Chaotic Flow

Streamlined angles on turbulent technologies

At the end of 2008, I promised a special new year post on SaaS Economics 101, so here it is.  Introducing the SaaS Scorecard, an online test to estimate the competitive advantage of your software-as-a-service business.

Click on the image above to go to the SaaS Scorecard and take the test.

The SaaS Scorecard is designed to help software-as-a-service entrepreneurs and investors evaluate the competitiveness of their businesses relative to licensed software and other SaaS competitors using the principles of SaaS Model Economics 101 and the Top Ten Dos and Don’ts of SaaS Success. Every attempt has been made to create a test that accurately reflects these economic principles, however, the goal is simply to provide feedback as opposed to analysis. That is, it’s really just a game. Have fun!

Scores are calculated across 20 key business dimensions that impact low cost advantage, differentiation, adoption costs, switching costs and network effects. For each dimension, a score is calculated for the potential competitive advantage that can be achieved, the current performance of the SaaS vendor in achieving it, and the combination of potential and performance resulting in the actual competititive advantage that is realized.

The earlier posts in this series discussed the economics of SaaS from the vendor’s perspective. But, there are costs associated with choosing SaaS over software that the vendor never sees: the costs of adoption and switching.

If you have built your software-as-a-service business well, following all of the Top Ten Do’s and Don’ts, then you have made it easy for your customer to find it, buy it and use it online. And, you have a solid, scalable architecture with massive economies of scale. But, your product is unusable without your customer’s data. Even if you are strictly a content provider, you must at least get registration and purchase data. Most business SaaS offerings require a lot more than that.

Once a prospect is sold on the value of the product, data becomes the most significant barrier to adoption. Getting data in and getting data out. If the primary users of your application are people,
then getting data in amounts to mouse clicks, typing, spreadsheet uploads, etc. and getting data out (and into the heads of your customers) amounts to learning how to use the application, both individually and organizationally. There may also be a need for other systems to get data in and out of your SaaS, then the adoption cost is integration.

The unusual thing about data is that what starts as a barrier to adoption over time, becomes the cost of switching. As a for-profit business, your goal is to lower the costs of adoption by providing a super easy, yet valuable initial offering, i.e., easy to buy, easy to learn and easy to add data. And, to raise the cost of switching, by making it easy to learn more and more features, add more and more data, and get more and more value over time. This is a process I call application discovery.

Application discovery can be illustrated well by comparing a consumer oriented SaaS, like Amazon.com or Google to enterprise software. There is actually quite a lot you can do at Amzaon.com other than buy a book. You can create wish lists, write reviews, manage your one-click account, you can sell books, or music, or videos, and you can have your books printed on-demand. But, you don’t get it in your face all at once. You discover it as you use the service. In contrast, enterprise software is notoriously difficult to use and integrate. Why? Because, it is purchased up front. The license cost is sunk and the audience is captive. So, strap the users to their chairs and make them sit through two weeks of training. Kick off that middleware project. Get the data in. Get the data out. Now we can really start realizing that ROI the sales guy promised us.

The enterprise model of adoption is still available to SaaS vendors. There is nothing about the Internet that takes this option away. And, some applications may be so inherently complex that it is required. But, this labor intensive approach provides no competitive advantage. In truth, it is possible to build application discovery into enterprise software, however, license pricing and revenue from high-touch services remove any incentive to do it. SaaS on the other hand is sold on-demand over the Web, and if done well has data-driven mass customization built in. So, managing the process of application discovery is simply another example of mass customization, except customer needs vary over time instead of varying over market segments. By fully automating initial adoption and enabling easy application discovery, adoption costs can be reduced to the lowest possible point and switching costs increased naturally over time as the customer discovers and invests in more advanced capabilities of the product—giving the SaaS vendor another powerful competitive advantage.

This is the fourth (and last!) post in a series on competitive advantage in SaaS entitled SaaS Model Economics 101.  Going on hiatus for the holidays, but there is a surprise fifth post coming in the new year.  Stay tuned. Enjoy.  JY

Competing through differentiation is the essence of the software business. Feature wars, solution selling, performance testing, roundup reviews…its all about proving superiority, so you can win the deal and charge a premium. One of the hardest lessons to learn in SaaS is that differentiation usually comes second to cost efficiency. But, if you have put your cost structure in order with solid economies-of-scale, then differentiation can be the ultimate competitive advantage.  If you have not, then your software competitors will have price parity, and you are unlikely to out-differentiate the masters.

That said, if low cost advantage is the cake of SaaS, then Internet-based differentiation is the icing. All the coolest stuff that happens online, e.g., search, forums, social networks, media sharing, viral marketing, micro-financing, syndication, crowdsourcing, etc etc. follows systematically from the inherent nature of the Internet, or in economic terms network automation and network effects. Ironically, enterprise software companies have been some of the slowest adopters of the Internet as an open network. In the Web 1.0 wave, B2B software firms just scratched the surface of the Internet’s potential to create competitive advantage. They put up a marketing website, set up a support email and maybe a knowldegebase, but not much more. B2C software has and still does lead the way on the Internet. Unfortunately, this near-sightedness has heavily influenced SaaS when viewed as an outgrowth of enterprise software. SaaS is simply a dumbed-down enterprise application delivered through a browser with lower TCO, so SMBs can afford it…right?   Wrong!  This perspective all but abdicates the core advantage of being online and the natural birthright of software-as-a-service. Don’t just deliver your application over the Internet—become part of 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 potential competitive advantage of network automation and network effects. Any in-house inventory management system can eliminate cycle counts, but only the Internet allows you to look ahead into customer inventory and automate replenishment from suppliers. Any old enterprise helpdesk will allow you to take a phone call and track tickets, but only the Internet allows your to reach out directly to customers and integrate the experience across phone, email, forums, chat, etc. and have the products themselves report back through remote monitoring.

One of the biggest challenges of many SaaS businesses is the cost of customer acquisition. They drink the Koolaid of multi-tenant architecture, and expect it to be a panacea of cost reduction. They offer their service at bargain basement prices. Then, they wake up to realize that their sales, marketing and support efforts don’t look any different from the average enterprise software company. High acquisition costs are killing the bottom line. The solution is network automation. Where are your customers? Out on the network. How can you get them to find, try and buy your product cheaply? Reengineer and automate customer-centric business processes across the network. Master online search and social marketing. Make videos, not brochures. Don’t just educate, entertain. Enable online trial. Crowdsource support. Crowdsource product development. Wrap it up seamlessly into a single online experience and transform your SaaS application into an Internet business. Most importantly, do things your SaaS competitor hasn’t figured out yet, or for that matter do things no one has ever done before.

Network effects are the benefits your customers derive simply because you have lot’s of customers. They are the difference between an empty singles bar and a packed nightclub. They have always existed in software. For example everyone uses Microsoft Word, because everyone uses Microsoft Word which makes it easy to exchange documents. But, network effects on the Internet are different. They are easier to create. And, they can spread much much faster because you can enable them through network automation. In my Top Ten Do’s and Don’ts of SaaS Success, I assert that the smart software-as-a-service entrepreneur will not build his central value proposition on network effects. That is a house of cards. You have to get that first customer in the door. But, if your customers can benefit by interacting with each other, and you facilitate the interaction through your product, then you can often take a $50M company to $500M and beyond. Network effects not only expand your value exponentially, they also create lock-in through incredibly high switching costs (the subject of the next and last post in this series).

A unique aspect of the Internet is that it not only allows you to create new value through the network, but it also allows you to capture it. For example, you can’t price a print ad by the number of people who read it, but you can price an Internet ad by the number of people who click on it. The ability to track usage opens up new pricing models. Whereas software companies charge by the copy or user, SaaS companies have access to usage data across the entire network. When combined with network effects, this capability creates entirely new business models. SaaS companies have the potential to monetize the value created by their network in addition to the value created by their application.

Does any of this sound familiar? It should. Many of the ideas expressed here were touted during the Web 1.0 era and are no invention of mine. But, it is all about timing. While everyone was worried about when their grandmother would be willing to provide a credit card online, no one realized that the businesses and software companies that were so anxious to reach out to consumers over the Internet would be the slowest to reach out to each other. SaaS and cloud computing vendors have the opportunity to realize this vision. But, do they have the creativity? Those that do will develop enormous competitive advantage over their rivals.

This is the third post in a series on competitive advantage in SaaS entitled SaaS Model Economics 101.

In my very first post to this blog, I made the assertion that software-as-a-service is a commodity business. My intention was to make the essence of the SaaS model easy to understand, but also to make it clear that the reality of doing what you need to do to achieve SaaS success is a little difficult to swallow. I mean, who wants to be in a commodity business anyway, especially in software? It’s all about innovation and differentiation right?

You can achieve very strong differentiation in SaaS.  The next post in this series will explore that.  But, before you differentiate around the edges of your software-as-a-service offering, you must commoditize it at the core.  Otherwise, your cost structure will not support your pricing, and you will not be profitable–at least not for a very very very long time, like many of the of the recent SaaS “success” stories and IPOs. (Disclaimer: having received my economic training from the University of Chicago, I have a strong bias toward the idea that a business should turn a profit, especially public companies.)

I’m not going to go into the technical details of multi-tenant architecture.  I believe that this element of SaaS is well understood.  What I do want to emphasize here is that the SaaS competitive cost advantage arises from the general principal of aggregating customers to achieve new economies-of-scale, not the specific technology used to accomplish it.   Multi-tenant architecture is simply a means to an end for relational database-driven applications, like Salesforce.com.

The concept of aggregating customers onto a single infrastructure to lower costs extends far beyond the database.  It impacts the entire application infrastructure.  You are aggregating customers onto a common set of servers, a common user interface, and a common set of business processes.  And, it extends beyond the application to the entire business. You are aggregating customers into a common communication channel, a common purchase process, common pricing and a common support process.  You are Wal-mart.  Online. It is in the second half of the cost equation, customer acquisition and support, where most SaaS companies lose their way, or rather find their way to long term unprofitability.

If all your customers are identical: identical business needs, identical communication needs, identical purchase process, identical support needs, etc. then you will have no trouble aggregating them onto a common business infrastructure for an enormous cost advantage.   But, to the the extent that they are different, or simply believe that they are different, then you have your work cut out for you.

For example, how much website content do you have to present to get a customer to register for trial?  Is it a single, simple message for all customers, or do you need pages and pages that detail your benefits for each industry segment in the specific vernacular of that segment.  To maintain your cost advantage you must do your best to streamline all this complexity without losing customers, and ultimately walk away from customers whose needs are so unique that you cannot meet them.

Luckily, while this may sound like your own customers are the roadblock to achieving your ordained cost advantage, they can also provide you with the secret weapon to overcome the roadblocks.  It’s the one aspect of your single, uniform, vertically integrated infrastructure that can be customized  without limit and without eroding your cost advantage.  Data.  Unique data.  Customer data. In the Web 2.0 world they call it user generated content.  In SaaS, you should think of customer data as the user generated application.  Whether you capture it on your website to personalize the purchase process or you capture it in your application to customize security roles, it is the enabler of mass customization and it may allow you to push the economic boundaries of the commodity-based SaaS cost advantage through the complexities of the SMB market all the way out to the idiosyncrasies of the long tail.

This is the second post is a series concerned with creating competitive advantage in SaaS entitled SaaS Model Economics 101.

Today, Apprenda, a company that I’ve been tracking for a while emerged from stealth mode.  Some of you may be familiar with SaaSBlogs which is managed by the company’s founders.  The timing couldn’t be better from my perspective, because I’m in the middle of this series on SaaS Model Economics 101 that I kicked off this week, concerning the creation of economic value and competitive advantage for SaaS vendors.

Apprenda’s SaaSGrid is a potentially game changing approach to Platform-as-a-Service ( PaaS ) which is a sector that up until now has largely been limited to hosting, billing etc. solutions for existing multi-tenant SaaS applications on one end of the spectrum, and do the whole thing our way solutions, like Force.com from Salesforce.com, on the other end–without much in between.  The reason SaaSGrid is potentially game changing is that Apprenda proposes to allow you to take your single-tenant software application, rapidly plug it into their Web services, put it out on the cloud, and voila! what was not SaaS, is now 100% multi-tenant SaaS.

Before you say that it is not possible, and even if it is it has to be less efficient than native multi-tenancy, here is what the CEO, Sinclair Schuller, has to say about it.  “I’ll go out on a limb and bet my reputation that in most cases, a SaaSGrid application will be more efficient in almost all regards than most native multi-tenant applications…In some cases, a native multi-tenant app can be more efficient if it can exploit some sort of specialization in its architecture, but this scenario is not common.”  My personal view is that storage and processing are free, so who cares.  The real cost advantage comes from aggregating customers onto a single infrastructure, not the 30% higher computing efficiency of a specific infrastructure.   So much for your sustainable cost advantage SaaS vendors–legacy software companies and IT departments may be following hot on you heels.

If PaaS offerings continue to move in this direction, then current SaaS vendors will need to focus much more keenly on creating product differentiation and lowering acquisition and adoption costs.  Something I personally believe is only good business.  Cost advantages NEVER last.  In my SaaS Top Ten Do’s and Don’ts I assert that the technology cost advantage commoditizes SaaS markets.  It is something you must achieve to play in this game.  But, it does not guarantee that you will win.  Without proficiency at mass customization, driving down cost of acquistion and differntiation, you are simply a commodity in a commodity market.  And, that market just got a lot more crowded.

I’ve recently been asked a lot of questions like the following:

• Are there some applications that don’t fit the SaaS model ?
• When is the SaaS model appropriate ?
• Is it possible to have a “mixed” SaaS model ?

Mostly these are asked by startups that are struggling for growth or profitability and having difficulty actually achieving my Top Ten Dos and Don’ts of SaaS in practice.

To answer these questions accurately, it’s essential to have a strong understanding of how SaaS creates economic value over in-house, licensed or home grown software.  If you can create value, then the model is appropriate.  If you can’t, then in-house software is an equal or better choice.  And, as a SaaS vendor you will have no competitive advantage.

Be warned, that there will be few fluffy marketing tips in this post and the series to come, and you are likely to encounter some very specific economics terminology.  This is SaaS microeconomics 101! It’s going to get a little heavy.

The only difference between software and software-as-a-service is that SaaS is delivered over a standards-based network called the Internet.  Therefore, all new economic value and competitive advantage must flow from this difference.  SaaS economic value over software comes in two Web-enabled flavors:

1) A lower cost structure from economies-of-scale that derive from aggregating customers via the Web onto a single, vertically integrated infrastructure i.e., hardware, software, maintenance, etc. This cost savings is generally passed on to the customer through a low subscription price and is generally referred to as the SaaS lower total cost of ownership (TCO)

2) Reengineering business processes by leveraging network automation e.g., online trial, integrating local offices, support chat, etc. and network effects, e.g., crowdsourcing, support forums, revenue-sharing monetization, etc.

Both of these sources of value can create sustainable competitive advantage for the SaaS vendor, 1) is a low cost advantage and 2) is a source of product differentiation.

However, when the nature of your customers, application or technology limit your ability to create value from either of these sources, then you have reached the boundaries of the SaaS model for your business, because beyond these limits there will be no competitive advantage over in-house software.

Some markets have customer’s 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 customers, SaaS would simply be a foolish choice.  Alternatively, a market may be appropriate for software-as-a-service, but the SaaS vendors may not be building their product to leverage the potential of customer aggregation and the general principle that their SaaS offering is part of the Internet.  In either case, the only possible business result is failure.

If you read between the lines of my Top Ten Do’s and Don’ts of SaaS, you will see one or both of these economic truths shining through.

This will be the first post in a (thankfully) short series where I try to hone in on the economics of competitive advantage in the SaaS model.  The next three posts in this series will dig deeper into each of the following economic factors that can determine the long term success or failure of a SaaS business.

• Aggregating customers for a low cost advantage
• Leveraging the Internet for differentiation
• Reducing adoption and switching costs

Expect a new SaaS Model Economics 101 post each week in December (minus the holidays)
…and a surpise final post right after the new year!

JY

It has taken almost a decade for the software industry to absorb all the ramifications of moving from perpetual license pricing to SaaS subscription pricing. The longer payback period for investors, the headaches of high acquisition costs, and the upfront pre-revenue investments in infrastructure being just a few of the issues with which SaaS entrepreneurs and VCs have had to wrestle.
So, why go out on a limb looking for new revenue and higher margins by experimenting with even more unconventional monetization models? Won’t this just make a bad situation worse?

To temporarily borrow a well known trademark, the reason is simple: it’s the network. If there is a common theme emerging from this short list of dos and don’ts then this is it. It’s the network. It’s the Web. SaaS is not software. New business value arises from the characteristic that your software-as-a-service offering, unlike licensed software, can become a network hub that can connect any business entity, user or system it touches to any other: your prospects, your customers, your partners, your customers’ customers, your customers’ vendors, your customers’ partners’ customers, and so on all the way out to the edges of the Web. Given that value is created by the network, it follows that new network-based monetization opportunities are also created. Here is a quick (and very incomplete) list of new monetization opportunities open to software-as-a-service businesses.

Network-enabled services

• Advertising
• Syndication (content/applications/data)
• Benchmarking and market intelligence
• Integration
• Cloud services
• Marketplaces

Revenue models beyond subscriptions

• Referral fees
• Transaction fees
• Consumption-based pricing
• Performance-based pricing
• Reseller margin
• Revenue sharing

The monetization opportunities open to you will depend on many factors, including the nature of your business, the attitudes of your customers and the sophistication of your product. But most importantly, it will depend on your own creativity.

In the first post in this series, I presented a somewhat trick question in the hope that anyone who digested the entire series would have no difficulty coming up with the right answer.

Quiz: What is the most successful enterprise SaaS application to date?
Hint: It’s not Salesforce.com

For those of you who have read all 5 posts in this series, thank you for your patience. And, if you haven’t guessed it already, the answer is…

Answer: Google Adwords

If you own, manage or are considering starting a software-as-a-service business, then you can’t afford NOT to check out these fundamental rules of the game and cutting-edge tips for success.
Hot off the presses!

Enjoy,
JY

Quiz: What is the most successful enterprise SaaS application to date?
Hint: It’s not Salesforce.com

It is ironic, but the unfortunate fact is that most SaaS vendors see the Web as little more than the browser through which they deliver an enterprise software application. In fact, the phrase itself software-as-a-service, creates a subtle bias toward viewing the business as simply a piece of traditional software delivered on-demand over a network. Connecting an application to the Web unleashes disruptive economic forces that go far beyond multi-tenant architecture and reduced TCO. It enables viral organic growth, low cost customer acquisition, business productivity gains across-the-firewall, and new monetization models to augment simple license subscription. That is why the most creative SaaS vendors are realizing that the real opportunities for business innovation lie outside the firewall and are transforming their SaaS offerings into Web 2.0 businesses.

Below is a list of principles that can help you transform your low-cost, commodity SaaS into a high-value Web-based business.

Accelerate organic growth

• Master “free” online marketing tactics
• Streamline and automate the entire customer life-cycle

Reach out and become a hub on the Web

• Links, links, links
• Encourage community

Build the business into the product

• Automate the customer lifecycle
• Crowd-source new capabilities

Reach across the firewall to unleash disruptive economic forces

• Re-engineer external processes
• Integrate through the cloud

Monetize creatively

• Leverage the network
• Look beyond subscriptions

After I’ve had a chance to elaborate on each of these ideas in a separate post, I’ll provide the answer to my somewhat trick question above.  However, I’m hoping that the solution will emerge as obvious.

Because B2B SaaS roots are in enterprise or office software which have traditionally been delivered on a CD, i.e., like any offline commodity that is physically seperate from the business itself, the opportunity to change the game by building your business into the product is one of the most overlooked by SaaS vendors.

When you move your software product online into a software-as-a-service delivery model it enables you to connect the product directly to your customers on the outbound side and directly to your internal systems on the inbound side.  I’ll dig deeper into how you can leverage this for your customers to create disruptive economic shifts in the market in another post, but for now I want to focus on how this enables you to reengineer your fundamental business processes by building them out from your product.

Perhaps the best role model for building the business into the product is one of the earliest Internet success stories: Amazon.com.  Although most of what you can buy at Amazon is a physical product, the fact that it gets shipped to you is almost an afterthought–you could achieve the same purpose by ordering through an offline catalog.  What you are really buying when you shop at Amazon is convenience and credibility, and these capabilities are fundamentally features of Amazon’s SaaS application.  It includes affiliate referrals, product search, offers, recommendations, one-click checkout,  order management, support and nurturing. More specifically, it automates the buying process. Amazon’s affiliate programs spread points of entry (links!) all over the Web, and when you reach the Amazon website you are naturally led through every stage of the purchase cycle. These are the automated business processes you want to build out from your SaaS product.

Chances are that your business is different from Amazon’s in some fundamental ways, e.g., target customers, product complexity, community involvement, etc.  and you will need to tailor your approach to your market.  But, I’ll bet if you study this success story and fully understand the implications, you will find analogies that you can apply to your business. For example, crowd-sourcing has become a very popular approach to international translations, but Amazon was crowd-sourcing automation of the decision stage of the book purchase process10 years ago by encouraging customers to create reviews and top 10 lists.

This is post number three in a series of five.

For more on how to build your business into the product, check out…

• Software as a service is all about the product
• Build for the long tail and get the rest for free