Microsoft's launch of Dynamics AX 2009 ERP software last week in only an on-premises version has raised the question once again about what midmarket companies are demanding from CRM and ERP applications and how that demand will shape the future of business software.

The lack of a cloud-delivered version of Dynamics AX is puzzling in two respects. First, Microsoft does offer the front-end Dynamics CRM in SaaS (software as a service), so it's odd that it does not offer its back-end ERP via SaaS.

The other oddity is that other midmarket providers are seeing explosive growth in their SaaS offerings. For example, Intacct is doubling its sales year over year. NetSuite reports a 62 percent growth, and Sage is reporting a 30 percent increase year over year in its SaaS offerings.

The promise of on-demand ERP is not quite here
Those growth figures mask a key fact, however. While many vendors are riding the crest of a huge wave for SaaS CRM applications, there is no similar sales tsunami on the ERP beachfront. Customers appear to be moving at a slower pace when it comes to replacing current ERP systems because unlike CRM apps, they are so central to their operations.

For example, the bank Wilmington Trust uses Sage's on-demand CRM app but not its on-demand ERP app, says Paul DeSaro, senior operations officer for IT. Going outside the firewall for an on-demand ERP solution "is a [security] concern," he says.

A slower approach to on-demand ERP makes sense, says Denis Pombriant, managing principal at Beagle Research Group. "ERP is one of those things that might be tricky to implement as an on-demand system," he notes, because it handles the core information of a business and typically interacts with multiple key systems. Microsoft's decision to not yet offer an on-demand version of its Dynamics ERP thus makes sense, he says. "It makes sense to take a staged, modular approach, not do the front office and back office at the same time."

Pombriant notes that even the on-demand ERP vendors are moving carefully. "SAP is putting a lot of resources on site for the first few customers, treating it very much like a traditional implementation. Even NetSuite will bring in appropriate resources to help customers get up to speed," he says. And he notes that Intacct is focused on being an extension, rather than a stand-alone ERP system, to Salesforce.com's CRM app.

Microsoft has another reason not to deliver its midmarket ERP app via the cloud, says R "Ray" Wang, a Forrester analyst: "They still value their partner relationships and indirect sales model." Moving to SaaS would put Microsoft in competition with those sales partners, both for on-premises and for on-demand offerings, because some of those sales partners offer hosted versions of Dynamics AX, he adds.

What should drive adoption
Nevertheless the ERP vendors are seeing growth in their SaaS offerings and expect adoption to grow as their customers grow. "Nobody wants to change a core system of record, but at some point they have to make a transition. You simply run out of steam with QuickBooks," says Dan Drucker, senior vice president of marketing at Intacct.

As businesses grow beyond the capabilities of "mom-and-pop shop" apps such as Intuit's QuickBooks, SaaS-delivered ERP offerings will become attractive, especially when compared to the complex offerings from SAP and Oracle, Pombriant says.

For example, Dan Buettin, CFO of Domin-8 Enterprise Solutions, makers of property management software, went the SaaS route to avoid the traditional ERP vendors. Familiar with J.D. Edwards and PeopleSoft apps, he says he knew what his company would have "to deal with every day" if it went that route. He chose to adopt NetSuite ERP instead. "We did not have to make investments for on-premise hardware and technical capabilities," he says.

But the easier upfront economics of SaaS aren't the long-term advantages that will attract most midmarket businesses to SaaS offerings, says Josh Greenbaum, a principal at technology marketing consultant Enterprise Application Consulting. SaaS providers should be able to deliver enterprise-class apps to smaller businesses because the SaaS model lets them develop one version of the software for everyone, providing an economy of scale that each smaller company could not duplicate individually. This is increasingly true because small and mid-size companies are working more and more with sophisticated partners, especially in the supply chain, that are demanding more functionality from their vendors, Greenbaum says.

The ability for midmarket companies to offer similar services as their larger competitors will drive the major wave of adoption, Greenbaum says. "Everyone is competing for shelf space at Walgreens or Office Depot. As a supplier it is a competitive advantage to offer a big retailer the same inventory management capability as your biggest competitor," he says.