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Rethink Your SaaS Channel Strategies

By February 9, 2011Article

The notion of channels in the distribution of SaaS is a topic with very little consensus in the industry. Many people seem to think: “if it’s on the Web then the Web is the channel.” This is a very narrow-minded view that can significantly stagnate, if not completely stall, growth. There are industries and market segments where the people making the purchasing decisions do not spend their time searching the Web for the best solution. In these cases they turn to trusted advisors for recommendations.

Unlike in traditional software where the channel partners had to have some level of technical expertise, with SaaS, that is not the case, significantly expanding the type of company that could fill the role. It is up to the vendor to fully understand the role of intermediaries in their market and how to leverage the existing relationships those third-parties have with their target end customers.

Expand your concept of channel

When considering channels for a SaaS offering, do not focus only on typical technology intermediaries but look to vertical-specific players such as consultancies and Business Process Outsourcers (BPOs), industry and trade associations, or supply chain intermediaries such as freight brokers and food distributors.

It is really the technology-centric VARs and SIs that are having the most trouble with SaaS for two reasons: they are misaligned with the SaaS vendors at the business model-level and there is little or no technology to manage. The companies that have traditionally done business through those channels who are moving into SaaS are also having problems figuring out the appropriate way to leverage those relationships.

SaaS vendors need to stop thinking like software companies, and, when it comes to distribution, think more like they are part of a supply chain. The intermediary might “sell” the product to the end-customer, but the SaaS vendor still controls their use of the system. What can the SaaS vendor do to help the intermediary help the end-customer? Can the SaaS vendor help the intermediary make more money, beyond simply selling their solution to the end-customer?

SaaS vendors attempting to fit their subscription revenue model into traditional channel relationship are having a hard time attracting intermediaries with purely financial incentives. This is not surprising since it is difficult for SaaS companies to figure out how to compensate their own sales team, let alone how to adequately compensate and motivate channel partners.

“Network effect and ecosystem,” along with subscription revenue streams can be leveraged in channel distribution deals, with the first two likely being the most lucrative. The “Freemium model” can even be used quite well when the free product is used to incentivize the end user to leverage the services of the intermediary, and the SaaS vendor monetizes the relationship with the intermediary rather than the end user.

Like most things, approaching channels in the same way legacy software vendors have always done will cause both the channels and the SaaS vendors to stagnate when the opportunities can be significant.

Understanding network-centric vs. “Network”-centric

Market position, brand power, and popularity, can drive up valuation in an exit, providing multiples far and above those applied solely to top-line revenue or EBITDA. It is easy to see, then, how some could extrapolate that a large user base could raise valuation, and that this is potentially more valuable than revenue. With a niche B2B SaaS product, this large user base is likely not going to matter as much as the number of paying customers, unless that glut of users is adding value to the business (i.e., revenue, actionable intelligence, etc.).

Also, remember that valuation only means something at very specific times in private companies (like when the company gets acquired); topline revenue has value all the time. A SaaS vendor cannot run their business or generate profit without revenue, at least in the long-run. It is wise for SaaS vendors to look at revenue as a metric on which to base their company’s standing.

For example, Ivan Farneti, Principal at Doughty Hanson Technology Ventures in United Kingdom says:

“Growth without monetization is unsustainable in a competitive market, but profitability without growth (or moderate growth) ensures survival in hard times and the chance to fight another day. That’s why very few of my investments in 15 years have gone under.”

A large pool of users leveraged intelligently, however, can be quite valuable and lead to more revenue. For example, a SaaS vendor can:

  • Up-sell to get them to pay to use the system or to buy more
  • Sell information on how they use the system
  • Expose their eyeballs to advertisers
  • Learn from their behavior and sell that intelligence to industry
  • Learn from their behavior and leverage that in product management
  • Build a community from those users and customers
  • Leverage community to handle first-level support
  • Leverage network effect data to secure better terms with suppliers on behalf of customers

Vendors, users, customers, and partners all benefit from the Network-Centricity of SaaS through network effect data, collective intelligence, and a true ecosystem of users, partners, and integrated third parties to an extent not possible with non-SaaS business architectures.

The communities and networks of users and customers of a SaaS vendor can be closely tied into the application, unlike in non-SaaS models where these were simply “bolted on” to the application or completely independent. In legacy products, users could trade experiences and advice about the application, but there was nothing tying the community directly to the application. In SaaS, all this changes.

There are many benefits of SaaS being network-centric; the fact that the one application is used by hundreds, thousands, or millions of users and customers, and that it is hosted or “in the cloud” makes for a potential user experience unlike any behind-the-firewall application. Additionally, SaaS provides end customers with the benefits of interconnectivity with third-party applications and data services made possible by the network-centricity of SaaS.

SaaS, as a single-instance, multi-tenant application, meaning everyone from Company “A” to Company “Z,” logs into the same application, is also “inherently collaborative.” Though the core architectural elements of single-instance, multi-tenancy are required for the social nature of SaaS to be taken advantage of, the extent to which the vendor exploits this should be determined by the market.

In highly regulated or governed industries, perhaps the collaborative nature of SaaS would be downplayed; but in something like the recent Social CRM movement, perhaps this can be exploited further. The true social nature of SaaS can be seen in everything from collaboration across customer accounts, to more open forums accessible from within the application, to sharing workflows, reports, and other custom objects created by one customer with the rest of the users or customers.

Regardless of the inherently collaborative nature of SaaS, even in a Freemium model, it is critical for the vendor to build an application that has value to the end customer even if no one else ever uses the product. What makes SaaS so special, when architected correctly, is that the addition of users and customers to the application over time will make the experience better for everyone involved.

There are some applications where the network-centricity is more about the network of users and customers, and less about the functionality of the application as a computer network hub. These are more of the “social network” applications like LinkedIn, where the value of the application is directly proportional to the number of active users and customers. Some SaaS applications might fall into this category, but for line of business, departmental, or even horizontal applications such as ERP or HCM this is not the case.

The difference between users and customers

The terms “user” and “customer” are deliberately used, and not interchangeable, as a way to clearly distinguish revenue-generating usage of the system from usage which will not result in direct monetization. It is really very simple:

Customers pay to access or use the system

Users use the system for free

Customers could be individuals or companies. The individual customer will both pay the bill and be the only one that accesses the vendor’s system under that account. On the other hand, a company might have 1000s of employees using the system under one account with only one payer. Users could also be individuals or companies, with one or thousands f users; but since there is no payer, they are not customers.

This distinction is made between application users and application customers, but a SaaS vendor might have customers beyond the application. These could include buyers of advertising inventory, anonymous aggregate data, or channel partners paying for access to manage their customers. Unless access to those are given away for free, the consumers of those resources will always be customers.

Clearly delineating free users from paying customers will help the SaaS vendor in understanding who is a drain on precious resources and who is adding value and generating revenue. This is critical in measuring Customer Acquisition Costs and Customer Lifetime Value, two of the key metrics to use to measure success as a SaaS vendor. Free users can help the SaaS vendor generate revenue through indirect monetization (as noted above), but there will always be a customer involved even if the user never becomes a customer themselves.

The connection between distribution and customer acquisition

While it is true that it might take five times as long to get a paying customer as a free user, going after only paying customers will ensure customer acquisition dollars are used to directly grow revenue. However, free users have value when leveraged appropriately.

One way vendors can leverage having a large number of users in a Freemium model is to help create “value pull” when intermediaries such as VARs, System Integrators (SIs) or distributors are involved in the buying process. This is also effective when the intermediary for the end customer is the corporate purchasing department.

In a multilayer value chain where an intermediary sits between the vendor and the end customer, it is often up to the vendor to bypass those intermediaries and create interest with the end customer (referred to as “pull” through the value chain). The end customer will want the product and therefore pulls on the intermediary to deliver it.

Free access to a SaaS application can help the vendor create that value pull with their end customers by giving them the ability to try it out on their own before going to the corporate buyer. In this case the intermediary is the corporate buyer; do not forget that it could also be a corporate buyer that goes through a second intermediary such as a VAR or SI. The key here is that in a value pull situation  “try before you buy” is required, but something as extreme as Freemium is not.

If the vendor gives the application away for free in perpetuity, what incentive is there for the users to go to the corporate buyer to make a purchase? If the vendor limits the functionality of the free version, this could create a nonstarter scenario. A limited-use version will certainly keep the end customer from putting time and effort into setting it up, and thus creating barriers to exit.

A free trial, on the other hand, might get the end customer to invest time in the application, which, when presented to the corporate buyer, does not represent only an ongoing $19.99/mo investment, but hundreds or thousands of dollars in sunk people-hours invested in that product. Of course they will approve the purchase and will likely make it a group purchase or buy a “corporate” version.

The Freemium model as an entry point into corporate customers has many potential drawbacks. Quite often the application will be used by employees within an enterprise that do not know the others are using it because they all have individual accounts on the free version. This will lead to fragmented use within a company with no need to ever consolidate under one, very prompt and reliable, corporate payer.

Simply put, the SaaS vendor could be missing out on a large corporate sale because of their use of the Freemium model.

As Founder and Managing Director of Sixteen Ventures, Lincoln Murphy brings over 15 years’ experience in on-demand software product development and Business Architecture, focusing exclusively on SaaS since 2004. Working with clients of all sizes, from startups to those at the top of the Fortune 100, Lincoln helps companies recognize and execute on opportunities to generate or enhance revenue through the SaaS Business Architecture. This article was excerpted from the Sixteen Ventures paper, “The Reality of Freemium in SaaS.” Download the full report here.

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