Software as a Service (SaaS)

Recently, I was interviewed by ReadWriteWeb about investing in enterprise applications. The following is a link to that interview.

Investing in Enterprise SaaS

The following article was published in the WSJ today. I think it captures perfectly the issues we’ve been discussing on this blog.

Tech Giants Ramp Up Their Online Offerings

(From THE WALL STREET JOURNAL)

By Ben Worthen and Justin Scheck

The recession is forcing technology heavyweights Oracle Corp., Hewlett-Packard Co., and SAP AG deeper into a low-profit business that the companies have traditionally resisted: selling online software. As businesses look to cut costs many are turning to Web-based software, which saves companies from having to buy or maintain expensive back-office computers.

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One of the key issues that concerns investors and management teams alike vis a vis the SaaS business model is its potential to consume a large amount of capital until finally reaching profitability. Many people have written about this topic, including me.

SaaS companies are typically built upon a stream of relatively low cost subscription licenses, paid out monthly/quarterly/annually — even multi-annually. Unfortunately, for the vendor, the subscription model usually generates far less up front cash than a traditional ‘perpetual license’ software model. But, over time, the compounding effect of the SaaS model can build into a nice annuitystream — provided churn rates are minimized.

It is this up front cash differential that is the primary appeal of the SaaS model over the traditional software model with customers. However, this differential is also what makes the model vexing for the SaaS management team and the investors.

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By now, those of you who’ve read my previous blogs realize I tend to only post something when I think I have something interesting to say. Unfortunately, the empirical data suggests that this doesn’t occur with great regularity! It’s my hope, though, since you’re investing your valuable time reading this that I am providing something useful to you.

With that, here are my latest thoughts that pertain to ‘process work’ and ‘knowledge’ work and why I think the software industry has done a reasonable job addressing the former and has until recently let down the latter. Let’s start out by defining the two terms.

I define ‘process work’ as those sets of predefined actions that a person must perform in order to accomplish a business task. These include things like: placing an order, posting a transaction to the general ledger, entering a customer’s contact information.

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This is a follow on to my post on July 18th, 2008 titled “Does it Really Take $100M to Build a SaaS Business? Say it ain’t so, Joe!”. As part of some research I’ve been doing, I wanted to dig into the actual amount of capital it takes to make a successful SaaS company.

Wachovia Securities issued a report in May 2008 on the state of the SaaS market. On page 25, it shows amount of capital paid in prior to an IPO for 18 out of the 28 public SaaS companies. Here is that list below:

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Over the past year or so, PaaS – Platform as a Service - has emerged as a new and interesting strategy for Salesforce.com with Force.com and NetSuite with NS-BOS. The value proposition for developers is:

• Object-oriented development environment for rapid prototyping and application development.
• “Out-of-the-cloud’ integration with other applications developed on the platform
• No need to invest in commodity operational infrastructure such as “ping, power, and pipe” and disaster recovery services which can be expensive to set up yet completely non-differentiating.

So, if you’re a SaaS application developer or investor, what’s not to like?

Well, first let’s talk about the SaaS business model.

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Sarah Lacy, a reporter with BusinessWeek just issued this article about On Demand/SaaS businesses.

I had an opportunity to meet and get to know Sarah in 2004 because she did a long story about me and Siebel’s entrance into the OnDemand market.  I have a lot of respect for her and her opinion. However, I take issue with a few of the conclusions one might reach by simply reading this article and taking it at face value.

On Demand or SaaS isn’t a panacea, it’s a business model. Companies won’t succeed simply because they are SaaS-based. You still have to build a compelling application that solves a real business problem that people will really use and pay money for.  However, what the SaaS model has done is to give customers the ability to try a few seats and then “walk away” with relatively few sunk costs when a vendor fails to deliver real business value. Under the traditional enterprise model most customers needed months/years to do a pilot — which seldom gave them a complete picture - and once they committed they were committed forever because of the psychological and financial investment. So big projects like Oracle, PeopleSoft, Siebel, etc. rolled on even when it was clear that the customer wasn’t happy with the expense or the value.

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Market Overview

The enterprise software market, which includes a diverse set of software for different functions such as: HR, Sales, Marketing, Finance and IT is a mature market (with a range of 2% – 10% compound annual growth rate). This market is dominated by just a few global brands such as IBM, Microsoft, Oracle, and SAP. IT budget constraints and software complexity make it difficult enough for companies to support and maintain their current enterprise software let alone allow new vendors to enter the mix. As a result, IT organizations have created extensive policies to block new entrants, making it extraordinarily difficult for recent independent software vendors (ISVs) to break into the enterprise market. This, coupled with the high go-to-market cost structure of an enterprise software company has made the enterprise software market a relatively uninteresting investment area and caused innovation to stagnate in this field over the past decade. However, all of this may be poised to change due to Software as a Service (SaaS).

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