Making the transition to a Software-as-a-Service (SaaS) model isn’t easy for incumbent software vendors (ISVs).

Rearchitecting their applications may be the easiest task in the transformation process. Redesigning their go-to-market strategies and ongoing operations; restructuring their revenue recognition models; and reorienting their staff are the more difficult challenges.

Greater service delivery costs combined with lower per unit prices make it is easy to see why most ISVs have tried to resist the SaaS movement and denied its long-term viability.

Yet, a severe slowdown in traditional, packaged, ‘legacy’ application sales has made it imperative for ISVs of all sizes across every segment of the software industry to finally accept SaaS as a reality they can no longer ignore and must finally embrace.

Even Microsoft, Oracle or SAP are promising ‘cloud’ solutions and cranking up their PR machines to promote their promises. But, their SaaS offerings are still primarily hosted versions of their on-premise applications, and these companies are still hoping that their customers will accept their perpetual licenses and inflated maintenance services.

Callidus Software is taking more extreme action in response to today’s realities. The company announced during its second quarter earnings call on July 28, that it is moving its entire operation and set of offerings to a “predictable recurring revenue model”, i.e. SaaS.

Callidus has been offering an ‘on-demand’ solution for a few years, but it has only been viewed as a subset of its primary on-premise business until recently.

The company’s decision to make a ‘big bet’ on SaaS is driven by a combination of changing customer preferences and escalating competitive pressures.

On the customer side, Callidus saw its overall revenues go down 5% in the second quarter of this year compared to the same period a year ago. Callidus also reported its second quarter services revenues were down 18% and license revenues were down 38% compared to the second quarter of 2008. Part of this revenue drop is a result of recognizing the growing on-demand revenue differently. But, it is also a result of slowing perpetual license and maintenance service sales.

The company attributed the declines to its “shift to the on-demand business and the completion of certain implementations, but also delays in significant implementations due to customer budgetary constraints.”

On the competitive front, Callidus has watched Xactly grow rapidly and acquire Centive to consolidate its position as the leading on-demand sales performance management (SPM) vendor.

Having talked to Callidus’ CEO a number of times in the past, I know that he has always been a fan of the SaaS model but had to oblige the investment community’s concerns regarding the revenue recognition issues before making a significant move in this direction. (Callidus, Xactly and Centive, as well as Makana Solutions have all been THINKstrategies clients in the past.)

Rather than continue to try and balance its traditional on-premise and on-demand offerings, Callidus has chosen to put all of its efforts into moving to a SaaS model.

While there are plenty of risks involved with this strategic decision, Callidus’ executives have already seen some early indications of the potential financial benefits of this move.

Recurring services already represent 53% of Callidus’ overall revenues, or $11.8 million, a 17% increase over Q2 a year ago. The company also reported that it had generated 18% margins from its recurring revenues compared to a net loss from its overall operations in the second quarter.

The company recognizes that it is embarking on a difficult journey, but believes that it is the only path that can lead to long-term success. It has already made senior staff changes and additional staff reductions.

Callidus must make additional operational changes as it evolves its on-demand solutions. But its customers, many of them large-scale enterprises,are demanding SaaS alternatives to traditional on-premise software so they can better manage their rapidly changing businesses.

Crossing this chasm won’t be easy for Callidus, but others have proven that it can be done. The most prominent example of a publicly-traded company successfully making this transition is Concur.

Postscript: On August 4, Callidus’ Director Corporate Communications and Web Marketing, Jock Breitwieser, sent me this clarification regarding the company’s future direction in response to my commentary above,

“One comment on your article: While our focus moving forward is on the cloud and on-demand, Callidus still offers it’s proven on-premise solution. We are not abandoning our award winning on-premise offering. However, on-premise is now sold as a subscription service. It’s just a change reflective of our adjusted business model. Going forward for those customers who want our industry-leading On-Premises offering, we will sell subscription-based licenses. The subscription fee will cover both the software license and the maintenance service. This plays well into the current economic climate and, through various client discussions, it’s clear that there’s appeal in this model. The move away from perpetual licenses to subscription-based offerings presents a variety of benefits to the customers, including lower up-front costs, an easier purchasing decision and a better service relationship.”

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