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Cloud Computing Vendors Helped by Recession

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Web-based business software sales are growing briskly, even as most of the industry stalls, as the segment pioneered by benefits from the weak economy and fading concerns about security.

Gartner Research now expects 2009 sales of so-called cloud-based software to grow 22 percent to a record $8 billion, a touch higher than before, the firm said on Tuesday.

“We are still going strong,” said Gartner analyst Sharon Mertz, who advises IT managers on software purchases. “The model is pretty solid, even in these tight economic times.”

This puts pressure on established software companies such as Microsoft, IBM, Oracle and SAP to play catch-up, after standing on the sidelines for most of the past decade as Salesforce (NYSE: CRM) and others gained credibility with corporate clients.

Providers of cloud-based software and Software-as-a-Service (SaaS) host the technology in their own data centers, allowing customers to access it via ordinary Web browsers. That saves clients the cost of buying licenses in advance and running programs on their own computers.

Thus, SaaS sales have outperformed traditional software as the economy worsened. “It has low cost and low risk,” said Rebecca Wettemann, an analyst with Nucleus Research, which helps IT managers evaluate software programs.

SaaS provider NetSuite, founded by Oracle (NASDAQ: ORCL) chief Larry Ellison, this week reported a 22 percent increase in quarterly revenue, showing that its products were beginning to be accepted by larger companies in addition to its core base of small and medium-sized businesses.

While NetSuite (NYSE: N) is growing from a much smaller base, its performance contrasts with a 33 percent fall in software revenue at SAP, a 6 percent drop at IBM (NYSE: IBM) and a 5 percent rise at Oracle. Salesforce, which reports results later this month, is forecast to post a 23 percent increase in sales, according to Reuters Estimates.

Shares reflect growth

Gartner expects the SaaS market to grow at average annual rates of 19.4 percent through 2013, far above the 5.2 percent growth for the overall business management software market.

Investors have noticed and shares of major SaaS providers currently trade at a premium. Salesforce, whose stock has gained 40 percent this year, is trading at about 56 times forward earnings according to Reuters Estimates. NetSuite, which is up 48 percent this year, trades at a multiple of 93.

By comparison, SAP, whose shares have gained 12 percent this year, trades for about 14 times forward earnings. Oracle, whose stock is up 7 percent, trades at a multiple of 13.

Such a scenario was hard to imagine a decade ago, when Marc Benioff quit an executive job at Oracle to develop Web-based business software as easy to use as consumer Web sites such as (NASDAQ: AMZN).

He assembled a small team of programmers who worked out of a small apartment in the building where he lived on San Francisco’s Telegraph Hill. They developed Salesforce’s first software programs for managing sales and marketing fairly quickly, but getting customers was a bigger challenge due to security concerns.

“The idea of putting corporate information on the Internet was something that people thought was just not going to happen,” said Parker Harris, one of Benioff’s first employees and one of Salesforce’s top developers. “The real question was: Would people trust it? It is a huge issue.”

Salesforce gradually signed up customers, including major financial institutions like Merrill Lynch and insurer Aon, which conducted intensive reviews of its data centers. Having these references helped alleviate concerns about security.

“As people use it, we learn more about it. It evolves, it becomes more widely adopted,” said Gartner’s Mertz.

But about two years ago, some Salesforce customers were targeted by spammers seeking to obtain their system passwords. The company thwarted the attackers by alerting customers and adding new security measures.

“It is getting more secure over time,” Salesforce’s Harris said.

Technology innovations

Today, Salesforce counts among its 55,000 business customers Dell (NASDAQ: DELL), Sprint Nextel (NYSE: S), Starbucks Corp (NASDAQ: SBUX), Toyota Motor Corp. and the U.S. Army.

“The maturity of the SaaS model has come a long way,” said Tom Hattier, an IT manager with General Electric (NYSE: GE). “More and more companies have embraced it. That’s usually the way to really prove something.”

GE, which has been using Web-based software to a limited extent for several years, went live last October with a corporate-wide system hosted by privately held Aravo Solutions that manages GE’s database of more than 500,000 suppliers.

The surge in popularity of cloud-based business software has been support by innovations in Web 2.0 technology from companies including Google (NASDAQ: GOOG).

Google sells business versions of the email, calendar spreadsheet and word processors it offers consumers, offering them extra collaboration and archiving functions.

Microsoft (NASDAQ: MSFT), which has been relatively late to embrace cloud technology, offers online marketing software, programs targeted at small businesses and is getting ready to bring its widely used line of Office software online.

IBM and Oracle are launching new SaaS products for mid- to large-sized corporations, while SAP has tried to put out a line of accounting programs for small to mid-sized companies.

And a string of smaller companies sell niche software to manage sales, marketing and human resources that they hope will become the next big hit. They include Constant Contact, Kenexa, RightNow Technologies, SuccessFactors, Taleo Corp and Ultimate Software Group.

Copyright 2009 Reuters. Click for restrictions.

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