Why the Cost of Sales Gap is Shrinking between SaaS and Legacy Software Vendors

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Today’s leading Software-as-a-Service (SaaS) companies continue to steal share from their legacy, independent software vendor (ISV) counterparts due to rising demand for their cloud-based application alternatives. However, many of those offering enterprise SaaS solutions are also seeing their sales costs rise as well. This is raising some serious questions about the short- and long-term profitability of the SaaS model compared with its traditional, on-premises predecessor.

Legacy ISVs have been lamenting the market move to SaaS for many years because of its fundamental impact on their financials. Unlike their traditional product business, which enabled them to record the revenue from perpetual licenses and multiyear maintenance agreements up front, the SaaS model forces ISVs to provide software functionality and support services at a fraction of the cost via a subscription fee that can only be recognized on a month-by-month basis.

The first generation of enterprise SaaS solutions were designed to be simpler to use than legacy applications so they would appeal to renegade end users who would clandestinely adopt them and encourage their peers to try them across the organization — the “land and expand” account-penetration approach. This “try and buy” sales technique has permitted a low-touch, high-volume sales process, which has historically been uncommon in the enterprise software arena.

Now, many enterprise SaaS solutions offer similar functionalities to their legacy competitors, along with comparable integration and configuration capabilities.

In response, a growing number of legacy ISVs are repackaging and repositioning their on-premises applications into hosted SaaS solutions. While their hosted applications may lack the scalability, flexibility and other key attributes of true, multitenant SaaS solutions, they are still gaining customer attention and creating confusion among IT and business decision makers that translates into more intense competition and longer sales cycles.

Rather than rely on the bottom-up sales process alone, a growing number of enterprise SaaS companies are adopting a more traditional enterprise software sales approach. They are hiring experienced, enterprise software salespeople to sell directly to high-level corporate decision makers in the CXO suite. Leading enterprise SaaS companies such as Salesforce.com and Workday are the most prominent examples of this trend.

The financial repercussions of this trend were most recently apparent in Salesforce.com’s latest quarterly results, which revealed a 10 percent decline in sales productivity during the period. Fortunately, the company’s higher sales costs were far outweighed by an impressive jump in revenues of 35 percent compared with the same quarter a year ago. But some financial analysts found reason for concern in these mixed results.

Marc Benioff has publicly stated that his company is intentionally and aggressively investing in its sales engine to gain as large a share of the market as possible during today’s “land grab” or “Cloud Rush” period.

Workday is also boasting high sales costs to go along with its extraordinary average price per sale (APS) of approximately $480,000 and growing.

For now, Wall Street is not penalizing the leading publicly traded SaaS vendors for their high cost of sales as long they are also generating high sales growth rates. However, as these rates slow, continued high sales costs will become a bigger concern. Some industry observers expect sales costs to subside as the SaaS sales process becomes less of an uphill battle. They suggest that a more educated buyer will require less sales efforts and shorter sales cycles.

I’m not so sure. The rising tide of legacy ISVs “cloud-washing” their traditional offerings and recasting them as hosted SaaS solutions will continue to confuse IT and business decision makers and compound the cost of the SaaS sales. Oracle, SAP and other legacy ISVs are already intensifying their counterattacks via a combination of SaaS company acquisitions and “cloud-washing” campaigns.

Although customers are becoming more aware of the relative merits of SaaS alternatives, they are also willing to compromise on the benefits they can gain from true SaaS solutions if they think the legacy players can give them a better price or superior support.

This prospect is driving leading enterprise SaaS companies to invest more heavily in their sales engines to fortify their competitive position and may reduce their long-term operating margins in the process.

Jeff Kaplan is the managing director of THINKstrategies and founder of the Cloud Computing Showplace. He can be reached at jkaplan@thinkstrategies.com

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