SAP’s decision to enter the software-as-a-service (SaaS) is a victory for the SaaS industry and enterprises of all sizes that are fed up with the frustrations of traditional, ‘shrink-wrapped’, software applications.

Prior to today’s much-anticipated announcement, SAP had publicly questioned the long-term value of SaaS and the viability of the SaaS business model. By adding its name to the growing list of SaaS providers, SAP has acknowledged that its customers deserve an SaaS option and the SaaS market is more than just another over-hyped, short-term fad.

SAP’s entry into the SaaS market will certainly accelerate industry growth and maturation. SAP refers to its new offering as the beginning of a third generation of SaaS solutions. The first generation was the ‘single-tenancy’ hosting model that emerged during the dot.com era and was pioneered by Corio and USinternetworking. The second generation has been the multi-tenancy solutions offered by Salesforce.com and other independent software vendors (ISVs).

SAP characterized its “third-generation” SaaS solution as a hybrid approach that bridges the gap between the on-demand and on-premise models.

In THINKstrategies’ view, SAP’s “isolated tenancy” approach represents a new and improved version of the traditional hosting model by giving each customer equal access to a common set of applications, but supports them with a dedicated set of resources to meet their individual needs.

Bill McDermott, President and CEO of SAP Americas, said during today’s press conference that the goal of SAP’s new CRM On-Demand solution is to allow mid-size and large-scale organizations to “act immediately, but grow strategically.”

SAP is promising that its CRM On-Demand solution can be acquired and deployed on the same day. It is offering a simple pricing model of $75/user/month. It also promises users will not be locked into long-term contracts.

SAP’s announcement not only validates the SaaS movement, it also reinforces THINKstrategies’ view that the SaaS movement isn’t restricted to just small- and mid-size businesses (SMBs).

Instead, SAP stated that it is targeting upper mid-size and large-scale organizations. It served up senior executives from American Standard Companies and DuPont to bring this point home, and endorse SAP’s solutions and strategies.

To counteract Salesforce.com’s efforts to make AppExchange pivotal platform and ‘de facto’ SaaS industry standard, SAP invited IBM to participate in its announcement and emphasized the “thousands” of other developers/partners that support SAP applications.

This aspect of the announcement was also aimed at reassuring customers about the ease of integration and ongoing infrastructure reliability of SAP’s On-Demand solution in light of Salesforce.com’s recent service disruptions.

IBM sales and consulting units, along with SAP’s other partners, will also be a key component of the SAP’s go-to-market strategy.

In THINKstrategies’ view, if SAP puts its vast marketing and sales engine fully behind its new On-Demand CRM business, it can not only position SAP as a market leader but also firmly establish SaaS as a legitimate software alternative.

However, SAP still faces three serious challenges winning a meaningful share of the SaaS market,

1. Re-architecting its other applications to provide well-integrated, easy-to-use, web-enabled SaaS solutions,

2. Re-structuring its overall packaging and pricing models to balance the revenue and profitability requirements of its On-Demand and on-premise solutions,

3. Re-castng its corporate culture–from R&D to sales and support–to become more services-oriented.

SAP is promising to continuously expand its On-Demand portfolio with a series of monthly announcements.

Independent SaaS providers should respond to the new SAP competitive challenge by doing more than just boasting about the flexibility or price advantage of their SaaS solutions.

The recent series of service disruptions experienced by Salesforce.com has given enterprise decision-makers another reason to be apprehension about the reliability of SaaS. Those organizations that are already SAP customers, but not active CRM users, may be willing to test SAP’s On-Demand offering because of their confidence in their established software vendor. Independent SaaS providers that want to compete for those SAP customers will need to demonstrate a comparable range of solutions, superior reliability and greater accountability for their offerings.

SAP’s penetration of the SaaS market may be slow, but the impact of today’s announcement on the software industry will be swift and significant.

You can expect SAP’s announcement to be the cover-story of nearly every major trade publication next week, and among the top stories in the major business publications. This will bring even greater attention to SaaS among business as well as IT decision-makers.