hand, are not doing so well, possibly because they have been busy developing, acquiring, or bundling new functionality so that their packages go beyond the traditional realms of finance, materials planning & management, and human resources.
Users' visions of ERP are evolving from tactical to strategic, and users are no longer willing to choose between integration and function. Within the next two years, ERP will be redefined as a platform for enabling e-business globally.
Therefore, users need to be aware of the trends within the ERP market so they can take into account all the necessary factors when making an ERP software selection: product functionality, product technology requirements, vendor corporate strategy, and vendor corporate viability.
Overall user recommendations are included in this final note on the eight ERP software trends.
About This Note
This is a four part note, which each part covering two of the eight trends we have identified. Each part contains links to the preceding parts. The trends covered in each part are:
- ERP Functional Scope Expansion
- Sharper Vertical Focus
- Flexibility, Agility & Interoperability Enabled by Adaptable Architecture
- Web-Basing of ERP Systems
- Provision of e-Business Components
- Mid-Market Shakeout
- Advent of Application Hosting Services
- New Pricing Models
7 - Advent of Application Hosting Services
Application Service Providers (ASPs) have arisen on the Internet in response to such ERP woes as support expenses, misbehaving applications, and server downtime. Assuming an organization ports all application functionality to an ASP, the only real concern for internal IT individuals would be ensuring a rich and stable connection to the Internet. ASPs use a "Thin Client" configuration, which means that any hosted application accessed by an end user, such as e-mail or word-processing application, is transmitted to the desktop via a series of streaming screenshots, thereby minimizing the need for excessive bandwidth and software installations on the client machine.
The downside is the long-term cost of "leasing" the service. One of the primary benefits of outsourcing is the initial negation of "up-front" costs associated with the implementation of a production system. However, after certain period of time, the outsourced system will cost more than an "in-house" production system. An analogy may be made to a group of 3 college roommates who need a big-screen television to watch football. Each roommate pays $20 per month for 3 years, totaling $2160 when the television could have initially been purchased for $1200. The appeal is immediate gratification coupled with reduced initial financial pains.
The main challenge facing most ASPs is how to drive down long-term costs while accumulating a solid revenue stream. One of the cost inhibitors for ASPs is the amount of dedicated bandwidth they must maintain to support thousands of users. Another challenge facing ASPs is Service Level Agreements (SLA); if for some reason the ASP loses Internet connectivity, customers will lose connectivity to outsourced production systems, which negatively impact their internal SLAs.
The key to an ASPs success will lie in the targeted marketplace. Those ASPs targeting large organizations will most likely fail or scale back their profit margin in order to gain business. Those ASPs who can successfully market to small-to-midsize enterprises (SMEs) while providing industry-specific focus and good technical support coupled with frequent software and hardware upgrades will experience good success.
We believe that, within the next three years, application hosting will not be the dominant delivery model (less than 30% of installations) for packaged delivery for SMEs, but will represent the supplementary business model that the more nimble ERP players will have to provide (70% probability).
- Predictable, fixed cost for a customer.
- Reduced setup and configuration time, and greater operational simplicity.
- All upgrades applied to ASP servers. No need for client or desktop upgrades.
- Limited funds required for initial startup.
- Reduced need for internal IT support.
- ERP package maintenance performed automatically by external experts.
- Outsourcing is still in its infancy, first customers being early adopters.
- Potential security risk since customers' confidential and mission-critical data reside at the ASP's location.
- Becomes more costly over a long run.
- Offers little or no support for software modifications/customizations.
- Decreased control over infrastructure and deployment.
- Limited to Direct Access Points for your ASP or need for secondary Internet access account depending on user travel plans.
- Little to no control over hardware and software upgrades.
- Support costs are essentially negated and a monthly per user charge is assumed
The following types of enterprises should consider using ASP services:
- Those with limited investment capital and those that do not have an IT department.
- Those that do not anticipate a high rate of change in the way they do business.
- Those investing in an application to streamline costs rather than to enhance revenue.
- That that lack resources for the rapid implementation of a distinct project that possibly does not require complex integration with existing applications (e.g., HR/Payroll administration, email, etc.).
8 - New Pricing Models
As the nature of ERP software evolves into services and/or hosted models, the market might be experiencing the beginning of the end of user-based licensing. One emerging pricing model holds out the promise of users paying only for what they use through power-based, stratified pricing models. The Internet use is the driving force behind this licensing shift since it makes software accessible to a new realm of casual users, like visitors to a company's Web site.
Furthermore, since fewer than one in four ERP projects deliver workable solutions that last six years or more, clients are increasingly wary of committing huge sums of money before they have obtained measurable return on investment (ROI). To that end, the licensing of ERP software products is undergoing a fundamental shift from traditional up-front fees to incremental or success-based pricing. Success-based pricing is a popular alternative especially for small businesses and startups that lack the IT budgets of larger, established companies. It allows these companies to acquire software for a lower entry cost and pay more only as their business expands.
Implications of This Trend
Vendors who embark on the transition to the new model are sure to experience growing pains, however. As traditional license revenues decline, recurring revenue generates comparable figures only after time. This can produce unsightly red marks to appear on income statements and eventual success is by no means assured. Organizationally, vendors must make fundamental changes to sales and support processes for transaction-based pricing.
For users, success-based pricing models offer a "pay-as-you-grow" alternative to up-front license fees. Though often touted as cheap and convenient, these models can bring unexpected IT costs down the road. As with any long-term contract, prospective clients should carefully review the fine print to understand the implications that transactional revenues will have on future expenses. A transaction may appear cheap at $10, but detailed growth projections that factor in per-transaction increases, milestone increases, as well as other contract attributes are a must for companies to understand the magnitude of future payments. Also, without a fixed upfront price, planning of yearly IT budgets will become much more difficult.
Summary and Overall User Recommendations
Without a doubt, ERP remains the information backbone for contemporary manufacturing enterprises. However, today's ERP systems are required to address more than the processes taking place within the walls of an enterprise. They must be able to address the players and processes involved in extended enterprise - the people and partners that the manufacturers collaborate and coordinate with in their supply chains.
While the Web and e-commerce will continue to be a major ERP direction, we foresee more ERP trends will appear on the radar screens of industry observers and IT managers. Easier enterprise applications integration (EAI), more flexible pricing, reduced need to customize an application and easier customization when needed, product design collaboration/product lifecycle management (PLM), tools for business process change analysis (beyond a mere business process modeling), and embedding analytical applications and knowledge management are some of the best prospects among the next wave of ERP hot-buttons.
Users' need to understand their e-business requirements and critical business processes can never be overemphasized. Not knowing their present business state of affairs as well as their strategic intent and direction will disqualify any future ERP system implementation from being a success. Clarifying this should help users create a long list of vendors to include in an ERP package selection. Precedence should be given to vendors with a proven vertical focus on the user's industry.
Users should also be aware of consolidation in the ERP market, and corporate viability should play a prominent role in every selection process. Virtually all software selection teams appreciate the importance of product functionality and product technology requirements in making the right decision. Too often, however, these are the only criteria that play a role in the decision-making process. Other often overlooked factors can determine the eventual success or failure of a new system, including vendor corporate strategy, global service and support capabilities, financial viability, and, of course, cost. 'Bolt-ons' should be selected only from official business partners of the primary ERP vendor, after making sure that partnership is not a mere marketing pitch.
With the Internet making access to enterprise applications both cheaper and easier, it is becoming increasingly difficult to imagine why a manufacturing company would remain without them. Success-based and power-based pricing, as well as applications hosting might offer compelling financial incentive for small to midsize companies to consider an acquisition. The Internet will not eliminate traditional application licensing, but these trends will cause a significant percentage of application license revenues, at least 15%, to shift to transaction-based models within the next 18 months. Absolute market growth will also occur as the Internet streamlines the ability to roll out applications to a greater number of users, though it will be tempered somewhat by reduction of support and maintenance fees that result from web-based deployment of these services.
Large and small companies can benefit immediately from engaging in Internet-based trading exchanges and/or portals. By signing on to an e-market, whether a public exchange or a private network hosted by the vendor or a large "anchor tenant" supplier, a corporation can effectively outsource its entire tactical procurement operation, at least for commodity items. Continuous Planning, Forecasting & Replenishment (CPFR) will be the collaborative paradigm of choice for direct goods procurement and non-commodities over the next five years as it allows large companies with several key suppliers and/or resellers to individualize their relationships while at the same time exploiting the speed and efficiency of the Internet. For the longer term, CPFR will provide the framework for end-to-end collaboration across the entire supply chain.