At Bessemer Venture Partners we fundamentally believe that the emergence of cloud computing – and the three core components of Software as a Service (SaaS), Platform as a Service (PaaS) and Infrastructure as a Service (IaaS) – is going to completely change the economics of the multibillion-dollar software industry. We have been fortunate to be investors in many of the early cloud winners (such as Postini, Netli, Trigo, and Cyota), and continue to invest actively behind one of the largest cloud portfolios in the venture capital industry. Periods of tremendous transformation create tremendous opportunity, and we consider ourselves privileged to be working with many of the great entrepreneurs who are currently creating the next giants of the software industry.
The cloud computing stack is currently defined by three levels: SaaS, PaaS, and IaaS. SaaS, the most mature of these segments, is comprised of end-user applications like Salesforce.com. PaaS is the service and management layer of the cloud platform, and is evolving dynamically to include things such as intelligent provisioning, as well as application and network management. IaaS is the foundational layer of cloud computing, and includes raw storage, compute, backup, disaster recovery, databases, and security.
As the first segment to emerge in scale and the most application oriented, SaaS has led the market to date with the largest market size, highest gross margins, and highest per-seat pricing. Recently, however, we’ve seen the rapid emergence of hyper-growth businesses in the PaaS and IaaS markets demonstrating that these will soon be independent, multibillion-dollar segments in their own rights with the potential for massive sales volume and attractive cash flow characteristics.
Here are Bessemer’s top 10 laws which will drive software success in the cloud:
BESSEMER CLOUD COMPUTING LAW #1: Less is more!
Leverage the cloud everywhere you practically can, both for your internal systems as well as for your own product offering(s) and “just say no” to on-premises deployments! This will not only give you a direct understanding of the customer experience and best-of-breed strategies of Cloud Businesses, but it will free up your technical resources and balance sheet to focus on your core product and customers. (Read more on Bessemer’s Cloud Law #1.)
BESSEMER CLOUD COMPUTING LAW #2: Get instrument rated, and trust the 6C’s of Cloud Finance
Any good pilot (CEO) knows that you can’t fly in cloudy weather without an instrument rating, yet many CEOs are attempting to do exactly that. Build and trust your CEO dashboard. Your key business metrics must include: 1) Committed Monthly Recurring Revenue (CMRR), 2) Cash Flow 3) CMRR Pipeline (CPipe) 4) Churn, 5) Customer Acquisition Cost (CAC), and 6) Customer Life Time Value (CLTV). (Read more on Bessemer’s Cloud Law #2.)
BESSEMER CLOUD COMPUTING LAW #3: Study the sales learning curve and only invest behind success
Years ago, Bessemer was fortunate to invest behind Mark Leslie at Veritas, and as a result our firm became big believers in the Sales Learning Curve (SLC), a concept Mark helped pioneer. The core concept is that software organizations often fail because they staff up their sales efforts too quickly, before the sales model has been refined. This concept is even more critical for Cloud businesses, given the large upfront investment required to acquire customers. Ramping up too quickly will burn precious cash reserve and could sink the business. This typically means you should hire sales reps slowly upfront, only focus on your core geography until your business starts to scale considerably, and separate your “hunters” and “farmers” as you start to ramp. (Read more on Bessemer’s Cloud Law #3.)
BESSEMER CLOUD COMPUTING LAW #4: Forget everything you learned about software channels.
The Internet is your new channel, and technology enabled service providers are among the few partners that actually care if you succeed. It is now possible to reach customers in a 1:1 fashion as never before, with freemium models, limited trials, access-based pricing, and very low friction processes overall, giving the nimble startup a sizeable advantage over many of the traditional incumbents. (Read more on Bessemer’s Cloud Law #4.)
BESSEMER CLOUD COMPUTING LAW #5: Build Employee Software. Employees are now powerful customers, not just their managers! We’re witnessing the “Consumerization of Software” so focus on ease of use.
The gig is up. Pandora’s box is open. Your customers all now know that software doesn’t have to suck anymore. They use rich Internet applications including Facebook and Skype to communicate with their friends; they use LinkedIn to manage their business networks, Google or Wikipedia/Wikia to find accurate online content, Yelp to find restaurants, and Travelocity to book flights. Products will now see rapid adoption by virtue of being intuitive, aesthetically appealing, and dynamic as opposed to deep and complex. (Read more on Bessemer’s Cloud Law #5.)
BESSEMER CLOUD COMPUTING LAW #6: By definition, your sales prospects are online – Savvy online marketing is a core competence (sometimes the only one) of every successful cloud business.
You sell a product that requires an Internet connection and a web browser for access, which means your prospects are online! Numerous studies show that your customers are now doing most of their primary research online, and this should not surprise you. In this new era, the creative elements of marketing are becoming secondary and quant jocks and analytical wizards are starting to take over the CMO and VPM positions.
At the marketing executive’s fingertips should be detailed reports showing pipeline sources, costs per lead, funnel conversion rates by stage, costs per acquisition by source and campaign, effectiveness by channel, and so on. The most advanced marketing executives are also starting to embrace social media and to do multimodal attribution analyses. (Read more on Bessemer’s Cloud Law #6.)
BESSEMER CLOUD COMPUTING LAW #7: The most important part of Software-as-a-Service isn’t “Software” it’s “Service”! Support, support, support!
The only acceptable reason to lose a customer is death (bankruptcy) or marriage (acquisition). Every Cloud company is in the service business, and therefore your customer service can be the difference between failure (churn) and huge success via high retention and up sells. Given the growth of Employee Software and the fact that many customer orders are starting very small and growing very large over time, you may find that up sells from account management become more critical to your long term business model than the initial sale itself. (Read more on Bessemer’s Cloud Law #7.)
BESSEMER CLOUD COMPUTING LAW #8: Leverage and monetize the data asset.
While cloud computing is about providing a subscription service to your customers, one of the happy consequences is that you end up hosting their data. This becomes a critical asset that you can monetize by increasing the value of your offering; by leveraging it across your customer base in the form of benchmarks; or for specific businesses, by using the data to generate leads (within the contracted obligations). In these difficult economic times, where prices are under pressure and customers are tightening their budgets, data can be a difference maker. (Read more on Bessemer’s Cloud Law #8.)
BESSEMER CLOUD COMPUTING LAW #9: Mind the GAAP!
Cloud accounting is all about matching revenue and costs to consumptionwell, except for professional services! For a recurring revenue model, even if the cash is collected upfront, the revenue needs to be recognized ratably over the lifetime of the contract. In addition, the revenue recognition cannot start before the service goes live, to ensure that revenue will match consumption. According to GAAP, professional services for recurring revenue businesses are also tied to the subscription service, and therefore cannot be accounted for separately. In this respect, even if the professional services are delivered only over the first few months of the contract, the revenue recognition needs to match at least the length of the contract. (Read more on Bessemer’s Cloud Law #9.)
BESSEMER CLOUD COMPUTING LAW #10: Cloudonomics requires that you plan your fuel stops very carefully.
There is no denying that the cash flow characteristics of a cloud business are wonderful in the long term, but can be lousy in the short term. Cloud companies require you to fund research, development, sales and marketing upfront in return for a multi-year stream of revenue. This typically demands enough investment capital (over stages) to fund 4+ years of runway before a company can achieve positive cash flow (GAAP profit is even longer). Imagine you are flying a private plane from Silicon Valley to Wall Street (which sometimes is the figurative or literal goal), and you need to stop a couple of times for fuel (investment capital) for the trip. It is critically important that you plan your equity and debt financing events in advance to maximize value and minimize dilution.
We believe that the best second-generation cloud businesses may be more efficient than many of their predecessors as they leverage cloud services and shift many of their costs to variable models, but in almost all cases, significant capital will still be required to build a dominant cloud business. If you plan these stages thoughtfully, you will be able to minimize dilution by progressively decreasing your cost of capital and mixing seed capital with venture capital and, eventually, debt before attracting public market investors. As private investors and public acquirers become more cloud savvy, multiples of CMRR will likely become the primary valuation metric.
Finally, don’t let the volatile economy “cloud” your judgment (sorry, couldn’t resist). Trust your metrics and your dashboard. You can’t drive by the rear view mirror (GAAP Revenue), but if the 6 C’s show strength, then it would actually be irresponsible not to invest aggressively in growth. Great businesses are built in all market conditions, and tough markets are often the best opportunities to gain market share. And please call us at Bessemer as we’d love to be your partner and join you for the path ahead! (Read more on Bessemer’s Cloud Law #10.)
BONUS LAW: You can ignore one or two of these rules, but not more – Great companies innovate, but pick your battles!
You might be reading this and saying to yourself, “But wait – we’ve got a great channel partner that is going to take us to the moon!” or “I took an early chance in Europe and it’s now driving the majority of growth for my entire business.” To which we would say “good for you!”
If you find yourself questioning several of these Ten Laws, however, it’s probably time to step back and take a hard look at your business. As former cloud CEOs and investors ourselves, we have learned the hard way that much of the battle is just learning from the mistakes of those who went before us. In our analysis of more than a hundred cloud businesses, we encountered several successful companies that were on the borderline with one or two of these laws, but none that challenged several of them. (Read more on Bessemer’s Bonus Cloud Law.)
We hope that you can benefit from some of these best practices we’ve learned through the years and these “laws” can help you run your cloud business more effectively! This work is literally the result of hundreds of conversations that the partners of Bessemer have had with cloud executives from our past and current portfolio companies, as well as other leading public and private Cloud companies. If you have thoughts, edits, or additions, please add them in the form below or send them to cloudvc@bvp.com as we always welcome new input!
Click here to download the full PDF version of Bessemer’s 10 Laws of Cloud Computing. Because many of the core concepts in this overview document are touched on only briefly, Bessemer has made several additional whitepapers and presentations available on its Web site to answer further questions.
Byron Deeter is a partner at Bessemer Venture Partners. Partners David Cowan, Bob Goodman, Philippe Botteri, Jeremy Levine, Sarah Tavel, Anil Sarin, Devesh Garg, Adam Fisher and Gary Messiana also contributed to this report. Bessemer Venture Partners is a global investment group with offices in Silicon Valley, Boston, New York, Bangalore, Mumbai, and Tel Aviv. As the oldest venture capital practice in the United States, BVP has partnered as an active, hands-on investor in leading technology companies including Ciena, Ingersoll Rand, Parametric, Skype, VeriSign, and Veritas. More than 100 BVP-funded companies have gone public on exchanges in Canada, India, London, and the United States. Bessemer has been focusing on cloud computing and recurring revenue businesses for the past 15 years, investing in industry pioneers such as Verisign, Cyota, Netli, Postini and Trigo, and the firm has today a portfolio of more than two dozen active cloud computing investments. Find out more about BVP’s Cloud Computing and SaaS practice online at www.bvp.com/cloud.