SaaS Economics

Software on-demand is a commodity business

There, I said it. Difficult customers with highly specific requirements who expect to derive competitive advantage from your offering need not apply. If your target market consists of a list of fewer than 500 control-freak customers with sophisticated IT organizations, and lots of unique requirements, then you are wasting your time thinking of the SaaS model as the underlying approach to your business model. At best, you are a “managed service” where the underlying cost structure is identical to customized, licensed software, i.e., it really doesn’t matter if you run it or they run it, it will take the same number of people, the same number of servers, and the same number of lines of code.

It is important to note that the term “commodity” refers to the fact that the SaaS model is a mass market, high volume business where by and large “one size (read code base) fits all.” We don’t have to look any further than Google search to demonstrate this. How much more “one size fits all” does it get! Type in what you want to find, push button. Also, I am not precluding the possibility that you can attempt to overlay another competitive advantage on top of the inherent cost advantage SaaS entails (see below). But, your efforts will be visible to all your competitors and often short-lived. The proposed idea is that cost efficiency trumps product differentiation, and you deviate from this principle at your own risk.

Fundamentally, the SaaS model is the further commodifation of software achieved by freeing it of physical distribution and increasing interoperability through interchangeable parts (services) to create a disruptive software delivery model with new economies-of-scale and business models that achieve a significant cost advantage—not a functional advantage—over traditional licensed, installed software. It is typicially characterized by the following attributes:

  • Commodity capabilities
  • Remote, network-based delivery
  • Massive economies-of-scale
  • Easy adoption
  • Interoperability
  • Usage–based revenue (subscription, transaction, advertising, etc.)

The closer you get to achieving these requirements, the stronger your cost advantage over licensed software vendors and the greater the opportunity for success under a SaaS model. These basic requirements include a much wider set of applications than most people think of when they think SaaS. It obviously includes, the poster child for SaaS, but it also includes Google, eBay, Amazon, MySpace, web hosting, social networks, syndicated widgets, and seemingly all things your borrow or rent over the Web. But don’t be deceived, these businesses are successful, because they meet these criteria. The truly successful ones often combine the fundamental SaaS cost advantage with some other source of strategic advantage such as a proprietary “secret sauce” to your service offering, brand loyalty, mass customization (one of the many concepts here that I am un-repentantly borrowing from the manufacturing world), or or a first-mover advantage. So, here’s the SaaS elephant in the room: It is already here!! There are hundreds, if not thousands of successful SaaS companies. It is the essence of the Web. The small set of struggling B2B enterprise software wannabe replacements comprise but a handful of vendors in the SaaS landscape. And, they would do well to look to their successful B2C counterparts for creative solutions to their problems.

One might argue that this definition encompasses such a large variety of companies and business models that it loses its value. I don’t believe this is the case, because it recognizes the underlying essence of these businesses and provides a framework for creative thinking and rigorous analysis when considering the myriad strategic and tactical options for building your own SaaS business. For example, when the first challenge you face as the developer of a B2B on demand scheduling and collaboration platform is “How do I build awareness and draw leads to my Web site?”, you are just as likely to find the solution to your problem by looking to vendors like eBay or Amazon, in addition to the obvious

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  • SaaS is not a commodity business – it’s not a business at all. It’s a paradigm shift. What is commodity and what is price-premium is the same as it always was. The higher up the stack you go, the less the characteristics of your business are subject to commoditization. Infrastructure = commodity, apps = price-sensitive and differentiated.

  • YK

    I’m not understanding your comment.

    Differentiated products are price in-sensitive, not price-sensitive.
    And, the claim that commodity vs. differentiated status correlates to the stack is not true. Standardization does correlate to lower levels in the stack, but this can serve to increase market share and lock in for the differentiated vendor, provided the vendor differentiates along a trajectory that does not violate the standard. Cisco, Intel and Microsoft come to mind immediately. The primary driver of differentiation in IT is innovation. And, this can occur at any level in the stack. It is no accident that Intel releases faster chips every year.

    I believe the confusion is a result of the two meanings for which I use the term commodity with respect to SaaS. First, the aggregation of customers onto one infrastructure implies that all these customers are buying the same thing…a manufactured commodity, like a Model T, as opposed to a custom built car. The second, arises when the SaaS vendor does not leverage the Internet for real innovation, but simply moves a client server app to the net. In this case, it is an undifferentiated commodity in a market sense.

    SaaS is clearly a paradigm shift, i.e., innovation. But it’s original goal was simply lower TCO. I argue that to achieve long term competitive advantage, SaaS vendors should leverage the Internet to differentiate. But, they cannot relinquish their cost advantage in the process. That is, you must be a commodity of the first type (a manufactured commodity), but you should avoid at all costs being a commodity of the second type (an undifferentiated commodity).


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