It seems a little late in the game for me to be asking a question like “What is SaaS?” But, I’ve always harbored a few embarrassing little secrets on the subject and I think it’s time I came clean.

There is a classic Harvard Business School case study called Marketing Myopia by Theodore Levitt that is familiar to every MBA student since the 60′s–the moral of which is not to define your business too narrowly lest you become obsolete. Well I don’t think software is going away any time soon and neither is service, but what about software-as-a-service? Between the rise of the cloud and the fall of the browser, SaaS seems so passe’.

What is SaaS?

Is SaaS software delivered as a service? As in renting, not owning the software. Or, is SaaS a service layered over software? As in a complete solution, not a tool. SaaS is both.

Software delivered as a service means on-demand. It means eliminating the feed and caring of the software itself through automation. Notice that I say eliminating, not obscuring or outsourcing. Automated deployment. Automated maintenance. The software simply arrives and runs as needed in a fashion that is all but invisible to the customer, so the customer realizes the benefit of the service without incurring the headaches of managing the technology.

Service layered over software means the software solves a problem without creating new problems of its own. Not only is the customer freed from managing the technology, but the customer is freed from understanding the technology. A service doesn’t require the customer to master a bunch of technical mumbo jumbo in order to use it.

Software-as-a-Service Myopia

One of my embarrassing little SaaS secrets is that I’ve always Read more »

One of the mysteries I hoped to solve when I embarked upon this little SaaS metrics mathematical journey was the reality behind “The SaaS Company Magic Number” introduced by then Omniture CEO, Josh James, and immemorialized by my pal Lars Leckie over at Hummer Winblad. In principal, this number tells you how aggressively you should be spending to build up your customer base: “the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.”-Lars Leckie’s Blog

In this installment of the SaaS metrics series, I will show why this benchmark works, and introduce what IMHO is the single most important SaaS financial metric for measuring the overall health of a SaaS business. Now, being as Josh and Lars have already laid claim to “The” SaaS Magic Number, I really have no alternative but to put all humility aside and dub my latecomer SaaS metric as “Joel’s” SaaS Magic Number (After all, I did similarly snag “The” Top Ten Do’s and Don’ts of SaaS, so it’s all good.)

SaaS Metrics Rule of Thumb #9 – Joel’s SaaS Magic Number

The truth be told I feel a bit guilty about the name, because Joel’s SaaS Magic Number is neither magic, nor mine really. It’s simply the the average customer rate of return, or rather the inverse of the average customer baseline break-even, 1/BE₀, that has so consistently popped up as a driver and a constraint in the SaaS metrics rules-of-thumb.

Where “ARR” is the average recurring revenue per customer, “ACS” is the average recurring cost of service per customer, and “CAC” is the average customer acquisition cost. Customer rate of return is powerful, because it measures the economics that make a SaaS business work (or not), whereas the individual revenue and cost metrics are simply accounting figures that in isolation say little about the health of the business. Let’s recap some of the things we know about this nifty magic number from earlier SaaS metrics rules-of-thumb.

Intuitively, the long run profitability of SaaS companies requires
the recurring contribution of current customers to cover the acquisition cost of new customers,
therefore the average customer rate of return for SaaS companies
must exceed both the current customer churn rate and the new customer growth rate.

So, what is a good value for Joel’s SaaS Magic Number? Well, I don’t think anyone could argue with 1, a valiant goal, but rather optimistic. Read more »

I’m in the process of updating my blogroll, and I’d like to expand the SaaS-Cloud section. If you write a SaaS, Cloud, Startup, Sales or Marketing blog, or have some favorites that you read, besides Chaotic Flow of course, please leave a comment or send me an email. Looking for active blogs with loyal readers that deliver consistent, well thought out original content, and I’m happy to do a link exchange if your blog meets these criteria. (blogroll located at the lower right sidebar)

Cheers,
JY

Much has been written about how software-as-a-service can lower a customer’s total cost of ownership (TCO) by eliminating the high up-front investment and ongoing maintenance costs of in-house software and hardware infrastructure.  Most SaaS vendors deliver on this promise with a bargain basement subscription price, putting their faith in the miracle of multi-tenant architecture, and working to build enough volume to make the theory a reality.  Meanwhile, they bleed cash.

Multi-tenant architecture simply is not enough.  In fact, it can distract you from the real economic challenge of achieving economies-of-scale and driving out costs across the entire value chain.  You’ve lowered TCO for your customer, now it’s time to think about lowering Total Cost of Service (TCS) for your business.  TCS is the total cost of delivering your service to a customer, and if you expect to run a profitable, cash-positive business it can only happen if your lifetime customer value exceeds TCS.

Life Time Customer Value  > Total Cost of Service

Total cost of service is the the mirror image of total cost of ownership. If you think of the value that your customer realizes from your product as resulting from the sum of all the work that you do (TCS) and all the work that your customer does (TCO) from raw idea through product delivery to realized benefit, then it becomes clear that creating a disruptive technology is really about taking costs out of the value chain, regardless of which side of the fence they sit on, because you pass your cost savings on to your customer in the form of lower prices.

The Mirror Image of Total Cost of Ownership : Total Cost of Service

In my recent series on SaaS Sales Tips, I suggest that the margin delivered by the sales operation, or the difference between revenue and fully loaded sales costs, is actually more important to the SaaS vendor than revenue alone.  Read more »

I consistently find myself lamenting the dearth of creativity in the SaaS community. Too many SaaS applications that could be as exciting as the Internet itself are offered up as enterprise software pushed through a browser, simply cheaper (and slower) than their otherwise indistinguishable client-server predecessors.

However, creativity is not easy to come by in any profession. Several years back, I found myself working in Delhi for about a month. In addition to work, my wife Christy and I set out to experience as much Indian culture as the trip would allow, visiting all manner of villages, markets, museums, shrines and the like. Christy, who is an artist, spent a great deal of time being driven around by the local Delhi taxi drivers in search of Indian miniature paintings, and never failed to bring back an interesting cabbie story as a bonus–mostly about wrestling with the driver in order to go where she wanted to go as opposed to where he wanted to take her…always a very special shop. While out on one of these adventures, she decided to go see a real Bollywood film at a local Delhi movie heater. The driver (who preferred to take her to a shop) said “Why would you want to do that? Have you seen one before? There are much more interesting things to do while you are here. Those films are all the same. If you have seen one, you’ve seen them all. There is a good brother and a bad brother. And, a pretty girl. In the end, the good brother gets the girl. Then, dancing! The end.”

Several weeks ago, Christy and I enjoyed seeing the film Slumdog Millionaire, which last night won Oscars for Best Picture, Best Director, Best Screenplay, etc. To our unbridled amusement, this was exactly the plot of the film. In truth, the film not only appears to lack originality, it is also highly derivative.  Produced out of the UK, it incorporates a wide array of European and Hollywood tricks. So, what makes it a great movie? The real creativity lies in its synthesis, not its originality. The decision to reuse this worn out Bollywood motif right down to the dancing that evidently even the Delhi drivers know as well as any film critic was clearly done with intent, perhaps for irony or humor or formulaic box office success or for all of the above. But, the film also weaves together a wealth of authentic India modernity from slum children and organized crime to reality TV and the indeterminate values of the new Indian middle class, while simultaneously staying true to its traditional genre.

It seems to me Read more »

There is an argument that has been passed around the SaaS community that software-as-a-service requires a long runway to profitability due to high up-front infrastructure and customer acquisition costs coupled with the long payback period of a subscription-based revenue model. While this seems reasonable, my personal belief is that it is complete nonsense that usually just provides an excuse for poor management. Here is why.

1) Infrastructure investment is really not that much.

While infrastructure can be significant for a single customer, the cost per customer drops dramatically once you have reached a few hundred accounts. Most SaaS companies don’t spend more than 10% of revenue on infrastructure. This is the whole point of SaaS, lower TCO. While infrastructure cost may be significant, it is not enough to justify the huge losses that are typical of many SaaS vendors (including some prominent, ostensibly successful public companies). The vast majority of costs of any software company is labor. This is still the case for SaaS. And usually, most of that labor is in sales and marketing.

2) Acquisition labor costs are fixed, but not easily avoided.

The common misconception that SaaS companies can and should recoup acquisition costs over several years of recurring revenue comes from a textbook investment model where a fixed up-front investment is paid for over time by a variable income stream. Like buying an expensive machine that produces lots of inexpensive widgets. Or more similarly, spending heavily on direct marketing to sell high margin magazine subscriptions.

Under this theory, as SaaS vendor can justify high acquisition costs compared to an annual subscription price, because these costs will be recouped over the full lifetime of the customer…right? Wrong. Read more »

Succeeding in SaaS requires a fundamental shift in sales and marketing mindset from push to pull revenue generation.  Lower revenue per transaction, and even lower first year subscription revenue creates intense pressure to decrease average customer acquisition cost.  It is not possible to drive revenue through the high-cost offline marketing and sales approach that is well known to enterprise software.

This shift entails an unpleasant loss of control over the sales process and forces SaaS companies to focus more keenly on facilitating purchase than on driving sales.   If this sounds like semantics, consider how you personally develop interest in and buy products on the Web.  Are you more likely to respond to an unsolicited email and attend a Webinar or click on a link in a blog post?  How often do you click on sponsored search links versus organic results?  Your prospects don’t behave any differently.  You as the customer are in control, and there is no marketer or salesperson present to wrestle that control away from you.

With the customer firmly in control, the role of sales and marketing shifts from chemist to catalyst Read more »

Here is a picture I find myself drawing often. It is closely related my last B2B SaaS post regarding old enterprise habits, but it is actually much more general. Most Web application / Software-as-a-Service companies will find themselves spending up to 50% of revenue on sales and marketing. But, how much should you spend on sales vs. marketing. And, how tightly integrated do these two functions need to be? Of course it is common wisdom that sales and marketing need to work together, but this need is acute for most Software-as-a-Service companies. In enterprise software, where the price point is $100-500K per transaction, the marketing organization is only loosely coupled to revenue through lead generation, messaging /collateral / website, and generating awareness through events and PR. Contrast this with a consumer application, where the tables are turned completely and what sales does exist typically takes the form of partnering and business development—which may be revenue generating, but is not aimed at closing revenue directly, i.e., getting more users.

Most B2B SaaS offerings and B2B2C Web applications (e.g., email marketing, Gadget platforms, online survey research, customer and channel support, etc.) tend to fall right in the middle of this graph. One reason for this is subscription/transaction- based pricing (as opposed to a three year, 1000 user enterprise agreement), as well as the general expectation of a Web or SaaS application to cost significantly less than software. The result is that SaaS companies must continually strive for reduced selling costs, increased marketing efficiency and tighter sales-marketing integration to create a revenue-generating machine—often by leveraging technology to automate as much of the sales cycle as possible from awareness to trial to acquisition and even through to support and add-on selling.

Most software executives are familiar with the concepts of using the “bowling alley” strategy to usher a new product through early adoption to market acceptance as presented by Geoffrey Moore in his book “Crossing the Chasm.“ However, they may not be aware that this strategy has unique pitfalls when it comes to launching an on demand Web application. When you introduce a new product, the initial design often needs minor (or major) adjustments to gain general market acceptance. In addition, target customers may have requirements that are unique to their segment or that conflict between segments. In order to resolve these issues, a vendor will enter a number of iterative cycles of trial, feedback and revision of the offering with representative customers. Moreover, in order to “cross the chasm” it becomes critical to capture reference customers to begin the process of dominating each “bowling pin” segment.

In these early stages, the company must engage in strategies and behaviors that are the exact opposite of the ideals required to achieve the highly efficient, low cost, high volume, commodity-oriented execution required to deliver a successful on demand application. Read more »