Feb 25, 2008

Why Software As Service Businesses Are So Interesting

It’s that time of year again. No, I’m not talking about spring cleaning. No, not taxes either. It’s the time of year when every MBA student thinks about his or her career plan. Today I had the privilege of meeting with one of Stanford GSB’s finest scholars. His number one question: should I get into venture capital?

While I won’t answer that question in this blog entry, I will talk about one of the items we discussed at length. Here’s what I like about SaaS companies:

  • Recurring revenue model. One of the most compelling aspects of any SaaS company is its revenue stream. Although it takes some time to develop, once a SaaS company has a customer base and has reached a steady churn rate, it has a predictable, repeatable revenue stream. Then it all comes down to continuing to acquire customers while reducing churn.
  • Low cost of sales. Another incredibly compelling aspect of the SaaS model is the low total cost of sales associated with these companies. The product is available for demonstration, evaluation, and long-term use right over the web. While some customer accounts may still require in-person sales, the vast majority can at least get up and running without an on-site customer visit. As a result, a great SaaS company can be very successful at a “land and expand” strategy.
  • Ease of delivery. Unlike the old installed software model, SaaS companies, like Consumer Internet companies, get to deliver updates when they want to. Customers lose some control in this model — whereas they used to be able to decide when they would roll out software updates, now the company delivering the software decides that for them. But companies benefit immensely because they get the most up to date capabilities without the overhead associated with traditional software delivery and maintenance. Companies can also deliver these releases more quickly and more efficiently than before.
  • Stickiness. Most if not all SaaS offerings require that the customer input or import data into the service. For example, a human resources management offering would likely require a customer to import its organizational data. Having the customer complete the initial work is critical, and sometimes challenging. But once the customer does this, they are likely to stick as long as they are getting some value from the product. Having gone through the process once, they are not likely to switch to another system. Moreover, extracting and exporting data from service based offerings is harder than it was with installed software.
  • Measurable growth. Finally, with SaaS business model, a company can really measure its performance. Once the revenue stream is established, a company can focus on a few key metrics. Monthly Recurring Revenue (MRR) indicates how much recurring (vs. new) revenue a company has each month from its customer base. Companies can track their customer Payback Time to see how long it takes to recoup the cost of acquiring a customer and getting that customer up and running. Then companies can focus on reducing this time.

It’s always fun meeting with the next great MBA graduates. Thank you to the student who came by today for the thought-provoking discussion.

10 Comments

  • [...] by smoothspan on February 26, 2008 David Feinleib at Mohr Davidow Ventures likes SaaS.  He eloquently lists some great [...]

  • Do you meet with undergrads as well?
    :) ,
    harsh

  • I forgot to link to Bessemer’s recent unveiling of 10 laws of SaaS available here: http://cracking-the-code.blogspot.com/2008/02/10-laws-of-saas-unveiled-at-bessemer.html

    Also McKinsey Quarterly on Delivering SaaS:
    http://harshjshah.googlepages.com/McKinsey_Delivering_SaaS.pdf

    cheers
    h

  • Good post Dave. Coming from a company that’s trying to move into SaaS, your article really speaks toward a lot of reasons why it’s potentially successful.

    Let me play devil’s advocate for a bit. In consulting, SaaS has begun to have the stigma of being a buzz word. It’s today’s “Web 2.0″ phrase. That aside, I’ve run up against some real-life problems getting client buy-in for these type of projects.

    First, SaaS is rarely commercially viable if it stands on its own. Most of the time, you’re not able to attack a market where you’re effectively selling “the same old thing” that we all know is better (think replacing something like an ERP application with a service-based one). You run into a lot of resistance to service models because a client is no longer owning something, and the difference is not immediately perceived as valuable. Quite often, you’re looking at integrating your new software service into existing applications, and that’s where the real costs start to add up in terms of professional expertise and development. To get a big enough chunk of the market, you may have to go through this process several times.

    Second, the value proposition, and the idea of recurring or transactional costs, make it tough to stomach for many small and medium businesses (SME’s). I’ve heard many owners complain “you’re charging me $X per month for Y software, when I’m not even going to own it?” Fundamentally, a lot of market education still needs to take place about how SaaS is beneficial, and MRR is something that many businesses just can’t handle paying right now. The other side of this is that a customer often recognizes that the ongoing costs of SaaS to a software vendor are substantially less than than the monthly sticker price (especially if it’s a per transaction charge – there is almost no per transaction cost to base that charge on). These crafty folks will do some crazy total cost of ownership math to determine if over the lifetime of the software they would be better of to build it in-house or buy a more tangible resource from another vendor. In short, they’d rather take a lease for tangible software than feel like they’re paying too much for intangible software, even if the TCO is the same.

    I would argue that ubiquitous SaaS, especially within the SME space, is going to be years away. That’s no surprise, since SME’s typically lag behind the curve anyways. It is going to take more proven revenue models (read ROI for the customer), and more customer education for it to really penetrate the skepticism of today’s business owner.

  • A meta point about why SaaS companies are interesting–you can boil most things down to the fact that SaaS represents a better fundamental alignment between vendor and customer.

    At its best, SaaS is about simplifying the vendor/customer relationship: Easy trial, easy purchase, easy adoption, easy operations, easy management.

    Making the customer’s life easier increases willingness-to-pay. It is then up to the vendor to make sure that it architects its business appropriately to be able to serve the customer in a profitable manner.

  • Great article, and I also agree with Chris.

    SaaS businesses have to usually figure out how to deliver enough value to customers so as to continually earn their business month after month, year after year. The risk shifts to the vendor — which increases adoption.

    One thing that’s different (that hasn’t been talked about much yet) is the capital requirements for SaaS businesses. The quality of revenue is high and it has a lot of benefits, but it takes more cash because to some degree, a SaaS company is financing it’s customers.

  • [...] Tech, Startups, Capital, Ideas. » Why Software As Service Businesses Are So Interesting Share and Enjoy: These icons link to social bookmarking sites where readers can share and discover new web pages. [...]

  • Low Cost of Sales??
    Have you seen the numbers from Salesforce, Netsuite and others…? Factor in marketing spend and the customer aquisition costs seem pretty high to me.

  • [...] SAAS is interesting – http://www.vcdave.com/2008/02/25/why-software-as-service-businesses-are-so-interesting/.  The discussion of churn rate (customers that leave) vs new customer acquisition rate got me [...]

  • [...] read an interesting comment by Chris Strahl on a SaaS post here which [...]

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