Three short years ago, there were roughly 13 different business models for providing software as a service. At the time, companies provisioning software in this way went by the moniker “”ASP”” (application service provider). ASPs took existing client-server applications and made them available for a monthly

fee to customers across private networks or the Internet. The resulting systems were expensive and cumbersome, and many people wondered if the hosting model was just another technology bubble, then the collapse of the “”dot-com”” boom sealed the fate of many companies that thought hosting was their route to the big time. In the aftermath a few start-ups – many of whom still had “”.com”” in their names – managed to survive and eventually thrive.

Economic and technology cycles have converged to give ASPs new life – the economy continues in the doldrums, and CRM’s early majority cohort is demanding cheaper, easier-to-use, and faster-to-install applications – all of which have made many people take a second look at CRM delivered as a service. But even more fundamentally, Aberdeen believes that even if the economy were going full tilt, the opportunity for hosted CRM would still be present, and vendors in the space would be doing well. In other words scarce corporate resources are no longer the driving force behind the uptake of hosted applications.

Hosting has developed into an important alternative to conventional software licensing, and many signs indicate that the space will continue to grow, ultimately displacing at least part of the business flow that software vendors have taken more or less for granted. Until recently, however, the software industry had been fairly immune from the effects of disruptive innovation such as those that affected hardware. Hosting is a “”disruptive innovation”” [1] equivalent to the introduction of the minicomputer or, later, the PC and the PC network. In hardware each new technology had a pronounced and, more often than not, a devastating effect on prior generations of equivalent technology. Aberdeen thinks the pattern will be repeated in software. This Aberdeen Executive White Paper first defines disruptive innovation and goes on to examine how the disruptive innovation variously called hosting, ASP, or the “”utility model”” will affect CRM and the entire software industry for a long time to come.

What Is Disruptive Innovation?

Simply put, a disruptive innovation is one that displaces a technology from a niche with something that accomplishes the same purpose but at a completely different price point and with a very different business model. Some would even say that a disruptive innovation destroys one niche and replaces it with another. An opportunity for disruptive innovation occurs when an opening exists at the bottom end of a market for products that are at once both easier to use and under performant compared with the market-leading technologies. A disruptive innovation caters to the needs of a small population at the low end of the overall market that the dominant vendors abandon because of insufficient margins, price sensitivity, weak demand, or numerous other reasons that make “”up-market”” niches look more attractive.

For example, the first minicomputers could not compare with the mainframe technology of the day in terms of performance, but they offered other attributes to certain market niches that made them very attractive. The minicomputer was smaller and less expensive than a mainframe. It was more easily programmed and could often serve the needs of a whole department, freeing it from the control of the IT organization. It also was at the departmental level, especially in areas like science and engineering – and away from the mainframe-based financial systems – that this technology took hold. The mainframe manufacturers did not take the minicomputer seriously because the minicomputer occupied a niche and a price point that the mainframe makers deemed too small to be profitable.

Over time, however, minicomputer vendors poured research and development dollars into making their products’ performance competitive with costlier mainframes, and as the minicomputer business grew, it began siphoning business away from the mainframe manufacturers. As the minicomputer matured, many minicomputer vendors followed their customers up market to larger and more profitable niches, taking business away from the mainframe and leaving the lower end of the market exposed to the next disruptive innovation, the personal computer, and the cycle began again.

The Disruptive Innovation in CRM

The software industry has so far been largely immune from the kind of successive waves of innovation that caused rapid obsolescence in hardware. The software model has been one in which vendors pioneered new application areas, such as imaging and workflow, data warehouses, ERP and supply chain management, and CRM. More typically, early entrants into new application areas have been able to consolidate their positions in textbook fashion and eventually drive most of their competition out of the market – nonetheless, the market niche survived. However, now the development of the hosted model is enabling software newcomers to treat established vendors in the same way that minicomputer vendors once treated mainframe makers.

CRM delivered as a service is exhibiting many of the signs of a disruptive innovation. It began life as a point solution for sales force automation, and some vendors have already gone on to build integrated CRM suites mimicking the established CRM vendors except in one key aspect. By delivering their products as hosted offerings, today’s hosted CRM providers can undercut vendors that deliver their products through the more conventional licensing approach by as much as 80% to 90% [2] . The market took notice. Another important sign of disruptive innovation is that the hosted solutions are not only being offered at a very low cost but they are also no longer being purchased by small companies that cannot afford an in-house system. Many hosted suppliers are delivering their services to big companies that are defined as having hundreds or thousands of users and billions of dollars in revenues.

Thus, in only three short years, hosting has gone from a curiosity and a solution that did not look as if it would succeed as a viable alternative to costly CRM implementations. At this point, both conventional CRM and hosted CRM have traversed two of three important phases of the early CRM market and a third phase beckons:

* Phase 1 CRM Modules – Most CRM started as individual modules. Conventional vendors bought up competitors to arrive at full suite offerings, whereas hosted vendors have either built their own vertically integrated suites (e.g., Salesforce.com) or developed partner networks (e.g., Salesnet, Upshot, and others) to fill out their capabilities.

* Phase 2 The CRM Suite on the Net – Over the last two years, most CRM vendors have completed extensive rearchitecting of their product sets to convert them from client-server architectures to modern Web-based architectures with browser-based user interfaces (UIs). Some hosted vendors architected their suites in this mode and avoided the need to rebuild. At this point, most vendors, whether conventional or hosted, support very similar architectures.

* Phase 3 Reliability, Ease of Use, and Affordability – As the CRM industry shifts its audience from early adopters to the early majority cohort of the mainstream, the emphasis on what customers perceive as important in a product suite is changing from functionality and performance to usability – reliability, ease-of-use, and affordability. These demands, more than economic cycles, are driving the market’s interest in hosted CRM for this reason: although all CRM vendors have improved their on-time and on-budget performance significantly through rearchitecting, hosted solutions beat all others by orders of magnitude.

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