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.  This tip is a special case of the more general objective of lowering TCS. SaaS vendors should look to drive costs out of the value chain and out of their operations across every function, not just through multi-tenant architecture.

SaaS vendors should lower TCS by driving costs out across the value chain

Every business activity should be examined for the potential to apply the following cost-eliminating techniques:

• Standardization
• Mass Customization
• Process Automation (internal and external leveraging the Internet)
• Customer Self-service

Standardization and mass customization are essential to a true multi-tenant SaaS product, but these concepts can be applied to achieve economies-of-scale across the entire value chain.  For example, mass customization can be applied to customer acquisition through website personalization and automated nurturing programs that serve up content to prospects based on their history with your company, i.e., if the prospect spent 5 minutes on the widget page, then send that prospect an invite to watch a video on your widget capabilities.  Or, apply Internet-based automation to your external support processes by offering a portal, knowledgebase, forums and online chat.

Customer self-service has the double benefit of automating tasks to drive out costs, but also shifting the cost back to the customer.  This may sound like bad business, but the truth is that sometimes your customers would simply rather do things themselves, particularly if it means saving money.  When was the last time you paid for full service at the gas station?  I’m probably dating myself, because I honestly can’t remember the last time I pulled into a gas station that  even offered full service. It used to be the standard, but it was eliminated by disruptive technologies for pumping and payment that eliminated and shifted costs within the value chain.

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.

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.