Why is SaaS so attractive to Businesses?

I’ve said it a few times before, and think its worth repeating. It is my belief that in SaaS IT is actually delivering on its promise. That is meeting the business objectives.

The more i think about it the more i realise that the key part of the Acronym  SaaS is the word “Service” and what this actually means to the business. To select a SaaS provider the IT department has realised that their business is after a service. The business want an outcome not a bunch of technology.  SaaS is about an outcome and in choosing a SaaS provider (assuming they’ve got the correct one) the IT department has actually connected with and understood the business and their requirements..

Having just spent the last 2 days at a CIO conference it is appallingly apparent that many IT departments fail to make the connection between the business strategy and needs and what they do!

By choosing to go with the SaaS model, the CIO also has to do a sales job on the business. “here’s this new thing, it will be better than the old way and you will get that outcome and make / save  XYZ / be more productive / have better customer sat / retain your staff”. You will notice that the language above is the same language as the business uses, not techno mumbo jumbo (as is often the case). So by using the language of business you have also connected with the business. They understood you, what you were proposing and what they will get! Nice work! Another major barrier broken down between IT and the business. (as an aside, personally i think SaaS are better at articulating business benefits and selling to non IT people than your traditional company – any one else think that?)

Another core drive for SaaS is undoubtedly cost. Check out this graph of the top 5 reasons for SaaS.

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Clearly when undertaking this research, they only spoke with the IT part of the business because no where on it does anyone mention a business function, benefit or outcome. All of those metrics are important to the CIO and don’t really mean much to anyone else. No one said “ SaaS companies can do it better than we can”, “speed to market”, “flexibility” or (ouch) “at least with the SaaS company we will get something delivered”. Ok, i’m being provocative but if you sat in the CIO conference i’ve just been in you’d be a little disillusioned too.

Back to cost, it is important but for different reasons. IT is only now getting a handle on the lifetime cost of some of their assets. Let me explain. In IT there is an universal truth that components commoditise and then get cheaper. The cost of storage, a server or a notebook is much cheaper now than it was 3 years ago. This means that IT departments have the cash to buy more of these items. (same budget, cheaper cost per unit = more units). But there is a catch to this proliferation, the spiralling cost of management! Here are some stats for you. Since 1996 the total global spend on server hardware has remained static in real terms. We are simply buying more cheaper units. But here’s the killer, the total spend on Server management over that same time has increased 8 times. More power, more cooling, more systems management licenses, more DBA’s more sys admins. This isn’t a one off either, its well known that while storage is cheap, storage management isn’t. This massive increase in cost is also mandating the investigation of a new approach. Enter SaaS (grid computing and storage in the cloud). Other companies are simply better at this now than you can ever be, have the economies of scale and understand the business benefits of what they do.

Finally I also think that business (not IT) have had enough. They (through experience) are over IT not delivering. They are also very clear on what is critical to the business success and they aren’t very interested in the how, but the what. SaaS come on down.

market reversal

Quick post, 

I've just left a meeting where one of the guys was talking about product development . His point really resonated with me. 

He said that 5 years ago, no IT project was started until the XYZ had been in Forbes for 3 Quaters running. NOW tho, employee's are turning up to work say "well i can do XYZ at home why can't i do it here" A complete reversal…

Take Instant messenger, Video messenger… voip 

How can you make money from SaaS?

One of the things that I became very conscious of from my previous post is that in this instance the research showed a very limited view of the SaaS ecosystem by only analysing the core software elements. In looking into this wider ecosystem and the associated auxiliary services i was struck by the question

 

            “where are the profit pools in SaaS?”

And of course, which part is the most profitable. It’s an interesting exercise.

{mosimage}

The core application space has the potential to be the most profitable when you get scale (see this post by Smoothspan). Up till then it might not be the most optimal part of this ecosystem (13% EBITDA).

Right now, at this stage of the SaaS market maturity, it seems to me that the consulting strategy businesses are doing pretty well out of this. They get to double dip in some ways, helping the ISV with the what and how as well as the end customers. It’s easy to see the appeal and given by the amount of interest and trumpeted thought leadership coming out the big 4 this seems to be a large and growing profit pool. I am going on gut feel but it would say that these guys operate way over 13% EBITDA. I also think that there is a clear divergence going on here. You can see the big 4 doing the same old stuff here. Frameworks, sizing, BPO etc. You can also see specialists like Mural ventures emerging. Guys who actually done (and continue to do) SaaS and are monetising their experiences. (in my opinion one is eminently more valuable)

SI’s are a niche but growing business currently. I think in real terms they are only a small fraction of the SaaS market but will grow enormously. Mainly because businesses will still need technical help to get SaaS in, but will still face the traditional foes of being resource constrained. SaaS SI is in opinion the next evolution of technology implementation services, and when SaaS companies get this they will be dis-incented to make their stuff self provisioned. There's an interesting post here by Dennis Howlett with the stunning take out of:

At Microsoft’s recent Worldwide Partner Conference, Tami Reller, corporate vice president for Microsoft Business Solutions said the predicted 2008 market opportunity for services is $93 billion. Set that against the software and enhancements prediction of $51.7 billion” 

That puts the SI profit pool at nearly 2 times the application space. Wow!

Service industries like research and sales and marketing will make quite a bit out SaaS, at quite good margins i would guess. But in real terms this will be quite small. But if you are into niche, highly profitable markets this is a great play.

Network access. The telco piece of the pie. Unless they morph into being a platform provider like BT, then they run the very real risk of being sidelined to a pipe provider who will operate at ever decreasing margins. Regulation, elimination of value (public networks) and global competition from application companies all contrive to make the future of Telco quite bleak.

Platform providers (interesting debate about what a platform provider is to follow) have a good chance through scale to do very well. It depends on their model, the value they provide and their own success in winning over new ISV’s but platforms could be the big winner. Look at portal wars, Yahoo, MSN and AOL spring to mind. These could define themselves as content platforms of some sort. They got massive scale and have evolved their business models to a point where things are ok profit wise. Just ok because you could argue the value they provide is…limited? But if you look at APEX, Apprenda , Opsource and facebook, they are all seeing the value of platforms. The Platform play done right is one of those rare things as it has value up and downstream. If you get scale this could be the big winner. And as i said above if you get the model right it could be even better. Revenue share or stock in a start up, acquisition like Salesforce.com, clip the ticket on a per transaction, SI and business level consultancy, additional services (we’ll even bill for you). And let’s face it, the success rate of SaaS companies isn’t going to be that great, so the chances of one of them being big enough to move to its own datacentre are remote so you got great lock in. There are also great customer benefits too, someone who knows about up-time and reliability managing the app. It’s a good story.

I think there is also money to be made from widgets, gadgets and supplementary applications. Again its niche, but if you make your little customisation available worldwide using someone else’s platform you could do very very well.

So where does the profit SaaS profit lie? Well if you are thinking scale, then in my opinion it’s in the platforms, core applications and SI business. All of these others get have a degree of focus that means their reach is somewhat more restricted.

Ok, lets flip this on its head.

Enough with the problems, how about some solutions. 

Firstly, having re-read my last post I guess i gave off the opinion that SaaS is questionable. I apologise for that, i’m a very big fan. Its my personal belief that with this model Software companies may well finally deliver on the promise of IT. That is provide business benefit. It seems to me (and i get exposed to this every day at my currently employer) that every IT project comes with a significant cost, and that in its traditional sense, that delta isn’t that great. To quote Socrates

 “without evil there cannot be good”.

But in SaaS the downside equation (effort, resource contention, ongoing management, shelfware, missed business deliverable, components etc etc) is being marginalised.

SaaS revenue is easier to predict as its incremental (not lumpy) and due to its huge popularity amongst its users ( and the fact that its really hard to leave) there seems to be very low churn. It would seem to be that SaaS companies who ARE profitable would be very good investments because of this reason.

Having said that though, the concerns (not alarm) over the individual viability of SaaS companies is still real. I also think due to the immaturity of the segment, these companies are still searching for the optimum business model, be it channel, partner or differentiator as well as having to overcome the naivety of the market to the benefits of SaaS.

I think its worth looking into the different business model approaches and how they could impact on EBITDA.  EBITDA is to my mind the critical aspect as I still hold to the belief that it is the fuel that business use to innovate and grow regardless if it is a fell swoop or on an incremental  (cash burn ) basis.

 As a framework I liked Ben’s post which basically says that the value proposition (and hence its differentiator and long term financial viability) for SaaS companies seems to fall into either a “me too play – done differently/cheaper” or a “we’ve got true differentiation and scale here” play. I’d argue that the third play is the building of a product that so fits a market niche that they’re difficult to displace (imagine PlanNZ – who do mortgage lending CRM – done SaaS).

Lets look at each of these plays then

The me too play – done cheaper of differently. These guys are taking on established markets (like CRM) but are saying their way is different (and better {mosimage})or cheaper. At the moment the different part is pretty much SaaS. In this instance these guys are expending huge amounts of effort in Sales and marketing and CoGS, hence the lower EBITDA.  I would argue that they should be hell bent on a Get Big Fast plan, get scale no matter what it takes as this will have the benefit of bringing down the CoGS line as well as making the market. As Sinclair points out SaaS still has a mindshare problem so the Sales and marketing numbers should stay high until they achieve scale, then if you maintain expenditure and increase revenue the percentage naturally falls. If they don’t then they’ll end up looking like SunRocket who with its 200k customers didn’t get scale (as opposed to Skype with its 200 million). These guys could help bring down their costs by using SDP providers rather than build their own. They could then divert that CAPX spend to M&A activity or customer acquisition. To my mind SaaS companies should be better at merging because they are used to mashups, they just get it. Therefore they can get the joint proposition out faster, use the IP or the people better or get to the customer base they’ve just bought sooner (the rule of 78 applied to revenue).

Next we’ve got true differentiation play, this one is harder to identify as its quite rare. Given that I would argue that Facebook and Myspace when they were new did achieve this. Who’d heard of social networks 2 years ago?  These guys based on their differentiation attracted users in their hordes (scale) and are now sitting pretty. If I understood how they made money i’d comment more but i’m still perplexed on this apart from the rule of eyeballs. They obviously have a need for SDP’s to bring down
CAPX, but id bet that their Sales and marketing costs are were minimal as they had viral marketing going on for them (see my post below and reference to guerrilla marketing). If you are unique, fulfil a market need and have scale then it’s about as good as it gets. You should have massive EBITDA.

The final major strategy is nicheing where you don’t really get scale but your differentiation provides you with a safe position in the market. You can therefore keep your margins up (no price based competition) and can survive quite well. These guys can bring down there COGS using SDP’s to further increase their EBITDA.

Any else think of ways SaaS companies can increase their EBITDA?

How Do SaaS companies make money?

I’ve been spending quite a lot of time trying to work out the right model for my currently employer to make money out of SaaS. This hasn’t been an easy task, and i don’t think the answers going to be good, but what it has exposed me too is some really interesting analysis work done on the SaaS market in general.  Things like the announcement of the NetSuite IPO , and this post by Rod Drury on Software RnD really got me thinking.  How do SaaS companies make any profit?

 
This post points to some of the more alarming things about SaaS companies. This one is relates to Netsuite

 

the provider of on-demand enterprise-resource planning software reports solid revenue growth: from $17.7 million in 2004, to $36.4 million in 2005, and then $67.2 million last year. But up until last year, sales and marketing costs always exceeded revenue: $27 million in 2004, and $39.2 million in 2005. Last year, sales and marketing costs were $43.9 million, or 53% of revenue.”

 

The Sales and marketing costs exceeded revenue.  What about the RnD, infrastructure, support maintenance, datacentre etc etc…

 
According to this by McKinsey this is a little out of wack but you can see why i think there's an issue.

 {mosimage}

Clearly traditional software companies with incumbency are the cash cows. They’ve cut their code (the RnD mountain) and are leveraging their digital asset for all its worth.  From now on in its BAU enhancements, marginal based pricing (every unit sold only increases the cost of sales by the price of a CD) and stay abreast of what is going on in the market.

BUT the other thing i found interesting here is the parallels between the smaller software companies and SaaS companies (none of which are greater than $1.2b in revenue to the best of my knowledge). 

EBITDA  is quite frankly alarming. From this small percentage shareholders get a return. Hardly appealing. It’s worth noting that because of the licensing model (consumption) you can’t force the client to upgrade and pay more fees either. This EBITDA number is critical because also the money that companies use to reinvest in their product, infrastructure and delivery to help themselves grow.

The Marketing and sales spend is staggering. It makes sense that these companies are massively customer acquisition driven but the return is what?  Surely some clever guerrilla marketing or channel model could help out here? Given that each seat only pays a small about pa or per month you don’t see the massive revenue hikes year on year going head to head with traditional software companies isn’t ideal.

But users are very sticky (at present, but history would indicate that this will change. Imagine if you could export your CRM data (just like you do your feed reader file) and import it into the competition). But if you are a pure play vendor like Salesforce.com, your ability to cross and upsell to increase the ARPU is limited? Netsuite might be slightly different due to the breadth of their portfolio.

 The RnD line did surprise me. To me SaaS software is in constant beta, always being enhanced, optimised and revised in real time. Perhaps like all companies, RnD happens at the genesis of the company. The one cracking good idea and everything else is just evolution?

 The COGS line says to me scale problem. In comparison to large companies they haven’t achieved it.  It poses and interesting problem, one that Rod Drury has again mentioned. How do Kiwi organisations go global (or with my interpretation get Scale)?  It’s my view that the NZ market is too small in its own right to provide true scale benefits to a service provider, including SaaS. 

Xero seems to be targeting right from the get go at being a global enterprise. I think that’s important. But will that be enough? Can the loop of small EBITDA, incremental revenue (per user pricing) and borrowing (VC or IPO) continue on?

I’d be really interested to hear about others thoughts on this as it seems to me that if SaaS companies cannot solve this then the market as a whole is in question.

Where to next for software?

The news about Google acquiring Postini solutions is just another indicator of a wider consolidation trend within the industry. 

Back in 2000 when i was working in the UK we did some crystal ball gazing and predicted that by 2010 there would be 3 behemoths in the software industry left, with a massively fragmented innovator community vying to either get VC or be acquired. These companies were basically acquiring for growth. (incidentally we said they would be Microsoft, SAP and  Oracle). This prediction was based on a whole lot of gut instinct combined with some insight gained from other technology industries,  predominantly the pharmaceuticals industry who at the time were at market maturity, were consolidating at a massive rate due to an inability to meet sharemarket growth expectations with organic growth. It was in fact cheaper and faster for them to buy out competitors (with the IP and patents) than to develop the next wonder drug.

(With a couple of them you could argue that their strategic differentiator is the ability to merge or retain talent of acquired businesses, but that’s an aside).

My personal view is that this analysis is as relevant today as it was back then.  So where too from here. My pick for Google and Microsoft.

 

Google

Undoubtedly Google will offer more and more solutions that are business grade SaaS. I know people who think Google apps is a side show for them, and i guess in terms of revenue right now it is, but it is still a USD$100m business (according to a Google speaker at a conference i went to sorry can’t remember his name). But advertising has a revenue growth ceiling. Google has a massive consumer presence so logically all its growth will come in other segments. To this end, look for them to buy other businesses that provide standard business functions like SaaS CRM, accounts and finance, web-hosting, and DNS services. Gradually this will creep up market to include ERP, Supply chain etc business. I also think you’ll see Google become more involved in telecommunications (enhancements to Talk). Including video conferencing, small business calling packages, calling circles. All at rates that will make a Telco turn green. Why not, the have nothing to loose, its all incremental revenue for them.

 

Microsoft

A different beast all together this one. MS is to my mind suffering from the classic issues highlighted in the innovators dilemma . They are the desktop application incumbent. What motivation do they have to push SaaS? For this reason their whole MS Live play is lacking any real venom. They don’t have the channel to support it, the application developers aren’t quite there yet with their thinking (look at the turn around times for instance). Add to this their current customers aren’t buying the story (duh! Don’t sell it to them). The target group for MS Live seems ill-defined. The marketing messages at best is “me too” (its hardly a lead proposition is it?). This stuff just isn’t in their DNA. Having said that, i think if don’t correctly (ie calved off and run as a separate entity) MS could do quite well in this space due to scale. To that end I think you’ll see MS acquiring more companies to, security, storage and pureplay SaaS companies. Again speed to market, customer knowledge and channels here will be key for them

MS are clearly going to have a tremendous impact on Telecommunications, more so than Google with their consumer play. The SME PBX combined with their ICA Nortel alliance and their public internet at the access play mean they could be a real player.

I still struggle with the enterprise applications play. It still feels half cooked and has never really gotten market traction. The missing ingredient here is a consulting and operations business (again not MS’s core business). In fact when i think about it, MS has always struggled with Enterprise level plays full stop. Something they will have to address to keep their own share market masters at bay.

 

iPhone Madness

 

I am so, So sick of hearing about the iPhone. (rather hypercritically i guess this is just another post on it sorry). But enough already!

For anyone living outside the continental US this is hyperbole driven frenzy of Mac madness is a virtual non-event.

This post is more about the way the internet is driven by frenzy than a bitch about the iPhone itself, but then i’m not a massive fan anyways. 

The point being, the iPhone is locked into the AT&T mobile network. That network only (just) covers the US market. Hence the whole thing is a waste of time for anyone else.

What really urks me though is how much clutter this is causing in my RSS reader. I just don’t care. Obviously a major reason for this is iPhone won’t be here for 2 very long years (or longer if iStore is anything to go by). But also as this post by Jeremy Toeman points out, the likely impact of the iPhone on the mobile market is going to be minimal as well!

So then, WHY, please god, can i not get iPhone news. Why can’t filter that stuff out.

It also points to the overweight influence the US has on blogs, news and events. They’ve gone gaga over it, while the rest of us look on at the weirdness that is.

Its just a phone with an MP3 player. How could you have fallen for such hype and why can’t i block you?