As a technology investor, I have first hand experience of both SaaS and perpetual licence software models and I monitor with interest the long running debate in the software industry about which is the better model. In my view, neither model will entirely displace the other. Rather, both will apply in different customer use cases and segments of the market, co-existing for a long time to come.
However, I am a huge believer in the SaaS model. I was an investor in one of the UKs true single instance, multi-tenant software product with a single version of code. That investment, 4Projects, was recently exited to a US trade acquirer for an excellent return.
4Projects is a great example of a UK software company that believed in and embraced SaaS from the outset benefiting from a highly scalable, recurring revenue business model and opening up a large, global addressable market. I learnt a lot from working with the management team at 4Projects and I have eight key observations on the SaaS model which I hope will prove valuable to CEOs and management teams who are on various stages of the journey to build a great SaaS business.
The first four are in this post and the second four will follow in a later post.
1. Don’t give into temptation – no bespoking: for those starting on the SaaS journey, I cannot emphasise enough the importance of building a single instance, multi-tenant offering with a single version of code. This drives scalability and a lower cost base. It is inevitable that customers will, at some stage, ask for bespoke development and will dangle the carrot of lucrative professional services fees. If the aim is to build a valuable and scalable business, my advice is to politely decline. To the extent there are no regulatory or compliance barriers, the same message should be delivered to requests for on-premise deployments or dedicated hosting. You can of course virtualise to create multiple instances but this makes your engineering team much more expensive and less nimble.
2. Best of breed is winning the software battle: I accept that this is a slight generalisation but, historically, software customers tended to be faced with the trade off between buying a suite with easier integration but limited functionality or best of breed with optimal performance but higher integration costs. I believe that CTOs no longer need to think along those lines. And I also believe that it was a false economy to start with. How many large companies have implemented Oracle, SAP or PeopleSoft suites across their business only to find that licenses run to tens of millions of pounds, professional services to implement were likely 3x that number, and the whole system was so heavily customised that the time and cost to upgrade new versions wiped out an entire IT budget? And that was if the implementation even got that far with many system deployments being cancelled part way through the cumbersome project.
SaaS has changed all of the above. And best of breed solutions are wanted by customers and are changing the software landscape. Today, the best applications for each need and business case (CRM, HR, Marketing, Finance etc.) can be selected with standardised and pre-integrated APIs, a pricing model based on the exact number of seats required by duration and location, and deployments in days or weeks rather than months and years.
3. SaaS travels – market opportunity is enormous: in my experience, most markets for SaaS applications are significantly greater than even management teams initially believe. By their very nature, SaaS solutions are instantly available to businesses of all sizes and geographies and new mobile devices and platforms enable every worker to bring technology into the workplace. As a result, the opportunities available to SaaS models are a magnitude greater than the traditional enterprise software market.
In my experience, the key challenge for early stage SaaS businesses is how to access their large addressable market. There are, of course, pros and cons to the many different routes to market. 4Projects ultimately conquered selling internationally, but learnt a few hard lessons along the way; for that business, international success came from understanding the supplier ecosystem in each of its target territories and finding and incentivising the right partners to sell 4Projects software.
4. Strive for dominance in your category: the best performing SaaS businesses are viral in nature. Their software delivers their customers sufficient tangible business benefits, ease of adoption and ease of use so that the early adopters within a customer become “evangelists” and the rest of their team soon follow. Many of the best SaaS businesses also have such depth of knowledge of their customers end vertical (especially compared with traditional suites) that their software becomes the defacto industry solution. Vertical IP is what I like to call it.
But to become the category leader you need to grow…..and you need to grow fast. Growth rates are now becoming the primary driver of valuations for SaaS businesses as they represent a proxy for how big the business can become and how real future category leadership is. It’s simply the laws of compounding numbers; a £1m business that grows at 100% each year for 10 years will reach revenue of £1bn and dominate its category whereas a business growing at 10% per annum will only reach £2.6m in revenue.
Buyers and investors in SaaS businesses are now beginning to adjust to 40%+ growth rates having spent decades looking at traditional licence models in mature markets which were plodding in comparison, albeit still growing at respectable rates of 10% to 15% with strong margins and cash flow. I believe that the best SaaS businesses, the ones that have or are on their way to category leadership, are capable of delivering both; significant top line growth as well as long-term sustainable profit margins of 25%+.
Observations 5 to 8 to follow shortly…………..