SaaS as Recurring Revenue Justification


One common misunderstanding (at least in my opinion) I find when discussing SaaS with people (particularly SaaS vendors) is that they make statements like “SaaS is nice for business because it’s recurring revenue.” Why is this a misunderstanding? Well, the way that statement is framed is that SaaS gives the SaaS provider the benefit of recurring revenue. Instead, the topic of recurring revenue and SaaS should be framed under recurring payment from the consumer in exchange for recurring, high quality delivery of software functionality. It makes the issue seem much less one-sided and is a more accurate representation of what happens (Yes, I have a penchant for definition nuances)

A recurring revenue model, however, is exactly that: a revenue model. Conceivably, I can sell someone on-premise software and ask to be paid $500 a month for the use of the software as long as it is being actively used. Conversely, I could have a SaaS offering and sell it on the basis of “Give me $50,000 and up to 6 users can use it forever.”  There is no direct coupling between the delivery model and the revenue model and with some craftiness I could use any combination of delivery and revenue model. In essence, I can achieve the benefits of stable, long term, and predictable recurring revenue or the benefit of large revenue influx and good periodic cash position via perpetual license sales without worrying myself about how software is delivered. Technically, we have the following four combinations:

  1. On-Premise, Perpetual License
  2. On-Premise, Recurring License
  3. As a Service, “Lifetime License” (a re-labeling of perpetual to fit the SaaS conceptual framework)
  4. As a Service, Recurring License

So what then, is so special about the coupling between the SaaS delivery model and the recurring revenue model? From the provider perspective, it makes the recurring revenue model an easy sell since its justified. It’s tough (although possible and has been done before) to sell an on-premise license on a recurring basis without any sort of continued, measurable participation from the ISV. The real importance of coupling SaaS with recurring revenue is actually from the consumption side of the equation. Those who use SaaS offerings get to pay as service is delivered, with the ability to discontinue use and mitigate losses when service becomes subpar or the offering no longer provides adequate return. Moreover, it also keeps providers honest and overtime keeps service quality levels high. This is a huge selling point that is not stressed enough and is significant in the SMB space since the cost associated with migrating to a new substitute SaaS offering is relatively minimal in nature and low in risk. When prospective or current SaaS providers discuss SaaS, stress should be put on the fact that “SaaS gives my customer the ability to pay as they receive service and have quality guarantees in place” rather than “I get recurring revenue” Customers don’t care if you get recurring revenue, but do care about the rest.

Do you think that SaaS is necessary justification for recurring revenue, or could recurring revene models be justified using “old” on-premise delivery/other delivery models? How important do you think “pay as service is delivered” is to SaaS customers?

 

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November 20th, 2007
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Comment Number:
1
Written by:
Paul
Posted on:
November 20, 2007 at 10:37 pm

I think pay as you go, when coupled with the SaaS delivery method has a multiplying effect on decreasing barriers to entry. But OPEX based models only appeal to some companies, some prefer for tax or other reasons to go for upfront models.
I think you’re opening point about re-occuring revenue is spot on. Nicely put Sinclair.

Comment Number:
2
Written by:
Ben Kepes
Posted on:
November 21, 2007 at 1:28 pm

Yes - nice post Sinclair, good points

Comment Number:
3
Written by:
John A. Berg
Posted on:
November 22, 2007 at 3:29 am

I do not disagree with your observations purely looking at the licensing - but what about hosting and support? These types of services are quite often bundled with a SaaS license.

Also, when selling a SaaS solution the customer will usually anticipate new features and functionality (future versions) being added to the solution without reinvesting in the product - someting I belive points in the direction of a reccuring revenue model.

All in all I believe traditional software mostly comes with a one-time license fee because most of the investment in the product is up-front. With SaaS solutions there is a need for an ongoing investment in the product - so a recurring revenue model makes more sense.

Comment Number:
4
Written by:
Abe Sultan
Posted on:
November 22, 2007 at 9:16 am

John,

I think that is exactly what Sinclair is trying to explain.

The benefit of SaaS for a customer is not that it is on a pay as you go basis. It is the fact that you pay as you go because you expect more services so in reality you continue to pay for improvement on the service.

The burden of proof is entirely on the providers; they need to win your business again and again by ever improving the software.

So the important point to outline when you talk about pay as you go; or recurring revenue, is not necesarily the way you pay, but what you are getting in return (All the benefits of SaaS).

Comment Number:
5
Written by:
Troy Wing
Posted on:
November 23, 2007 at 10:06 am

I agree with your point on separating delivery from revenue model. But I believe that is a benefit of the SaaS model only. I don’t believe you can do the same with On Premise. SaaS offers flexibility in choice, although the recurring model should be preferred by vendors due to lower cost of supporting each customer. On Premise incurs a higher cost of ongoing support and maintenance per customer irrespective of user counts, which cannot be covered by recurring revenue, which it makes it tightly bound to a perpetual license plus annual maintenance fee.

Comment Number:
6
Written by:
Frank Zheng
Posted on:
November 24, 2007 at 1:41 am

Very Good Observation!
There are two other combination of delivery and revenue models:
5) On-Premise, Perpetual License, pay by installments. As Competition of business software in China is becoming very severe, many traditional software vendors have already adopted this model.
6) As a Service, “Lifetime License”, pay by installments. As a software service provider in China, we adopt this model.

Chinese people don’t like to “pay forever” for something. Recurring model is very difficult to succeed in China. We have to introduce “payment installment” concept to promote SaaS. Hope when customers pay up their balance ( usually after a few years), we will come up with new ideas to make them continue to pay ( Any ideas are welcome :) .

Frank @ http://www.oksbt.com

Comment Number:
7
Written by:
Joel York
Posted on:
November 24, 2007 at 1:54 am

To use a little math terminology from my old days as a student, I think SaaS is a sufficient condition for recurring revenue, but not a necessary one.

In plain English, traditional software can be sold both as a perpetual or rental license (I have done both), but you do not have this option with SaaS, because the customer can never really own the software or hardware infrastructure, i.e., your option 3) above is not really possible…it is a red herring.

From the customer’s perspective, it is really a question of risk. Renting reduces risk by making switching easier. Purchase reduces risks associated with lack-of-control (in most cases inflated and emotional, but real in others).

The real benefit of SaaS is extreme cost reduction, which in most cases trumps risk.

Comment Number:
8
Written by:
Sinclair Schuller
Posted on:
November 24, 2007 at 8:01 pm

I agree with your point: extreme cost reduction does generally trump risk, at least in the broad case. The problem is, I’m not sure that it’s generally the case that SaaS is “riskier”. Rather, it is a question of perceived risk (which you’ve labelled as emotional), and even then, yes cost will prevail if it is significant.

Framing “recurring revenue” from the customer perspective, however, may attack the perceived risk directly without requiring that a switch be analyzed strictly from a cost analysis perspective.

Comment Number:
9
Written by:
Uri Lederman
Posted on:
November 30, 2007 at 5:04 pm

I Agree whole heartedly with Joel..

Although you can sell traditional software both as perpetual license model and a subscription model, the fact that true SAAS players go that extra step and take care of delivery means two things:

1) Total cost of Ownership for end users are drastically reduced
2) ISVs are able to capture the hardware & people costs of software as REVENUE.

Just my two cents,