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SaaS Business Model Competitive Advantage Revisited

What is SaaS? We seem to need to ask this question every couple of years, because the answer is a bit of a moving target. It was simple enough when SaaS was merely software applications pushed through a Web browser, but now we have to contend with the cloud, mobile and even social. Recently, Scott Maxwell of OpenView partners sparked an interesting debate on the topic on LinkedIn that got me pondering it again. I’ve weighed in on the “What is SaaS?” question before, however, every time I encounter this debate, I can’t help feeling that it skirts the more important issue: Why SaaS?

saas business model why

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When trying to create a successful SaaS business model, being SaaS is interesting, but doing SaaS is essential. It’s far less important that your SaaS business model meet the exact definition of SaaS, than it is that your SaaS business model creates sustainable competitive advantage through SaaS. Why be SaaS in the first place? Why not just be software? At any rate, this recent debate got me to re-reading some of my old blog posts on the topic and I realized that they were very text heavy and could use an upgrade. So, in this post I revisit the topic of “Why SaaS?” with a short visual tour of SaaS business model basics.

SaaS Business Model Economics

At the risk of repeating myself, I will repeat myself. 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.

The SaaS business model creates competitive advantage in two Internet enabled flavors:

  1. Lower costs from…
    • Network automation of labor-intensive services and business processes
  2. Economies-of-scale from aggregating customers via the network onto a uniform infrastructure
  3. Differentiation from…
    • Reengineering business processes and service delivery through network automation
    • Network effects enabled by customer-customer interaction

Yes, it’s a mouthful. So let’s look at some pictures.

saas business model competitive advantage

Competitive advantage in the SaaS business model comes from leveraging the customer-vendor network connection to reengineer business processes and service delivery, while building a large customer base to create economies-of-scale and network effects.

Network Automation in the SaaS Business Model

SaaS begins and ends with the Internet. The first impact the Internet has in SaaS is to connect the customer to the SaaS business through the product. Let’s think about that for a minute. How many products do we use everyday that can make this claim? Read more »

SaaS Business Model | On the Cloud, the Customer is King

This may sound like evangelical cloud mumbo jumbo, but I’m actually alluding to the central importance of the ongoing customer relationship in the SaaS business model and its direct linkage to the financial success of a SaaS business. In the SaaS business model, the ongoing customer relationship is a continuous source of revenue, cost, business activity and risk. This contrasts sharply with traditional software where the short-term sales transaction has always taken center stage.

The fundamental shift in value from copies to customers
turns the economics of licensed software upside down,
and is still an elusive financial concept for the industry
when evaluating SaaS business value, profitability
and capital efficiency.

A traditional software vendor makes and sells perpetual license copies, whereas a SaaS business makes and sells ongoing service subscriptions. Each new SaaS customer brings a new thread of recurring revenue and cost which are woven into the larger tapestry of customers to create the total SaaS recurring revenue stream and associated SaaS cost of service. This fundamental shift in the unit of value from copies to customers turns the economics of licensed software upside down, and is still an elusive financial concept for the industry when evaluating SaaS costs, profitability, business valuation and capital efficiency.

Customers vs. Copies

In traditional licensed software, value is equated to the intellectual property of the code, and is monetized using copyrights in a fashion similar to books, music, and movies. Volume is measured in licensed copies and value is measured by the price of a license. But in the SaaS business model, volume is measured by the number of customer subscriptions and value is measured by recurring revenue. Read more »

Cloud Computing vs. SaaS | Mass Customization in the Cloud

SaaS Do #8 Enable Mass Customization is a core principle for building SaaS applications. Salesforce.com, for example, has taken it to new heights with offerings such as the Force.com platform. However, do SaaS-based development platforms such as Force.com represent a fundamental shift in application development, or are they simply the SaaS equivalent of Microsoft Visual Basic for Access? How do they stack up against cloud computing platforms like Amazon Web services? This post examines the potential for competitive advantage through mass customization in cloud computing vs. SaaS.

The short answer is this…
Mass customization in cloud computing is more natural, more flexible, and offers more potential for competitive advantage than in the wildest dreams of SaaS, because cloud computing is built on Web services that are a) inherently abstracted, b) independent components and c) accessible at every layer of the technology stack.

Note: In a previous post, I claimed that the salient difference between SaaS and cloud computing is that SaaS has largely been about Internet applications used by people, whereas cloud computing is about Internet application components used by other computers. More succinctly, Websites vs. Web Services. Although everyone seems to have their own definition of all the cloud buzzwords, I’m going to be rather specific and equate them as such: Cloud = Internet, SaaS = Websites for human users, Cloud Computing = Web services for computer users. My intent is not to debate or define the industry terminology, but simply to keep track of what the heck I’m talking about here at Chaotic Flow.

The Role of Meta-data in Mass Customization
Mass customization in SaaS is achieved by converting hard-coded application functions into meta data configuration settings.  For example, multi-tenancy converts hard-coded deployments of multiple customer databases into a single database infrastructure where each customer deployment is identified by a unique customer ID. All the technical miracles that distinguish one customer’s data from another customer’s data are abstracted to this single piece of meta-data to enable data-driven functionality like Customer[1].Name = “Company X” and “Customer[2].Name = Company Y”. Voila!  Mass customization = meta data abstraction of functional capability.

More Natural – The Inherent Abstraction of Web Services
Mass customization is more natural to cloud computing vs. SaaS for one simple reason: meta-data abstraction is inherent to Web services, but it is optional for websites. SaaS applications must be carefully architected to enable mass customization at all, i.e., it is a matter of good SaaS application design discipline to employ a multi-tenant database, configurable security settings, customizable page views, etc. In contrast, every function of a Web service is inherently abstracted to meta-data in the XML inputs and outputs of the API.

stock quote web service

The Xignite stock quote Web service can return a wide variety of information
such as the current stock price, an intraday stock chart, and financial news
that varies by the stock symbol (meta-data) supplied to it.

For example, given a particular stock symbol (meta data), the stock quote Web service above can return a wide variety of information about a company such as the current stock price, an intraday stock chart, and financial news. Let’s say Company X above is a manufacturer that uses this Web service to create a website with detailed, current financial information about the company for potential investors. Read more »

The SaaS Hybrid Dilemma : Don’t Get Stuck in the Middle

Pure on-demand software-as-a-service businesses are difficult to build.  It is the rare B2B SaaS startup that masters all the Dos and Don’ts of SaaS Success from the beginning.  When the going gets tough, many find themselves falling back on traditional enterprise software approaches to product delivery and business operations.  However, there is a big difference between making the strategic decision to deliver your product in a hybrid model and stumbling into a hybrid model through tactical mistakes. In the first instance the market requirements demand a hybrid approach, in the second executive management is simply not disciplined and creative enough to avoid it.

In an earlier post, I presented the relationship between pure on-demand SaaS and it’s closest hybrid cousins: managed services, packaged software, and enterprise software. The four models differ along the dimensions of pure commodity product (SaaS and packaged software) and pure online delivery (SaaS and managed services).  When a business travels down the hybrid path, it is making a choice to deviate from pure on-demand along one or both of these dimensions.  The farthest deviation being enterprise software. Seems straightforward enough.  So, why avoid a hybrid approach?  Let me state up-front that there are markets that absolutely demand a hybrid model—-a great example is anti-virus software, which requires a fat client for rapid response (packaged software), Internet delivery of virus definitions, software updates and threat alerts (SaaS) and a semi-automated, labor-intensive process for collecting, analyzing and categorizing threats (managed service). However, it is much more often the case that complex market requirements provide the rationalization for poor management rather than the rationale for good business strategy.

The Perils of Hybrid Models
Competitive advantage in SaaS is built by leveraging the Internet to lower costs through economies of scale or to develop differentiation through network-native capabilities. Moving away from a pure commodity product (toward managed services) breaks economies-of-scale, while moving away from pure online delivery (toward packaged software) breaks network-native capabilities.  Deviation due to a lack of discipline without compelling market requirements results in the textbook failure of competitive strategy:  getting stuck in the middle.

“The firm stuck in the middle…is almost guaranteed low profitability
…probably suffers from a blurred corporate culture.”

Sound familiar?  This is the primary reason that some of today’s most well known SaaS companies have yet to attain profitability.  It has nothing to do with the so-called up front investment costs of building a SaaS business (seriously…do NetSuite, Omniture and Success Factors ever plan to stop posting losses?).  They have given up too much competitive advantage in pursuit of revenue from markets where they are not competitive or from customers that they cannot serve profitably (as evidenced by this nice little financial analysis by Bob Warfield).

The Right Way to Go Hybrid
Many markets present challenges along both the dimensions of product uniformity and online delivery.  Unique customer processes,  complex technologies and heavy integration requirements for example can all create serious strategic hurdles.  To overcome them successfully, it is essential to be clear about exactly the business you want to be in and exactly where your competitive advantage truly lies.  Read more »

The SaaS Hybrid Question : Demystifying Software Business Models

Since it’s inception, software-as-a-service has labored under an identity crisis. What truly distinguishes SaaS from software? How should it be priced, sold and serviced? Is it possible to succeed with a hybrid approach where a vendor offers both SaaS and software versions of a product? Recently, Jeff Kaplan reported that Google will be offering Gmail as an installed service–flying in the face of the current conventional wisdom that SaaS players should stay true to their model. Alternatively, Oracle is finally making a serious challenge to salesforce.com with its Oracle CRM OnDemand (I know because their sales reps keep calling me, but I’m still not buying it).
What does it all mean?

First and foremost I would like to say that IF YOU ARE A STARTUP, it doesn’t matter if you are offering enterprise software, B2B software-as-a-service, online games, or even hardware—STICK TO ONE BUSINESS MODEL!!! Handling multiple business models almost always entails increased organizational complexity and heightened internal politics. It is often essential to separate organizational functions (e.g., sales, marketing, engineering, etc.) or even entire P&Ls (e.g., divisions, spin-offs, etc.) in order to achieve the right cost structure and culture required to be successful in each line of business. In short, it is death to a severely resource constrained company.

The most common software technology distribution models arise naturally from the economics of information goods. Computer software does three basic things: copies data, transforms data, and moves data. But, the unique thing about software (unlike hardware) is that it just happens to be made up of data itself. Why is this important? Because the costs of copying, transforming and moving data around is decreasing everyday, and in many circumstances it is economically equivalent to zero. This is why so many Internet applications are free! The more a software application lends itself to this sort of self-referential automation, the lower it’s cost. Pretty theoretical, so here it is in plain English. Custom applications are hard to deploy (copy and transform) and fat or data-intensive applications are hard to deliver over the Internet (move). And, here is the picture.


How costs give rise to different software distribution models.

The more you can align your business model with the underlying economics of the technology, the better off your will be. Perfect alignment is rarely achievable, because your customers will pull your business in one direction, while your technology will pull it in another. So, choose your customers and your technologies wisely! However, here is how the most common software business models line up with the technology choices above. Read more »

How Competitive is Your SaaS Business? Take the Test!

At the end of 2008, I promised a special new year post on SaaS Model Economics 101, so here it is.  Introducing the SaaS Scorecard, an online test to estimate the competitive advantage of your software-as-a-service business.

saas competitive advantage scorecard

Click on the image above to go to the SaaS Scorecard and take the test.

The SaaS Model Scorecard is designed to help software-as-a-service entrepreneurs and investors evaluate the competitiveness of their businesses relative to licensed software and other SaaS competitors using the principles of SaaS Model Economics 101 and the Top Ten Dos and Don’ts of SaaS Success. Every attempt has been made to create a test that accurately reflects these economic principles, however, the goal is simply to provide feedback as opposed to analysis. That is, it’s really just a game. Have fun!

Scores are calculated across 20 key business dimensions that impact low cost advantage, differentiation, adoption costs, switching costs and network effects. For each dimension, a score is calculated for the potential competitive advantage that can be achieved, the current performance of the SaaS vendor in achieving it, and the combination of potential and performance resulting in the actual competititive advantage that is realized.

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. Read more »

Software-as-a-Service Success | Monetize Creatively

It has taken almost a decade for the software industry to absorb all the ramifications of moving from perpetual license pricing to SaaS subscription pricing. The longer payback period for investors, the headaches of high acquisition costs, and the upfront pre-revenue investments in infrastructure being just a few of the issues with which SaaS entrepreneurs and VCs have had to wrestle.
So, why go out on a limb looking for new revenue and higher margins by experimenting with even more unconventional monetization models? Won’t this just make a bad situation worse?

To temporarily borrow a well known trademark, the reason is simple: it’s the network. If there is a common theme emerging from this short list of dos and don’ts then this is it. It’s the network. It’s the Web. SaaS is not software. New business value arises from the characteristic that your software-as-a-service offering, unlike licensed software, can become a network hub that can connect any business entity, user or system it touches to any other: your prospects, your customers, your partners, your customers’ customers, your customers’ vendors, your customers’ partners’ customers, and so on all the way out to the edges of the Web. Given that value is created by the network, it follows that new network-based monetization opportunities are also created. Here is a quick (and very incomplete) list of new monetization opportunities open to software-as-a-service businesses. Read more »

Software-as-a-Service Success – Build the business into the product

Because B2B SaaS roots are in enterprise or office software which have traditionally been delivered on a CD, i.e., like any offline commodity that is physically seperate from the business itself, the opportunity to change the game by building your business into the product is one of the most overlooked by SaaS vendors.

When you move your software product online into a software-as-a-service delivery model it enables you to connect the product directly to your customers on the outbound side and directly to your internal systems on the inbound side.  I’ll dig deeper into how you can leverage this for your customers to create disruptive economic shifts in the market in another post, but for now I want to focus on how this enables you to reengineer your fundamental business processes by building them out from your product.

Perhaps the best role model for building the business into the product is one of the earliest Internet success stories: Amazon.com.  Read more »

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