B2B SaaS Flies in the Ointment – I can’t turn a profit

The overriding problem with most B2B SaaS vendors today is their inability to reach profitability. Customer acquisition costs in particular often run 50%+ of revenue, and while logic says that one day subscription revenue will overtake this as the market matures (i.e., all prospects are now customers, so they just pay maintenance and we collect the cash), this plan is not playing out in practice. Welcome to the Silicon Valley world of VC-backed software where growth is EVERYTHING. You will never reach a time where you have all the customers. Even if you do, no one will recognize it and there will be unrelenting pressure to spend MORE on acquisition and new product development to gather up that one last customer to increase top line revenue. You can do all the break-even and NPV analysis you like, the psychology of the industry will not let you follow through on this strategy.

A paradigm shift is required in the minds of both SaaS executives and VCs if on demand enterprise software is to reach the level of success of traditional licensed software: growth follows efficiency, not the other way around.

Everyone gets excited about a stable subscription revenue stream, but they forget that the requirement of profitability implies a stable cost structure that is below that revenue line. If you’re annual subscription fee is $1000, then your average annual cost of sales, marketing, support, development, operations and administration better be under $900/customer. Too many companies and investors are trusting too much in the inherent technological economies of scale of SaaS and are waiting to see how the rest of the SaaS cost structure shakes out. This is foolish, because the subscription fee that your target customer (usually SMBs) is willing to pay for your service is completely unrelated to your technology or your cost structure. It is your job to make them meet at a profitable price. I believe SaaS vendors should be targeting and driving toward a stable, lower cost structure throughout their operations from day one, or if not day two.

If you annual customer acquisition cost exceeds 50% of sales, you should focus on increasing the efficiency of your sales and marketing processes to reduce cost/lead (or increase leads/cost!), shorten sales cycles, and reduce or eliminate labor costs. The days of the high-flying, all powerful enterprise sales star are over. SaaS is a cost-reduction play and your organization must strive to be a customer creation and product delivery machine. Drive leads through low cost Web 2.0 PR and viral marketing techniques, develop an effective, low touch sales process with extensive self-service, and most importantly avoid prospects that are too expensive to acquire; they may look like your target market, but they are not, because you cannot sell to them profitably. Chasing risk-averse buyers in an early adopter market, over-marketing to prospects that are too difficult to reach, and wasting precious selling time on prospects that have requirements beyond your current product offering are all scenarios that must be routinely qualified out of your sales process.

One example I like to share with SaaS executives who believe this is a pipe dream is Atlassian. Demonstrating strong year-over-year growth, this company is selling what might be thought of as traditional license enterprise software under a shrink-wrap model at SaaS prices! How do they do it? By applying Web-centric, low-cost, prospect-driven, grass-roots sales and marketing techniques that creates a strong inbound lead flow and keep out-of-pocket marketing and sales labor costs to a minimum.

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