“I had no idea what a NetSuite was from a hole in the ground,” said Sylvia, who was charged with picking new software. “But I’ve used Oracle, I’ve used SAP. If they had a similar product, I would have more than likely gone that way.”

The Tier 1 vendors still don’t have a true widely available SaaS ERP. SAP seems to be the closest — with Business ByDesign, the product it trotted out and then yanked from the market about two years ago, citing functionality concerns. It now says 40 customers have gone live with it, and another 40 will be online in the coming weeks.

There’s no doubt in my mind that the engineers at SAP can make, or even perhaps already have made, Business ByDesign work. The engineering prowess lies in making it as profitable as SAP wants, or needs, it to be. It’s something SAP itself admits.

The question of whether SaaS is a profitable business model seems largely to have been answered for the niche vendors. Salesforce.com achieved a profit margin of between 6% and 7% this year, up from 4% a year ago. NetSuite is also pulling in a profit, and today, NetSuite acquired QuickArrow to advance its creation a cloud-computing application suite for services-based companies.

But that question hasn’t faded for SAP, Oracle or Microsoft, which are used to margins up around the 30% mark.

Profitability for SAP means getting Business ByDesign up around the 28% margin, according to Ovum analyst Warren Wilson.  At that point, sales of on-demand software can’t “cannibalize” on-premise license sales — specifically for the on-premise products geared toward SMBs, SAP Business One and SAP Business All-in-One.

SAP’s targeting Business ByDesign at companies with between 100 to 500 people, setting it between SAP Business One (10-100 employees) and SAP Business All-in-One (500 to 2,500 employees), Wilson wrote in his report, “SAP’s Business ByDesign and the future of SaaS”.

But with the on-demand model being as attractive as it is, would the majority of new customers want to buy the other products if Business ByDesign was as robust? Especially if it could then support the same level of customization that those on-premise products support and had the same library of best practices.

“The better SAP does with Business ByDesign, the more [customers] are going to want to expand their use,” Wilson said.

For their larger customers, SAP and Microsoft are taking a software plus services approach – offering customers on-demand, vertical functionality that will augment on-premise investments. This allows them to maintain lucrative maintenance and support revenue streams.

But how can they approach the SMB market and still make money?