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SaaS Economics 101b | Differentitate via the Internet

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.

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