If your SaaS business is confronted with issues such as the following:

• Why is my SaaS business losing money?
• How do I grow my SaaS business faster?
• How does a SaaS vendor create a long term competitive advantage?
• When does it make sense to take a “SaaS hybrid” approach?
• Will SaaS displace on-premise software entirely?
• Are there applications for which the SaaS is simply not the right choice?

Then, there is a good chance you will find the principles laid out in this e-book on how to develop competitive advantage in SaaS of significant value in your decision making.

It provides a comprehensive overview of SaaS model economics and how to develop competitive advantage in software-as-a-service. The PDF consists of compiled and augmented posts from the last six months, so it should make a handy archive reference or pass-along for those that have read the original posts, and a fresh look for those who missed them. Enjoy.

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 »

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 »

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 SaaS 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. Read more »

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. Read more »

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, Read more »

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. Read more »