I recently read and commented on a good post over at Unreasonablemen.net titled “How Do SaaS companies make money“. In summary, the article highlights the fact that SaaS companies have an alarmingly low EBIT, high marketing spend rate, and no mechanism for getting “upgrade fees.” While this is all true, I wouldn’t use the word alarming. In the comments I state that the low EBIT is a result of immaturity within the space, and that it will change.
To further the conversation, however, I also want to point out that SaaS is inherently not an early, maximized profit model. Instead, the tradeoff is reduced profit for increased stability. The software industry has done excellent with the traditional model, but as business consumers look for more and more choice as well as a way to reduce IT budgets, SaaS becomes a natural outcropping. SaaS providers need to recognize that while huge margins are gone, as are “upgrade fees”, they will see revenue stability and predictability. The SaaS business model is about reaping the benefits of this predictability. As for funding R&D via EBIT, one needs to recognize that SaaS (from the technical perspective) is about incremental and rapid improvement rather than “fell swoop” R&D and releases. Can a SaaS company pursue large scale R&D? Sure they can, but they have to hit scale first, and as we’ve seen via the Netsuite example in the referenced post, this could take some time.