THINK IT Services

Last month, Bruce Richardson of AMR Research published a provocative commentary entitled, “SaaS and the Elusive Path to Profitability” that heightened the debate regarding the financial viability of the Software-as-a-Service (SaaS) model.

Bruce’s column elaborated on a presentation he gave at SaaScon 2008 entitled, “Balancing Customer Acquisition Costs and Elusive Profitability.” The talk was driven by a question which Bruce claims to ask numerous software and service companies on a regular basis: “Do you know how much it costs to win a dollar of new business?”

Not surprisingly, Bruce has found that most SaaS companies are losing money acquiring new business in hopes of gaining long-term profitability over the life of the customer relationship. This has always been the logic behind the ‘land and expand’ tactics which are at the heart of almost every SaaS company’s go-to-market strategy.

In order to make his case, Bruce referred to recent annual and quarterly financial reports from the major publicly traded SaaS companies—salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo. In every case except Taleo, Bruce found high sales and marketing, R&D and G&A costs resulting in low or negative GAAP operating income.

What his analysis fails to do is fully recognize the trends lines, acknowledge the growing success rates and admit that many of his points simply reflect the stage of life of the SaaS movement.

Ironically, he identifies numerous operating improvements that have been achieved by each of the publicly traded companies, but treats them like they are simply financial compromises rather than the gains which come from the fundamental economies of scale of the SaaS model in a rapidly growing market.

For instance, if you look at the financial results of each of the companies Bruce identified over the past year they are all showing reductions in their relative sales and marketing, R&D and G&A costs. This is leading to lower customer acquisition costs for each of the companies.

Like Bruce, I spend a lot of time talking with senior executives at SaaS companies. While they all admit that the SaaS business isn’t easy, they have also told the SaaS market is evolving more quickly than they expected.

This trend has been confirmed by a number of industry studies which have reinforced THINKstrategies’ research and consulting work over the last 3-4 years.

Not only are companies of all sizes increasingly interested in SaaS alternatives, but they are accelerating their customer decision-making processes and reducing the salescycles for SaaS vendors. They are also signing bigger deals which promise greater margins for the SaaS providers.

For instance, salesforce.com has seen a steady rise in its average contract size and recently won a 55,000-user deal with Misys, a financial software provider. And, this deal pales in comparison to Workday’s announcement last week of a 200,000-user deal with global electronic components manufacturer Flextronics.

I had the privilege of talking to Workday executives prior to the Flextronics announcement who admitted that they’ve been surprised with the level of interest in Workday’s SaaS solutions and the speed at which customers are willing to make a purchase decision.

RightNow even reported to Bruce that most of its customers will make 5-6 additional purchases and spend 8x their initial purchase value over a three-year period.

Ironically, the SaaS financial model is built on the same economic principles which have been at the heart of the IT market research business since the 1970s—the annuity of predictable subscription services.

If you look at the quarterly and annual financial reports of Gartner or Forrester, as well as those of the privately-held firms, you’ll find that their most important performance metric is their annual contract value (ACV). This is the same metric SaaS companies use to measure their performance.

In fairness, Bruce identifies Taleo as an example of the profit potential of the SaaS model. He credits the company’s targeted sales and marketing approach as the major reason for its jump from an operating loss in 2006 to a $3.7M profit last year. I’ve seen the same tactic used by privately-held SaaS companies, such as Intacct, to significantly impact their financial performance.

While disciplined management deserves some of the credit, I’m sure Taleo’s executives would also admit, as others have told me, that market momentum is also helping to produce greater profit margins for many SaaS companies.

For the past 5-10 years, salesforce.com, RightNow Technologies, NetSuite, SuccessFactors, and Taleo have been burdened with the responsibility of educating the market about the viability and business benefits of SaaS. This evangelistic work required a significant investment in sales and marketing, R&D and G&A costs.

SaaS is entering a new stage in which the same level of evangelism and market education is no longer necessary. Instead, as SaaS gains mainstream acceptance and experiences broad-based adoption, SaaS companies must content with escalating competitive pressures created by the ‘gold-rush’ effect overtaking the SaaS industry.

However, the SaaS executives I’m talking to prefer this problem and are pleased to report that their cost of customer acquisition is dropping and account penetration is rising along with their profitability.

I predicted in December that IT would become more comfortable with Software-as-a-Service (SaaS) in 2008, helping to accelerate its growth over the coming months.

Here are some clear indications that my prediction is coming true,

1. SaaScon: CIOs from many big name companies, as well as smaller organizations, spoke about their positive experiences with SaaS and traded insights about how to take fuller advantage of SaaS to meet their end-user and IT management needs.
2. SaaS for IT: A growing number of major hardware and software vendors are offering SaaS solutions specifically aimed at the IT department. Although many of these offerings could be sold direct by the vendors as managed service solutions, they are being pushed through the vendors’ channel programs.
3. Platforms: While the initial platform plays in the SaaS market were aimed at software vendors and developers, the more recent initiatives by Salesforce.com, Bungee Labs and Google have been designed to also appeal to IT professionals and software architects within enterprises as well.
4. Compliance: Many of the CIOs at SaaScon and elsewhere have told me about how they are using SaaS to satisfy corporate, as well as government and industry, compliance requirements. Today’s storage and back-up services give many IT organizations the archival and audit capabilities they’ve lacked until now.

You can add standardization to the list. Many of the CIOs who spoke at SaaScon admitted that they like the limitations which SaaS places on customization. They have always known that business unit demands for customized solutions were a major factor in the high costs and failure rate of legacy applications. CIOs are seeing SaaS as a way of reshaping the expectations of business end-users.

The CIOs I’ve talked to recently also recognize the financial benefits of SaaS in today’s recessionary climate. Its subscription pricing model permits companies to shift their software acquisition costs from tightening capital budgets to more flexible operating expenses.

And speaking of the climate, many CIOs are viewing SaaS as a ‘green’ solution because it reduces their computing needs and ‘carbon footprint’.

This week’s third annual SaaScon was more than just another conference. It represented an historic breakthrough for the rapidly evolving SaaS industry.

What made the conference so signficant was the nature of the audience, and stature of the keynote speakers and many of the breakout session presenters. While the originators of SaaScon–including myself as an original member of the conference advisory board–always envisioned the event as an important user-oriented conference, we were unable to achieve this objective during the first two SaaScons. We couldn’t find SaaS users willing to talk about their experiences and couldn’t convince IT/business decision-makers to attend the show. As a consequence, SaaScon just became another place for software vendors, VCs and others to talk about the state of SaaS. This year’s conference was a whole different story.

ComputerWorld’s events team deserves a lot of the credit for overcoming these challenges. They tapped their vast reservoir of senior IT executive contacts to pull together an impressive array of keynote speakers and breakout session presenters. With these senior-level speakers in place, ComputerWorld was also able to convince other CIOs and IT managers to attend. In fact, when SaaScon opened its doors on Tuesday morning there were over 900 registrants, approximately three times last year’s attendance.

Getting this many IT decision-makers to attend SaaScon clearly shows they no longer view SaaS as something they can ignore or try to avoid. In fact, each of the speakers, as well as those IT managers who I talked to, said they now view SaaS as a potential solution to many of their IT management needs rather than a threat to their jobs.

They like the pay-as-you-go model at a time of tightening budgets and deepening recession. They like the shorter deployment cycles and lower support requirements. They even like the limitations which SaaS places on customizing applications because they don’t have to support needlessly complex operations when simpler solutions would suffice. Most importantly, they like the greater functionality and added value of many SaaS solutions.

The CIOs who spoke at SaaScon represented a major endorsement of the SaaS concept and the conference attendees proved that IT is getting onboard the SaaS bandwagon. This event confirmed my prediction in December that SaaS solutions aimed at IT departments will help to accelerate the overall growth of the SaaS market.

Last week’s OpSource SaaS Summit was a milestone event for the on-demand services market on a number of levels.

The first SaaS Summit in Silverado in 2006 was a gathering of industry pioneers to discuss the potential of the on-demand movement. Last year’s Summit in Monterey was an opportunity to celebrate the growing success of the SaaS movement. This year’s Summit offered a chance to take stock of what it will take to scale SaaS to meet the needs of the mainstream market. The theme was platforms and web services, but the event also raised other issues.

With over 600 registered attendees, this year’s SaaS Summit was the largest vendor-oriented conference focused entirely on the rapidly growing Software-as-a-Service (SaaS) market to date. While Salesforce.com’s Dreamforce user conference is still the biggest SaaS event of all, OpSource’s SaaS Summit has represented the benchmark for vendor-oriented conferences since its inception in 2006.

This year’s Summit marked the first time that many of the leading names were overshadowed by lesser known players with far more compelling messages.

Microsoft’s General Manager of U.S. ISV and System Integrator Partner Businesses, Greg Urquhart, outlined the company’s SaaS enablement capabilities but did little to convince the conference attendees that Microsoft is committed to quickly delivering its own SaaS solutions.

By the same token, Salesforce.com’s President and Chief Customer Officer, Jim Steele, wasted an opportunity to convince the Summit attendees that Salesforce.com is a leader in the rapidly evolving cloud computing market by dwelling too long on the basic virtues of SaaS.

Everyone I spoke with at the Summit agreed that it was Josh James, Co-Founder and CEO of Omniture, who stole the show. James provided an engaging and enlightening presentation about the factors which have led to the phenomenal success of his company. James provided valuable information and insight, punctuated by a key takeaway that every successful company should have a ‘number’ that drives its growth. In the case of Omniture, it is a monthly statistic based on a formula calculating sales growth specifically for its web performance metrics business.

I was privileged to moderate a panel of journalists that concluded the Summit. The panel consisted of Eric Knorr, Editor – Infoworld, John Pallatto, West Coast News Editor – eWEEK.com, Ben Worthen, Staff Reporter – The Wall Street Journal, and Aaron Ricadela, Writer – BusinessWeek. These prominent business and tech industry writers offered their candid perspectives regarding the state of the SaaS market and the key obstacles that must be overcome in order for SaaS to become truly mainstream.

Ironically, Forrester Research issued a new report prior to the Summit suggesting that the SaaS market will cool off in the small- and mid-size market in 2008. A drop in the rate of growth is conceivable because of the law of big numbers, but is unlikely because there are so many vertical and horizontal market segments still to be addressed.

As is often the case, the real value of last week’s SaaS Summit was the opportunity it gave attendees to network with their peers and get a reality check about industry best practices from informal discussions rather than formal presentations.

My guess is next year’s SaaS Summit will be far bigger someplace in Vegas and we will be discussing an even broader array of business opportunities and challenges.

In the meantime, this month’s SaaScon user-oriented event will be the next opportunity to gauge the state of the SaaS movement.

Until then, we should all be thanking OpSource for making the SaaS Summit possible and using it to help drive the success of the SaaS industry.

I had the privilege this week of participating in an interesting webinar sponsored by Makana Solutions regarding the sales implications of Software-as-a-Service (SaaS) and other subscription services.

Tom Wilson, of the Wilson Group; Makana’s founder, chairman, and CEO Liz Cobb; and I discussed how the sales skills and processes differ in the on-demand services world from the traditional packaged product environment. Specifically, on-demand services come at a lower price-point which necessitates higher volume sales to be successful. This requires a transaction oriented sales process and telesales skills, rather than the long salescycles and highly personalized approach of traditional legacy software sales. Therefore, restructuring the sales process and retraining or restaffing the sales team is critical to transitioning to the SaaS and subscription service model.

Similarly, the support function also changes in the on-demand world. Rather than rely on technical support to react to problems implementing and maintaining software, customers expect their on-demand solutions to be easy to deploy and administer. They also expect their SaaS providers to ensure the availability and performance of their online applications, and to proactively assist them in utilizing the solutions and continuously enhance the solutions to make them more useful and easy to use.

Mikael Blaisdell explores these differences in greater detail in his recent blog, “SaaS & The Ghost of Computing Past.” It is worth reading his perspective which he will also discuss during his presentation at SaaScon.

As Treb Ryan of OpSource likes to say, in order to be successful in the SaaS business, vendors must stop thinking like software companies and start acting like web companies.

I’ve referred to this transformation as an ‘inversion’ process because it forces most established software and technology companies to re-think how they operate and how they go to market. It also will force them to replace many of their staff with a new breed of people that view their jobs and their customer relationships differently.

It is for these reasons that many established players will face traumatic changes in 2008 as customer interest and adoption of on-demand solutions will become as mainstream as ecommerce.

Gartner is predicting that economic and organizations forces will combine to fuel greater outsourcing, with SaaS gaining the greatest traction as a viable alternative to traditional IT and business process outsourcing (BPO). Gartner’s market assessment echoes my reasons for forecasting strong growth for on-demand services in 2008.

In his latest entry on ComputerWorld’s SaaS Revolution blog, Eric Norlin shows how the evolution of SaaScon reflects the maturation process of the broader SaaS marketplace. I think his commentary is right on.

When we launched the conference a year and a half ago, SaaS was still an embryonic market opportunity. Although Salesforce.com had proven its viability as a business, and there was a proliferation of start-ups and established players entering the market, it was still unclear how far the SaaS movement would evolve. It was also a movement of greater interest to the market participants than to potential customers. As a result, a large proportion of the attendees at our first SaaScon event were vendor representatives trying to get a handle on the business opportunity.

Our second SaaScon produced a broader assortment of speakers from a wider variety of vendors, but still lacked the number of customers who hoped. Despite numerous industry surveys, like those produced by THINKstrategies in conjunction with Cutter Consortium, indicating that user adoption of SaaS was growing, user interest in tradeshows on the topic was still limited.

Early registration numbers for this year’s SaaScon clearly indicate that customers are now very interested in attending a conference to better understand the business implications of SaaS and learn more about industry best practices.

As an advisor to the ComputerWorld team organizing this year’s event as well as a speaker, I’ve been able to see very impressive statistics regarding the number of IT and business decision-makers from enterprise organizations who have already registered for SaaScon. And, this is with the agenda still incomplete and conference promotional campaigns yet to be initiated.

But, you don’t have to be a SaaScon insider to see the difference in this year’s event. Just look at the titles of many of the keynote speakers in this year’s agenda who are senior executives of major corporations that are using SaaS, rather than the corporate executives of SaaS companies who spoke at our previous events.

You can find the ten reasons why I think the SaaS market will soar in 2008 in my previous blog entry. My views were recently echoed by my friend and colleague, Phil Wainewright, in his ZDnet blog.

As Eric Norlin suggested in his blog, this year’s SaaScon is already shaping up to be an important milestone in the evolution of the overall SaaS movement.

Since the holidays are traditionally a time for people to take stock of the year past and offer their new year forecasts, here are my top ten predictions why the shift from packaged products to Software-as-a-Service (SaaS), utility computing and managed services will accelerate in 2008:

1. Services are Recession Proof: Escalating oil prices, the uncertain political landscape and faltering financial institutions beset with the aftereffects of the sub-prime lending debacle could mean a tough year for the economy. In this tenuous climate, consumer and executive confidence could decline, leading to an economic slowdown. As a result, many companies could hold back on their capital investments to mitigate their risks. The ability to adopt on-demand services on a pay-as-you-go basis will be a perfect sourcing strategy for businesses seeking greater cost-controls and flexibility.

2. Everyone’s Going Virtual: Most industry pundits and participants view virtualization as a technology trend, but it is also a business trend. Employees are increasingly working outside the four walls of a traditional office. Gen Y workers are always on the move and online. Traditional, on-premise applications and centralized servers sitting behind a firewall can’t effectively serve today’s mobile workers. SaaS and managed services are perfectly suited for these new, virtual business requirements.

3. Amazon, IBM and Google Bet on Utility Computing. After experimenting with its Elastic Compute Cloud (EC2) for the past year, Amazon has found plenty of demand for its computing power on-demand platform from startups, as well as established companies seeking a ‘sandbox’ for their new initiatives. Amazon is now confident it can deliver its computing power in a reliable and cost-effective fashion to a broader market of business users. So, expect more aggressive PR and marketing efforts to promote and sell this powerful utility computing service.

IBM Blue Tune: IBM originated the term on-demand and then walked away from the utility computing market seeking new opportunities among the avatars. When Amazon proved that the utility computing concept could become a reality, IBM repackaged its autonomous computing ideas in the form of a new ‘blue cloud’ initiative. Big Blue will push the idea hard in 2008.

The GooglePlex Makes It Move. Google is tired of sitting on the sidelines while Amazon’s success and IBM’s new ‘blue cloud’ initiative, Google has initiated a PR campaign to promote its ‘cloud’ computing capabilities and strategies. The GooglePlex has long been considered the prototype for a new large-scale computing architecture. Now Google’s incredibly scalable and economical computing engine is getting the attention of business pubs like BusinessWeek, the Wall Street Journal and other mainstream pubs.

4. Nick Carr Returns: In truth, he never left us. It was Carr who gave utility computing a major push with his seminal article in the Harvard Business Review and follow-on book questioning whether IT mattered. Despite venomous criticisms from many IT pubs and professionals, Carr became a popular speaker at corporate events because his message resonated with business executives and end-users. Now, he is putting the finishing touches on his second book, The Big Switch: Rewiring the World, from Edison to Google, which will be published on January 7, 2008. Although IT folks love to hate him, Carr has never lost his luster among corporate executives and end-users who agree with his basic premise that IT is a needless hassle and should be as easy as electricity and as reliable as a utility.

5. SaaS Solves SOX: A year ago, most publicly traded companies and other large-scale enterprises rejected the idea of SaaS because they thought they needed to take greater responsibility for their own compliance requirements. Now, they view the process controls, auditability and offsite hosting features common in most SaaS applications as a perfect solution for their Sarbanes-Oxley (SOX) needs. As a result, enterprise adoption of SaaS will accelerate.

6. Managed Services 3.0, Unified Communications Services and Service Automation: In the 80s, managed services were really outsourcing agreements offered by carriers to their largest corporate customers. In the 90s, a new generation of standalone MSPs promised managed services for SMBs. Neither model succeeded.

Today, we are entering a new age of managed services. Managed Services 3.0 combines the experience of the past with powerful new technologies to respond to growing customer demand. Cisco Systems will be pushing its IP communications and WebEx capabilities hard, while Microsoft promotes the virtues of its various “software plus services” solutions. The two are on a collision course in the unified messaging and communications market, but that will mean that they will each spend plenty on market education and channel sales programs.

At the same time, Dell will be leveraging its SilverBack Technologies and Everdream acquisitions to deliver a new set of automated, remote desktop and server management capabilities through channel partners and direct support services. Expect to hear more from HP and others.

7. Carriers and Channel Companies Find Success With New Services: Carriers have been perplexed about how to package, price and promote profitable managed services. VARs have been afraid that SaaS would ‘dis-intermediate’ them by eliminating their consulting and custom application development business. Carriers now see an opportunity to deliver an integrated package of IT managed services and SaaS business solutions to add value to their commoditized dial-tone services. Channel companies are also discovering that there are still consulting and customization opportunities in the SaaS market. As a result, carriers and channel companies will lend their marketing and sales support to managed services and SaaS.

8. Failure Doesn’t Matter: NaviSite suffered an extended outage in November and the on-demand services movement didn’t miss a beat. The trade press is now looking for horror stories rather than success stories regarding SaaS and managed services, but the vast majority of stories have been positive. In fact, my third annual SaaS survey in conjunction with Cutter Consortium found 100% satisfaction among the companies currently using on-demand software services. The upcoming SaaScon conference will highlight some of these customer success stories. THINKstrategies will also spotlight these stories throughout 2008.

9. IT Discovers Services are the Solution: In the past, the IT department was the biggest barrier to managed services and SaaS adoption. Many IT professionals were afraid these on-demand solutions would eliminate their jobs. Now, a growing proportion of IT people see managed services and SaaS as a way to out-task mundane work or overcome complex application/technology deployment and maintenance responsibilities. As they learn to take advantage of these on-demand solutions, IT departments will finally be able to put their daily firefights aside and focus on addressing the strategic needs of their business users.

10. Wall Street Buys Into Services: Some of the most successful IPOs of 2007 were in the SaaS market. Wall Street loves the predictability of subscription services and now that it has a solid set of market ‘comps’ to measure business success in the services market, it will be encouraging more privately held companies to go through the IPO door. At the same time, private equity funds will be encouraging publicly traded software companies to go private to enable them to shift to a SaaS model without the public market pressures. And, the investment bankers will be pushing a wide array of M&A activity. Expect the offshore IT/business process outsourcers (IT/BPO) and business services companies to buy SaaS vendors. Look for more consolidation in the managed services market.

Bonus Driver of Services Growth in 2008: THINKstrategies will be expanding its consulting and marketing programs aimed at educating IT/business decision-makers about the benefits of on-demand services, and continuing to help software and technology providers develop and deliver successful service solutions. Stay tuned to the SaaS and Managed Services Showplaces for more information and insight about these new programs and features.