In-Depth

Don't Be Afraid of Hosted ERP

Many IT professionals don't trust their enterprise resource planning infrastructure to a hosted model, but some who have taken a chance found it worth the risk.

It's a little scary -- very scary, actually. Businesses rely on the functionality that enterprise resource planning (ERP) software provides and the data it stores. Trusting customer relationship management (CRM), file sharing or even e-mail to a hosted-applications model is one thing; those things can go down without necessarily shutting down a whole business. But ERP? That's business-critical, back-end functionality. And moving it to a hosted model, in which a third party runs the applications and stores the data, can be frightening.

It's also risky. Aside from potential downtime, there are the obvious security concerns that go with moving to a hosted model. The critical nature of ERP only amplifies those concerns. Then there's the notion of having some third party run the software that controls your accounting, your manufacturing processes, your general ledger ... The idea of hosted ERP, at first glance, looks more potentially troublesome than beneficial.

Maybe that's why some vendors -- including Microsoft -- and some experts are less than bullish on the future, or at least the immediate future, of hosted ERP. And it's likely why many organizations have chosen to keep their ERP infrastructures in-house, despite the often-high costs of implementation and maintenance that on-premises ERP requires.

Despite the risks, not everyone is afraid to outsource ERP to a hosting vendor, and some companies that have done it have experienced the upside of hosted ERP: lower costs, easier maintenance, and even the freeing up of IT resources to go toward other, more profit-driving areas of the business. And while Microsoft and other big ERP players are still fleshing out their hosted ERP strategies with mixed results, a few smaller vendors have built businesses on the model (see "Catching up with the Little Guys").

Window Shopping in the Cloud
It's not that companies aren't interested in hosted ERP. Software as a service (Saas), on-demand software, cloud computing, hosted applications, Software plus Services or whatever name the model takes is generating lots of interest in IT departments. Salesforce.com Inc. has been successful selling its brand of hosted CRM applications; Microsoft, in fact, liked the idea enough that it introduced its own hosted CRM product, Dynamics CRM Live, last year.

Microsoft Online and Google Apps from Google Inc. have brought e-mail and desktop applications into the hosted realm. A hosted version of Microsoft Office SharePoint Server has become popular. Security and storage vendors have successfully moved customers to SaaS models. But ERP is different, and while companies are looking at ERP in the cloud, they're not necessarily buying it.

"I think there's a lot of interest" in hosted ERP, "but I'm not seeing a lot of adoption," says Sharon Ward, a former Microsoft ERP executive and currently director of software strategy at Green Beacon Solutions LLC, a Boston-based enterprise software consultancy and Microsoft Gold Certified Partner.

However, success with less-critical cloud applications might speed adoption of hosted ERP, Ward says. "We need to see more adoption of cloud applications that aren't business critical-things like storing your desktop files and collaborating," she notes.

At least one key player in the hosted ERP market agrees that other cloud services have paved the way for ERP. Sean Rollings is VP of product and industries marketing for NetSuite Inc., a San Mateo, Calif.-based provider of hosted applications. A pioneer in the field, NetSuite, founded in 1998, offers CRM, ERP and e-commerce applications in the cloud to 5,400 companies; more than 90 percent of those companies are running some form of ERP, Rollings says.

Other cloud apps, like CRM, have led companies to look into hosted ERP, Rollings notes. "We're seeing a lot of growth in ERP," he says. "Once people started to understand the benefits of outsourcing, we saw more companies coming into the ERP arena." Rollins adds that NetSuite is currently seeing more growth in its ERP business than in its CRM business.

Sheldon Kralstein, CEO of Holmdel, N.J.-based Clients First Business Solutions LLC, a Microsoft Gold Certified Partner and SAP AG partner, says that the presence of cloud computing in daily life -- with online banking, for instance -- is making people more comfortable with the model in the enterprise.

"Two or three years ago, when hosting and outsourcing were getting started, security was one of the main issues that people had," Kralstein says. "Today, it's less of a big deal. Once [companies] realize the breadth and depth and cost savings, they're interested," he explains.

It's (Almost) All About the Money
Of course, cost savings are what spur many small and midsize companies -- as well as some of their larger counterparts -- to look at hosted ERP. ERP licensing is a complex game, with different vendors taking different approaches to licensing terms and prices. It's sometimes difficult, therefore, to get an apples-to-apples read on the costs of on-premises ERP versus the cost of a hosted model.

The Web site InsideBusinessFinance.com publishes prices from various ERP vendors. In a report titled "2008 Midmarket ERP Solutions Buyer's Guide," the site lists the price of on-premises Microsoft Dynamics AX, one of Microsoft's four ERP suites, as $3,980 per user. Some other vendors don't disclose base prices or say they depend on customization and an individual company's needs.

Pricing with a hosted model is more straightforward.

NetSuite, company officials say, charges $499 per month for its base hosted ERP offering, plus $99 per user per month.

And Plex Systems Inc., a hosted ERP vendor based in Auburn Hills, Mich., which primarily serves manufacturers, issues site licenses rather than charging per user. While Plex doesn't have a set price list, CEO Mark Symonds says that a typical company with $50 million to $100 million in revenue might pay $10,000 per month for a typical implementation of Plex's service.

That's usually cheaper than on-premises ERP based on license costs alone, Symonds says: "On the other side of the ledger, with an on-premises solution, [customers] would have to pay [annual] licenses of $200,000 to $250,000 ... then 18 percent or more [of that cost] per year in maintenance," he explains.

But, as Symonds also notes, the cost of on-premises ERP goes far beyond license fees. For instance, Plex offers a test environment, failover and backup in its data centers so customers don't have to provide those elements.

Symonds cites the case of one customer that switched from an SAP system to Plex and now pays only 20 percent of the costs it paid for ERP with SAP. "That's an extreme case, but nonetheless it's impressive," Symonds says.

There are other impressive cases. Not only does on-premises ERP require technology investments that SaaS ERP doesn't, it also requires the hiring of experts to keep it running. That can be a major expense for many companies. In a March 2008 report titled "ROI Evaluation Report: NetSuite," Wellesley, Mass.-based analyst firm Nucleus Research Inc. provided a striking example of cost savings: "In one case, a customer moved from Microsoft Dynamics GP to NetSuite and was able to eliminate a $55,000 IT staff position and $20,000 in annual license maintenance, and retired three servers that cost $1,500 annually to upgrade. NetSuite averages $5,000 annually in licenses at this company," the Nucleus report says.

Calculated Risks
Still, in many cases, the decision to move into the cloud isn't an easy one, and IT professionals warn that it's essential to do due diligence before signing a contract and putting the running of the business into the hands of an external vendor.

Jim Piper, president of Ralco Industries Inc., a Plex customer and provider of stamping and robotically welded assemblies based in Auburn Hills, Mich., says his company was concerned about security before it signed on with Plex back in 2001. So the firm decided to spy on the vendor-literally.

"We hired a security expert to break into their system, and we were not able to do that," Piper says. And the expert wasn't just a garden-variety hacker; he was "a guy who used to work for the CIA," Piper notes.

David Jarrell, IT manager at Advantage Sign Supply Inc., a NetSuite customer based in Grand Rapids, Mich., that distributes equipment for making signs, also took due diligence seriously before moving into hosted ERP. "It took a lot of extra research to figure out the hosting model," he says. "How secure and safe is NetSuite? Where does my data sleep?" To find answers to his questions, he went right to the source.

"I flew out and toured the data center," he says. "They were surprised by that. I was blown away by the facilities." Advantage Sign Supply went live on NetSuite in November of 2007.

One concern with any hosted app is downtime, but Jerome Foskey, IT admin for GLI Pool Products, a manufacturer and distributor of swimming-pool supplies based in Youngstown, Ohio, says that hasn't been an issue with his NetSuite subscription. "We've been down for one hour in the last nine months due to NetSuite," Foskey says. And that wasn't even NetSuite's problem. "We're in an old industrial park" with aging T1 connections, Foskey says.

Rebecca Wettemann, vice president at Nucleus Research, says concerns about reliability and security in a hosted ERP model are overblown. She notes that on-premises implementations can run into the same problems.

Customize ... But Not Too Much
But there's more to moving to SaaS ERP than just checking out facilities and hiring spies, experts say. Green Beacon's Ward notes that it's not enough just to get a hosted ERP system up and running. Businesses, while not wanting to erase the advantages of lower costs, should look at doing some customization. And customization, she says, can be a weakness of hosted ERP.

"The most important thing that you can do with your business application is hone that application so that it allows you to be different from your competitors," Ward says.

Other experts warn against too much customization.

Wettemann says that over-customization -- often pitched by over-eager consultants -- is what gets a lot of companies into trouble with on-premises ERP implementations.

"Some of the worst ERP implementations were done by people who didn't know what they were doing and customized too much," Wettemann notes. She also explains that hosted ERP offerings have recently become more amenable to customization.

Aside from customization concerns, there's also the matter of the subscription-based payment inherent in the hosted ERP model. Companies need to negotiate terms carefully, especially because many vendors offer annual subscriptions, the prices of which could rise from year to year. But they often don't, customers say, and that's a good thing because moving data out of one data center and into another or back in-house is no easy task.

"We had discussions with [Plex], and that's never come up since our initial conversation with them," Piper says of price increases. "They've never even had a conversation about raising prices with us. Do they have us? Yeah. They definitely have us. But there's been no problem."

Benefits of Outsourcing ERP
Of course, the flipside to the risks of hosted ERP are its rewards. ERP in the cloud can mean decreased costs, improved efficiency and more effective use of IT staff. For companies that wouldn't be able to afford a serious ERP implementation otherwise, it can mean massively improved business processes. And it can be nice not having to worry so much about potential problems that crop up in ERP systems.

"If [the ERP system] wasn't hosted, I don't know if it would be doing the same thing," Ralco's Piper says. "We don't have to worry about having servers here and maintaining those. There's some cost savings to that. We lost power one weekend; it was in the middle of the night. I got this call at 3 a.m. from a Plex guy who was looking in our windows, seeing if we had power or not because he got a flag in his system that we had lost our T1 connection."

Piper, whose company went live on Plex on Feb. 1, 2002, says he believes Plex's offering is helping the company stay ahead of its competitors in a difficult automotive market. "This was the best decision we've ever made," he says.

Just having ERP functionality has been a boon for his business, Piper says: "One of the key things I have today is lot traceability. That's almost impossible to have without Plex. I may make 20,000 pieces out of [a] coil of steel. I can track what parts were made with that coil of steel -- all the way to vehicles. That's impossible to do manually." He adds: "When I bring customers in here and show them what I can do, it blows them away."

Advantage Sign's Jarrell notes that while some members of his IT staff worried that NetSuite would put them out of jobs, he has actually been able to make better use of his IT resources -- as well as contribute positively to his company's bottom line.

"It didn't put us out of a job," Jarrell says. "It really is a win for most people because [they're] not doing maintenance. If you just like doing that, you won't like a hosted environment. If you want to take that time and invest in business process development, you have enormous amounts of time to help IT drive the business." Jarrell has been able to dedicate staff to e-commerce and electronic marketing, he says, partly as a result of outsourcing ERP.

On the topic of IT professionals, Wettemann notes that many of the staffers most resistant to hosted ERP are the ones who are experts in particular technologies. "People who have SAP or Oracle in their titles within organizations are scared to death of what happens to them if somebody pulls back the curtain," Wettemann says. She warns companies not to decide against adopting a cloud ERP model just because some employees fear it.

She also says that the lower maintenance costs and shorter implementation times that hosted ERP offers versus an on-premises model are very real. Most big ERP vendors, Wettemann notes, charge annual maintenance fees equal to 18 percent to 23 percent of the cost of the original software license.

"You add a couple of bodies to support it and a database administrator, and you've got yourself a pretty expensive proposition," she says. "That's just to keep it up and running." Wettemann notes that procedures such as upgrades and bug fixes end up costing even more money.

For Jarrell, the cost savings at Advantage Sign have been tangible. "We've been able to tighten down our return policies and actually put in restocking fees and make them stick," he says.

Electronic delivery of invoices has also been a driver of cost savings. "We do a lot of transactions, and it costs a lot of money to print an invoice on paper and have someone to stuff it and put a stamp on it. That's the biggest cost savings to justify paying for NetSuite right there."

Foskey, of GLI Pool Products, says he also believes that his cloud ERP subscription has contributed to his company's bottom line. GLI has been able to customize its hosted ERP capabilities to deliver real-time, dynamic information both internally and to customers. That has become a major advantage of the system, Foskey says.

"We've been able to do a significant portion of that customization without heavy-duty IT support," Foskey says. "Can it translate into sales numbers? I'd like to think that it can."

No More Bad Dreams
Another benefit of on-demand ERP could save IT professionals some sleepless nights. Disastrous on-premises ERP implementations have become almost legendary; in the '90s, the Hershey Co. and Whirlpool Corp. suffered through botched SAP implementations that have become reference cases among ERP professionals.

And the nightmares continue. In January, Colorado-based jewelry retailer Shane Co. filed for bankruptcy and blamed its financial troubles, in part, on an SAP implementation that went way over budget. The company said in its bankruptcy filing that its SAP implementation had taken nearly three years instead of the scheduled one, and had cost $36 million instead of a budgeted $10 million. (SAP told Bloomberg News in January that the company was "assessing the situation.")

Botched implementations aren't necessarily the fault of vendors or consultants -- but they're much, much more likely to happen with on-premises ERP than with a hosted model, Wettemann says. In fact, she says, nightmare scenarios involving a cloud ERP model are virtually non-existent.

"I haven't heard of one yet," Wettemann says. "I haven't heard of anybody moving away [from hosted ERP]. What we've seen is customers be very successful with streamlining operations and improving productivity at much lower costs."

Lee says ...
Back in 2008, when I was still writing for Redmond's sister publication, Redmond Channel Partner, a Microsoft Dynamics partner told me that he was getting killed in the manufacturing space by a company called Plexus. Well, Plexus is now Plex, and it figures prominently in this story, as does fellow hosted ERP vendor NetSuite.

There's a reason for that. Microsoft wouldn't come up with any customers that were using Dynamics in a hosted model, and the company seems mostly disinterested in on-demand ERP. SAP declined to participate in this story, citing a quiet period related to the release of financial results -- even though the story was scheduled to run long after the quiet period was over.

So, I went with the vendors that are serious about ERP in the cloud. Hosted ERP isn't a silver bullet, but it's a more viable model than some of the market's giants seem to realize. Maybe the big guys should start to take it more seriously.

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