In a now legendary 1995 memo, Bill Gates raised the alarm that Microsoft was woefully unprepared for what he termed the “Internet Tidal Wave.” Fast forward 10 years to last October, and Gates blasts out another high-priority e-mail, this time warning of a coming “services wave” of applications available instantly over the Internet. “The next sea change is upon us,” he writes.

Ringing in Gates’ ears must have been the roar of Google -- and the Web 2.0 hordes, whose XML-based mash-ups of sites are transforming the Web experience. As Gates observed in that same message, however, SaaS (software as a service) isn’t new. Nor is it restricted to the consumers, developers, and very small businesses that Microsoft is targeting with its customizable Windows Live page and Office Live free Web site and collaboration service.

Salesforce.com, founded in 1999 and still the standard bearer of SaaS business applications, is enjoying dramatic growth, reaching 399,000 subscribers at the end of its most recent fiscal quarter. Employease, which launched in 1996, now delivers HR management through the browser to more than 1,000 customers managing more than 700,000 employee records. And among the major software vendors, Microsoft is hardly the only one exploring SaaS.

“All the big players are now in the water,” says Rick McGee, vice president of SaaS strategy for IBM Global Services, noting that Microsoft, Oracle, and SAP are staking their claims.

McGee should know. IBM provides the platform for SAP’s new entry into hosted CRM. IBM also has been busy assisting SaaS startups -- the darlings of the VC community -- to create a network of partners that can provide IBM customers with quick-to-market solutions.

Meanwhile, SaaS ecosystems are emerging, such as the on-demand, SOA-based platform developed by Rearden Commerce, which connects business customers with travel, shipping, and other service providers through identity-based Web apps. And then there’s Salesforce.com’s exciting new AppExchange platform, which offers a hosted space for sharing Salesforce.com-based apps that the company calls “an iTunes for business applications.”

All this activity, however, doesn’t mean the SaaS wave is poised to engulf traditional licensed software. SaaS’s share of the business application market today is more like a drop in the bucket. And enterprises have been slow to embrace SaaS, raising objections over reliability and availability, underscored by recent Salesforce.com outages.

Yet the arrival of the big enterprise-software guns, the emergence of integrated business communities in the cloud, and increasing desperation on the part of IT to minimize application deployment and maintenance hassles, suggest that SaaS is on the verge of much faster adoption.

SaaS at the barricades
Some IT managers see SaaS as a godsend, with time-to-market and low maintenance core to the appeal. “It’s a CTO no-brainer,” says Jon Williams, CTO of Kaplan Test Prep and Admissions, a Salesforce.com customer. “I love the fact that I don’t need to deal with servers, staging, version maintenance, security, performance, etc.”

Another benefit is escape from the application-upgrade treadmill, where customers wait years for big new revs and then suffer business interruption during deployment, says Robert Jurjowski, CEO of Intacct, an ERP on-demand provider.

“It’s not the cost of migrating from one release to the next that’s the killer,” Jurjowski says. “It’s the retraining cost and the disruption to your business model that it creates every time you want to do that.”

By contrast, Intacct and other SaaS providers incrementally swap in new functionality, streaming new innovations to all customers at once, keeping the UI as consistent as possible.

Yet the main attraction for SMB customers -- letting a service provider shoulder the burden of software deployment, maintenance, and availability -- can be a showstopper for large enterprises accustomed to maintaining full control. Not to mention that the huge cost sunk into existing CRM or ERP licenses becomes a whole lot tougher to justify.