Is SaaS About Maximum Profit for the Provider?

Jul 16, 2007 by Sinclair Schuller

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.

 

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The SaaS Investment Landscape

Apr 27, 2007 by Matt Ammerman

Although many in the SaaS-choir have long since been sold on SaaS, it seems that venture capitalists are finally joining us.  Existing firms are padding their portfolios with SaaS companies.  More interesting, though, is the fact that firms are forming with core strategies focused on SaaS investment.  Why is this?  Perhaps the most definitive evidence comes from market research as illustrated in Phil Wainewright’s most recent article “Resistance fades as SaaS goes mainstream”.  Bullet points like ‘Adoption is surging‘, ‘Resistance is fading‘, and ‘Deployments are multiplying‘ instill great confidence in the minds of financiers. That’s right, as investors see more research from sources such as Gartner and Saugatuck indicating that SaaS is viable and sustainable, it becomes a much prettier investment picture.

As always, the proof is in the proverbial pudding:

Warren Weis from Foundation Capital says “Software as a service is clearly a very interesting area because of the ease of selling into these types of environments where users can use it without a big IT implementation … We have about 11 of these types of (SaaS) investments and they’re doing very well… we’re looking for new investments in that area.”

Jeff Horing from Insight Venture Partners says ”SaaS offers a more predictable revenue stream and lower research and development expenses to software vendors than packaged software products.”  He continues, “Overall, if you can build a successful company it’s a much better business model than license sales.”

Horing says he and other investors at his firm are skeptical about growth for companies looking to make their mark by selling enterprise software applications, as opposed to those that market the SaaS model.

VCs have had time to watch the progress of early SaaS companies.  They’ve seen stability and better yet, growth.  Evidence is found in the performance of these four SaaS companies over the past two years (CRM, RNOW, VOCS, and SVVS):

 
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It’s no wonder SaaS companies whet the VC community’s collective appetite. IPO valuations of SaaS companies such as SalesForce.com, NetSuite and RightNow Technologies have come in as high as 10X revenue (although not the general case)!  Now there’s a nice exit.

Obviously, SaaS investments come with considerations, both positive and negative.

The Pros

• Demand from the enterprise IT community
• Predictable and stable revenue
• Predictable cashflow and growth
• The market for SaaS is expected to grow to 25% of all new business software by 2011 (Gartner)
• SaaS is an easier sell than traditional packaged software
• See Wainewright’s article for more.

The Cons

• A longer time to achieve cashflow positive (longer development times and amortized revenue model)
• Higher startup capital requirements

What do you think? Are you looking to invest in SaaS companies? Are you planning any SaaS deployments within your organization? What’s holding your back? We would love to know your thoughts, share them though comments!

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Do Traditional Channels Matter in a SaaS World?

Feb 15, 2007 by Sinclair Schuller

From the vendor’s perspective, SaaS is more than just a distribution model; it’s a new way of doing business. Many of you have heard it before; no more large license-fee deals, issues with compensating your sales team, planning around incrementally growing yet recurring revenue, etc. The single most important question, however, is “How do I sell?” SaaS poses an interesting scenario: as a provider, you now have extended your distribution power and reduced your per-unit cost basis low enough that your application is a no-brainer deal for the small-to-medium sized business (SMB), but how do you reach these SMBs? Obviously, the mid to enterprise market has warmed up to SaaS so that’s a great market to tackle, but there are established IT inroads into members of this market. There are many, many SMBs out there each without a CIO or CTO or any other obvious “goto” inroad. Getting the idea of on-tap software functionality out to this market is a very big challenge. In my opinion, SaaS providers that attempt to leverage traditional distribution and sales channels with SMBs in mind probably won’t find it to be too successful. I’m betting that SaaS providers targeting this space will have to use a lot of creativity to achieve a broad and deep reach across the SMB space.

A good starting point would be to answer the question “Where do SMBs do business?” or “Who do SMBs work with that I can utilize as channels?” An example (albeit experimental in feel and nature) was NetSuite’s deal with CompUSA last year; CompUSA has many SMBs as clients, and could potentially act as a point of sale for NetSuite subscriptions as well as provide NetSuite training to customers. Although this might not be the “killer channel”, it’s a decent example of creativity. We’ll see more of this unfold as vendors try and tackle the space. Any thoughts? If you’re a SaaS provider, have you had any success with some sort of non-traditional channel or partnership pairing?

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