Software as a service: It should be the best of times, but it isn't

It's a big week for the software as a service industry: Salesforce.com is establishing itself as a leading cloud computing provider, NetSuite is planning to take on SAP head on and Success Factors is upping its outlook. But underneath the surface there are more than a few questions marks lurking.

In theory, companies like Salesforce.com and NetSuite should thrive in a downturn. Customers can take what was a capital expense and turn IT into an operational cost. Forrester argues that the bean counters may give cloud computing and software as a service (SaaS) a boost. Gartner argues that software megavendors like SAP and Oracle will have trouble squeezing more revenue out of customers.

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But a funny thing is happening along the way to SaaS domination: These companies were hit with the same IT spending freeze as their larger rivals. Exhibit A is NetSuite. The company was widely panned for its fourth quarter outlook. As Dennis Howlett notes NetSuite reported a mixed third quarter that fell a penny short of Wall Street estimates. However, the outlook was shaky at best.

NetSuite said fourth quarter total revenue will be $41 million to $42 million, well below Wall Street estimates of $45.3 million. The earnings outlook was break even to a loss of a penny a share, in line with expectations. Meanwhile, Brian Sommer reports that NetSuite is looking to poach SAP customers. The differentiator: Price. NetSuite CEO Zack Nelson said "we expect to put price pressure on our competitors.”

Fair enough, but NetSuite (year to date chart above) is still seeing slowing demand. Thomas Weisel analyst Tom Roderick summed up the consensus (and very negative) view on NetSuite's results:

Given the relatively high visibility within the company’s model, we are somewhat taken aback by the degree of this reduction. We ultimately believe that the company’s ability to model its forward bookings has grown challenging and that the company is adjusting its outlook to reflect the weakness it encountered towards the end of 3Q08. We are also reducing our 4Q08 bookings estimate from $49.8mn to $42.4mn to reflect what we believe to be an increasingly difficult purchasing environment.

Tom Ernst, an analyst at Deutsche Bank, added that enterprise resource planning systems--SaaS or otherwise--are sensitive to the economy and more likely to be delayed.

And then there's Salesforce.com, which on Monday rolled out plans to host Web sites and hook up with Amazon Web Services. The message in a more than two-hour keynote from CEO Marc Benioff: Salesforce.com is reshaping the cloud. For good measure, Benioff announced a development arrangement with Facebook.

Also see: Salesforce mashes up the cloud so you don't have to

But like most things Salesforce.com, which likes to do everything big, you need to let the news settle a bit to see what really happened. Let the Benioff bluster die down (see video below) and ask yourself: Did I hear anything ground breaking yesterday? The answer: Not really. Salesforce.com's plan to host Web sites just makes sense--the service is very sticky and hosting sites makes it more so. Meanwhile, the hosting service--dubbed Sites--is necessary to get Salesforce.com closer to the end user. As for the Amazon cloud partnership--who isn't partnering with the e-tailer turned computing leader? And the Facebook development plan is a bit of a yawner.

Meanwhile, Salesforce.com didn't reveal its subscriber metrics (of course it did just close its quarter). UBS analyst Heather Bellini wasn't impressed:

Management outlined plans to take Force.com to the next step by promoting cloud computing, partnering with Amazon.com and Facebook to offer tight integration with their core solutions. We expect the enhanced capabilities to help strengthen the company’s position as a platform provider, but it remains to be seen how much additional revenue and applications the solution will drive. We note that Salesforce.com expects to derive revenues primarily from selling more seats of its core offerings.

That final point is key: Salesforce.com is increasingly going after large enterprise accounts. SAP and Oracle dominate those accounts. In addition, those large accounts are the same ones that are freezing IT spending. In theory, the money should bounce Salesforce.com's way, but even SaaS is under pressure . The buying cycle is being delayed at best.

The overriding theme: SaaS isn't immune to a downturn and the providers most tethered to large enterprises may bear the brunt of a recession (yet still grow relative to the big applications companies).

Perhaps the sweet spot in SaaS is areas where you're not trying to uproot entrenched giants. SuccessFactors, an on-demand human resources (or performance management) software provider, is one of those companies that has managed to grow--and up its outlook--even amid an ugly spending slowdown. Howlett profiles SuccessFactors and notes that the company is on a roll. Analysts agree as JMP Securities Patrick Walravens notes:

SuccessFactors is "joining the proud few software companies who successfully navigated the disruptions at the end of September."

But even SuccessFactors is cautious looking forward even though it raised its outlook. For the SaaS industry it should be the best of times, but individual vendors will still see some rough patches.