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SaaS Model Economics 101 | Competitive Advantage in Software-as-a-Service

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 the SaaS model 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 saas model economics series to come, and you are likely to encounter some very specific economics terminology.  This is SaaS model economics 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 model 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 model 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, the SaaS model 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.

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!


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