Software as a Service (SaaS) is moving from the cutting edge to the mainstream, but there is enormous disparity in the performance of SaaS businesses – from rapidly growing startups to embarrassingly unprofitable public companies – and only a handful of true success stories like Salesforce.com and Taleo where growth, profitability and ROI have gone hand-in-hand.
SaaS is pretty much on the far side of the hype cycle, but the future is anything but clear. Zealots would have us believe that on-premise enterprise software will be as extinct as the dinosaurs in 10 years, while detractors call it a fad and point to the minuscule market share of SaaS in the enterprise. Still, others espouse the wisdom of so-called hybrid delivery models. Is there a method to this madness?
My feeling is: yes. I believe investors and entrepreneurs that focus objectively on business and technology fundamentals will make better investment decisions, create wildly successful SaaS businesses, and avoid misguided and unprofitable SaaS experiments. The key is understanding how SaaS creates real economic value over on-premise software and leveraging that distinction in to a competitive advantage.
The basics of a winning SaaS strategy
SaaS executives and investors are wrestling with some tough challenges:
- Why is my SaaS business losing money?
- What can I do to grow my SaaS business faster?
- When does it make sense to take a hybrid approach?
- Should I invest in this SaaS startup?
Uncovering the answers to these questions is not easy, and requires a deep understanding of how SaaS creates real economic value over on-premise software.
Every startup begins with a vision that is deeply rooted in the experience and creativity of its founders. But, that vision should be informed and tempered by fact. And the fact is that any SaaS startup that can’t deliver 10 times the value over its on-premise software counterpart is unlikely to achieve a sustainable competitive advantage and is destined to slow growth, scant profitability and negative ROI.
The most important fact that every SaaS investor, entrepreneur and executive should keep top-of-mind in any strategic decision is this:
The only difference between software and SaaS is that SaaS is delivered over the Internet. Therefore, all new value and competitive advantage must flow from this difference.
One of the first rules of business strategy is that there are two primary sources of competitive advantage: product differentiation and lower cost.
When combined with the above insight, SaaS strategy can be boiled down to the following two fundamental approaches:
- Differentiation from reengineering high-value customer business processes that leverage the Internet in ways unavailable to on-premise software, e.g., online purchase, deployment and support, connecting customers with their customers (B2B2C), communities, crowd-sourcing, marketplaces, etc.
- Lower cost from economies-of-scale achieved by aggregating a multitude of customers via the Internet onto a single, vertically integrated infrastructure i.e., hardware, software, operations, etc. This cost savings is then passed on to the customer through a low subscription price and is generally referred to as the lower total cost of ownership (TCO) of SaaS.
Any effort or expense you make that doesn’t incorporate one or both of these fundamental strategies does nothing to strengthen the long term competitiveness or profitability of your business. At best it is time spent playing catch-up to the competition, and at worst it is a defocused siphoning away of resources in an unprofitable direction.
For example, while it may ultimately be necessary to duplicate the functionality of your on-premise software competitor, it contributes absolutely nothing to your competitive advantage. The ROI on such effort is incredibly low, whereas, investment in true multi-tenancy, easy online adoption and Internet-enabled business processes will have a much higher impact on your success.
Dare to be different: think Internet
If I had to pick one thing that every SaaS business could do to improve its competitive strategy it would be to stop thinking software, stop thinking service, and start thinking Internet. The software and the services that a SaaS vendor delivers create differentiation vis-a-vis an on-premise competitor only to the extent that they leverage the Internet.
Business process automation across the firewall has paled in comparison to internal enterprise process automation. When your SaaS application reaches out to customers, partners and vendors across the Internet, and then goes further to help your customers reach out to their customers, partners and vendors you begin to unleash the true potential competitive advantage of SaaS.
A subtle, yet incredible irony of traditional customer relationship management systems is that customers never touch them. Now that most everyone is on the Internet, customer-centric processes such as marketing, sales and support are particularly ripe for reengineering.
The success of companies like Taleo, Marketo and Zendesk is in no small part due to their seamless integration of internal business processes with external users.
SaaS companies in particular are uniquely positioned to leverage the Internet for their own business processes by enabling customer interactions through their offering, making it easier for online customers to find, try, buy and use their product. Moreover, SaaS companies can connect their customers to their customer’s customers and deliver even greater value through network effects, like benchmarking, crowdsourcing, and marketplaces. How can your SaaS application reach out across the Internet to create new value?
Reengineering across the firewall is the single most disruptive strategy a SaaS business can adopt, provided the capability adds real value for customers and is not simply a “field of dreams.” While SaaS is closely associated with internal enterprise applications, I’ll submit that the most successful enterprise SaaS application to date is not Salesforce.com, but Google AdWords. This B2B2C platform is essential to virtually every online business. But it typically would not be classified as SaaS, because it automates an external business process: customer acquisition. However, it is just one small step removed from marketing automation applications.
These enterprise software blinders must be removed to see the revolutionary potential of SaaS.
On-premise enterprise software has an internal bias, because the technology is internally constrained, i.e., it’s on-premise.
SaaS has no such limitations and SaaS strategy should not suffer from these legacy constraints.
At Xignite, our Web services are not only embedded in our customer’s applications, but they are frequently used by our customer’s customers. New opportunities abound when the definition of SaaS extends beyond internal end-user applications to include B2B2C platforms and Web services that enable external interactions.
Cost structure killers
Most SaaS startups set their bargain basement subscription prices entirely independently of their costs. They put their faith in the mysteries of multi-tenant architecture and hope against hope that someday revenue will exceed costs. But, there are many pitfalls along the way that you absolutely must avoid or they will undercut your long-term cost structure and ruin your competitive advantage.
Chasing big, bad elephants is by far the most tempting mistake a software-as-a-service business can make. You find a prospect that has lots of cash, but it needs special features, requires a long sales cycle and has restrictive legal requirements.
When you need cash, chasing even the most difficult and demanding customers can become attractive; perhaps even a matter of survival. But, one too many stumbles away from your core strategy and you wake up to find that you are a small consulting firm-not a rapidly growing SaaS business with a low TCO value proposition.
Moreover, if you intend to achieve a 10-times cost advantage, the concept of aggregating customers onto a single infrastructure to lower costs must extend far beyond the database. It should include the entire application infrastructure and business operation.
You should strive to aggregate as many customers as possible onto to a common user experience, a common set of business processes, a common purchase process, a common pricing model and a common support process. It is in this operational side of the low-cost strategy: customer acquisition and support, where most SaaS companies lose their way, or rather find their way to long-term unprofitability.
Impenetrable barriers to adoption
Barriers to adoption are by far the most underestimated enemies of SaaS. After the incredible success of Salesforce.com, it seemed that all an investor needed to do was to plant a SaaS seed in every software category from accounting to marketing automation and then sit back and watch the startups grow.
It didn’t happen.
In hindsight, it’s obvious that salesforce automation has a unique adoption advantage over applications such as ERP: SFA users can just start typing away and reap immediate value; ERP users cannot. And, when you compare the income statement of Salesforce.com to those of NetSuite, Omniture and Success Factors, it’s clear that the benefits of this advantage go straight to the bottom line.
Adoption costs are like set-up costs in a manufacturing plant. They strangle throughput and force large batch sizes, i.e., a smaller number of high-dollar deals because the value delivered must significantly exceed the cost of adoption.
At Xignite, adopting our service requires a little developer education and literally pasting three lines of sample code into an application. A savvy developer can do it in minutes. As a result, we can profitably book online orders as small as a few hundred dollars as profitably as our six-figure deals. And, we’re adding a new customer every day.
But, if your SaaS application is complex, requires a lot of data or integration to function, or is targeted at a competitor’s installed base, then it is critical to do everything you can do to eliminate these adoption costs for your customers; otherwise they will force down your volume, force up your prices and wash away any cost advantage you have achieved through multi-tenancy.
If you are an investor, then adoption costs are likely to constrain growth, market potential and long-term profitability. If a SaaS business is characterized by high adoption costs, then the rule-of-thumb strategy is investment in lowering adoption costs, high capital efficiency, and extreme patienceor exit.
To SaaS or not to SaaS
Some markets have customers whose needs are so unique and applications that are so complex that they are intractably fragmented and customers cannot be aggregated onto a single, uniform infrastructure. For these applications, SaaS is simply a foolish choice.
In general, I am not in favor of a hybrid approach where a vendor provides an application as both SaaS and on-premise. The on-premise installations will come with all the well-known upgrade versioning and maintenance headaches of enterprise software, and eventually the vendor will be forced to either sacrifice the cost advantage on the SaaS side, or the customization differentiation on the software side. It’s a classic “stuck in the middle” strategy that is bound to produce poor results. (Note: this is distinctly different from an approach where the vendor offers two different applications, SaaS and an on-premise alternative, but even this approach may entail a debilitating defocusing cost for a small startup.)
The would-be SaaS vendor that is faced with complex business processes, high adoption costs and big, demanding customers is probably better off taking a managed services approach. For example, at Xignite we service two markets: 1) financial data consumers like traders, researchers and web publishers and 2) financial data sources like stock exchanges and trading platforms.
Our core Web services platform connects them, so in that sense we are a B2B2C platform (where the C is really another applicationB2B2A). The data consumer side of the business is 100 percent on-demand. Customers can come to Xignite.com and try, buy and use our Web services online. The data sources side of the business is delivered as a managed service, where the core platform is multi-tenant, covering Web services delivery and e-commerce. But we offer additional outsourced services such sales, marketing, support and engineering to help customers build a complete SaaS market data business underneath their own brand.
In a managed services strategy, any on-premise complexity to the business remains within the vendor’s operation and under the vendor’s control, and while it may not be possible to create a complete multi-tenant offering, it will at least be possible to strive for a core multi-tenant platform and a high degree of standardization throughout the operation.
Lead, follow or get out of the way
I don’t believe SaaS will completely replace on-premise enterprise software. Customers have far too many complicated, unique, internal business processes that benefit from automation. This will remain the purview of on-premise software.
But I do believe that the true definition of SaaS is all things B2B on the Internet and, as such, we have only scratched the surface of its potential.
It is one of the great ironies of the software industry that enterprise software companies are shaping up to be some of the Internet’s slowest adopters. SaaS vendors with vision will continue to carve out entirely new application categories; those with slightly less ambition will re-energize established ones. But, SaaS is no more a fad than the Internet, and its potential is as limitless.