A new way to sell software

Software-as-a-service is transforming the information technology industry. The innovation changes the way corporate customers and software creators invest in their businesses, though people who use the software might barely notice a difference

The next generation of software companies is thinking outside the box -- literally.

Rather than selling businesses a shrink-wrapped box of software to handle payroll, manage inventory and track sales leads, they offer their software over the Internet. No installation required.

The new model, software-as-a-service, is being hailed as a cheaper, easier way of selling and supporting software that opens up new markets for high-tech businesses.

"You're seeing a metamorphosis of the whole software industry toward this model," said Mitch Mumma, a partner with Intersouth Partners in Durham. "I am a firm believer that this is a fundamental change in the way software will be consumed for the foreseeable future."

About 75 percent of the software startups evaluated by his investment firm plan to sell software-as-a-service products, Mumma said.

But the model isn't for the faint of heart or the undercapitalized. It can take as many as five years for a software-as-a-service company to generate the same revenue as it would under a conventional model.

Most companies charge large upfront fees for software that is installed on a customer's servers and computers. Under software-as-a-service, creators run the software on their own servers and bill customers monthly, quarterly or annually for subscriptions to get access to the programs over the Internet.

For customers, the new model means no licensing or setup fees and less overhead, because they don't have to maintain the software or their data. It also means updates are automatic -- and often more frequent.

For the companies that sell it, software-as-a-service provides stable, recurring revenue. It allows the company to invest in enhancing its software, rather than installing and maintaining it at hundreds of customers' businesses.

But the pay-as-you-go nature of the model puts extra pressure on companies to provide good customer service. If a client isn't happy, it can easily take its business elsewhere.

"The focus is more on the solution and the service, and less on the software," said Joe Colopy, CEO of Bronto Software. His Durham company delivers its e-mail marketing software over the Web.

Other local companies using the business model include SAS, SciQuest, 6th Sense Analytics, Near-Time and Smart Online.

The number of U.S. software-as-a-service companies tracked by TripleTree, a research-based investment bank, has doubled to about 1,000 over the past year, said Chris Hoffmann, a senior principal with the firm. He expects 45 percent of software revenue worldwide to come from the new model by 2010.

Several factors are spurring the change: widely available broadband Internet access, the reliability and security of the software and companies' desire to have someone else handle functions that aren't their core business. The rise of inexpensive open-source technologies such as Raleigh-based Red Hat's Linux operating system makes it more affordable for software companies to host products for customers.

Some major companies are recognizing the trend as an opportunity and a threat.

Oracle and SAP, giants in the business software market, have begun selling Web-based versions of some products.

So has Microsoft. In 2005, Chairman Bill Gates encouraged his company to seize and capitalize on Internet-based services. "The next sea change is upon us," he wrote in a memo.

But a full-scale conversion to software-as-a-service could be difficult for many companies, said Stephen Wiehe, CEO of Cary-based SciQuest, which has used the business model since 2001.