THINK IT Services

I had the privilege of moderating a fascinating panel session at the SIIA On-Demand Conference this past November entitled, “Systems Integrators: A Firsthand, Face-to-Face View on the State of SaaS”.

The panel consisted of three experienced professionals in the systems integration (SI) business,

• Chris Barbin, CEO, Appirio
• Cary Fulbright, President, North America Operations, Saaspoint
• Lonnie Wills, Senior Vice President, CIO Practice, Bluewolf

The SIIA recently posted a video of this session on their site. Click here to watch the discussion.

My friend Phil Wainwright’s latest blog post re: LucidEra’s new pre-sales program, Pipeline Healthcheck, confirms many of my initial observations when the company first introduced the program in October. Phil’s post includes a number of interesting stats which LucidEra’s founder, Ken Rudin, also shared with me at Salesforce.com’s Dreamforce event.

LucidEra’s decision to move away from the typical free-trial approach to selling SaaS is significant because it exemplifies a subtle trend which is brewing in the on-demand services market.

Although many SaaS solutions can be sold using a ‘try and buy’ technique, a growing number of SaaS vendors are discovering that they must employ other sales tactics to sell their solutions. In some cases, like the LucidEra example, it is because they are trying to demonstrate the power of their functionality to a target buyer who is unfamilar with the basic idea. In other cases, the SaaS vendor is offering a more complex solution which is going to have a significant impact on the customer’s operations and requires greater sales skills and resources.

An example of this second scenario is Salesforce.com’s growing focus on large-scale enterprise sales. Selling its customer relationship management (CRM) solution to Global 2000 companies requires more than a 30-day trial to be successful. That is why the company has been aggressively recruiting traditional software salespeople from companies like Oracle and SAP to attack major accounts. I had an opportunity to speak to over 700 of these ‘big-game hunters’ at Salesforce.com’s North America sales kickoff meeting last February.

This shift in sales strategies and tactics has raised concerns among the VC and broader investment community about the long-term viability of the SaaS industry. These investors are worried that adding more high-powered salespeople and creating more complicated sales processes will increase the cost of sales and reduce the operating margins of SaaS companies. They are concerned that this will undercut the price advantage of SaaS over traditional, on-premise software vendors.

An example of this thinking is a recent post by Evangelos Simoudis of Trident Capital. While there is a legitimate concern that many SaaS vendors, like companies in general, have a tendency to be inefficient in the way they allocate their sales and marketing budgets, I believe some of the investment community’s angst is based on an industry benchmark which is no longer relevant.

That benchmark is the exorbinant operating margins which incumbent software vendors (iSVs) have enjoyed over the years. Investors are concerned because they haven’t seen profit margins of over 60% from SaaS companies like those they’ve been accustomed to seeing in the packaged software industry.

However, if you look closely iSVs are finding it equally difficult to sustain their profit margins as customers become disenchanted with high upfront perpetual license fees and escalating maintenance costs. So, comparing emerging SaaS vendor profitability with historic iSV profitability is no longer valid.

I debated Bruce Richardson of AMR Research on this point earlier this year. Bruce was questioning whether the SaaS industry could sustain itself given the high cost of sales and marketing reported by the publicly traded SaaS vendors. My view then and now is that the long-term profitability of SaaS is not reflected in today’s financial reports for two reasons,

1. The SaaS industry is still in its infancy and SaaS vendors must spend a disproportionate amount of their revenues, and/or VC funds, on sales and marketing to educate customers about the intrinsic value of their on-demand solutions. This includes the ‘try and buy’ and other sales and marketing techniques aimed at encouraging rapid adoption.
2. Companies like Omniture, Salesforce.com and SuccessFactors are intentionally overspending on sales and marketing to aggressively win market share. As Josh James of Omniture has stated in his blog and at industry conferences, SaaS companies which know their ‘magic number’–the incremental revenues generated by every additional sales and marketing dollar spent–are obliged to put the ‘foot to the metal’ now so they can win as much market share as possible before the industry consolidates.

So, my concern isn’t whether SaaS is a profitable business model. Instead, my concern is whether the VCs, private equity firms and other traditional funding sources are going to retreat from the SaaS market because they have unrealistic expectations for this sector.

While it is reasonable for them to be more conservative in their funding strategies and investments given today’s economic crisis, it would be disappointing to see them abandon the SaaS market because they’ve lost faith in the business model.

Today’s deepening economic crisis is testing the mettle of IT/business decision-makers, IT solution providers and technology investors alike.

IT and business decision-makers in nearly every industry must make cuts to their capital and operating budgets in order to offset rapid declines in business and tightening credit markets. In many cases, this is forcing them to fundamentally reevaluate the way that they acquire and utilize technology and business applications, and leading them to seriously consider various on-demand service alternatives such as Software-as-a-Service (SaaS), cloud computing, and managed services.

I have recently suggested in commentaries in Datamation and the Business Technology Roundtable that any IT/business decision-maker who isn’t seriously considering these on-demand alternatives is doing their organization a disservice and could be jeopardizing their jobs.

THINKstrategies’ latest customer survey in conjunction with Cutter Consortium clearly shows that organizations of all sizes are adopting SaaS solutions to reap the economic and functional benefits of these on-demand services.

However, many of my clients are also reporting that they are putting a hold on all spending until they get a clearer picture of the state of the economy in 2009. In addition, many are also issuing requests for information (RFIs) to their current suppliers, including SaaS companies they are already using, to obtain additional financial data that can help them determine which vendors are most likely to survive a worsening economy. This is the first step of a broader initiative being undertaken by many of these companies to weed out those suppliers who may fail in the coming months.

Proving their long-term financial viability will become a key challenge for many SaaS, cloud computing and managed service providers (MSPs). Compounding this problem is the growing anxieties within the venture capital (VC) community which is facing severe pressures from their limited partners (LPs)–financial institutions, universities and others–who have been seriously impacted by the economic meltdown. With many of these LPs threatening to renege on their original commitments, the VCs are carefully scrutinizing and setting higher standards for their current and prospective portfolio companies alike.

As a consequence, many of the SaaS, cloud computing and managed service companies who were hoping to capitalize on the current crisis by increasing their sales and marketing efforts to promote their business benefits in a down economy are being forced to go slow or even cut back their spending instead. Many of these on-demand service companies are also facing longer sales cycles as customers delay their purchase decisions and demand more information about the providers’ operations and financial status as a part of their due diligence process.

Given that THINKstrategies’ SaaS Showplace already has over 900 companies from around the world offering over 4500 SaaS solutions organized into 80 Application, Industry and Enabling Technology categories and there may be twice that many companies actually offering on-demand services, an industry shakeout is inevitable and likely to happen sooner than expected.

These trends were the focal point of the recent Software Business and SIIA On-Demand conferences I participated in over the past few weeks. While Salesforce.com’s Dreamforce user conference was a celebration of the accelerating capabilities of cloud computing and SaaS, the Software Business and SIIA On-Demand conferences where more somber industry events were concerns about today’s economic environment were the center of attention.

I think the reality is somewhere between the euphoria and despair these two events. The measurable benefits and growing number of customer success stories that on-demand service providers can boast give them a clear long-term advantage over traditional, on-premise software and systems. However, these companies will face stiffer challenges from incumbent players and conservative decision-makers.

An indication of the competitive challenges facing SaaS and cloud computing vendors was provided by Anthony Lye, the Senior Vice President of Oracle’s customer relationship management (CRM) division, at the SIIA On-Demand conference. Lye spent about 30 minutes of what was supposed to be a “Point/Counter-Point” keynote session challenging the fundamental benefits of on-demand solutions and questioning the long-term viability of the on-demand services model, despite the fact that he is responsible for running Oracle’s on-demand CRM solution which has experienced significant growth over the past year.

Lye’s tough-minded presentation was an example of the same kind of subtefuge which his boss, Larry Ellison, the Chairman/CEO of Oracle, has been conducting for the past year with his own statements aimed at discrediting the on-demand services market despite the fact that Oracle is one of the largest suppliers of databases and middleware for SaaS and cloud computing vendors. (Click here to read THINKstrategies’ profile of Oracle’s SaaS enablement platform strategies and solutions.)

On-demand service providers will have to do a better job than Zach Nelson, the CEO of NetSuite, did at the SIIA conference. Nelson was supposed to offer a SaaS industry response to Lye’s incumbent software vendor (iSV) arguments, but he chose to side with Lye instead and distance NetSuite from the rest of the SaaS community. Rather than dispute any of Lye’s contentions and misrepresentations of the SaaS model, Nelson decided to take only 15 minutes of his portion of the keynote session “debate” to promote NetSuite’s integrated software and new focus on the service industry based on its acquisition of OpenAir.

Anyone who wasn’t aware that NetSuite offers SaaS solutions would have thought it was a traditional software vendor based on Nelson’s presentation. It was a disappointing performance which will do little to endear NetSuite to the rest of the SaaS industry. Instead, it only reinforced the impression that NetSuite and Oracle have a mutual understanding about how they will complement rather than compete with one another.

So, the on-demand services movement will continue to be led by Salesforce.com, Google, Amazon, Facebook and other innovators. It will also be led by bold, new leaders. Although Marc Benioff of Salesforce.com is the figurehead of the movement and Treb Ryan of OpSource is another important evangelist. Josh James of Omniture has emerged as an important spokesperson as well. James delivered a captivating presentation at the SIIA On-Demand conference which elaborated on a similar talk which gave at OpSource’s SaaS Summit last February regarding the key management metric for measuring SaaS sales effectiveness–the ‘magic number’.

It will take bold ideas and actions to succeed in the on-demand services market going forward. The winning on-demand service companies will be those who can convey a compelling message regarding the fundamental business benefits of their SaaS, cloud computing and managed service solutions, and deliver these tangible results in a cost-effective manner.

Like the well known line from Charles Dickens’ book “Tale of Two Cities” goes, these will be the best of times and the worst of times for the on-demand services movement.

Last week Appirio announced that it had secured Series B financing of $5.6 million led by Sequoia Capital, the investment firm which has become notorious for also backing Google, Yahoo!, LinkedIn, and PayPal. Sequoia also funded one of my previous employers, International Network Services (INS), one of the high-flyers of the 1990s.

Appirio’s latest round of funding comes on the heals of a Series A investment of $1.1 million which it captured earlier this year from salesforce.com and angel investors. Although there is lots of VC money chasing Software-as-a-Service (SaaS) and cloud computing opportunities, it is rare to have a start-up collect two rounds of funding in the same year.

What makes this latest round of funding for Appirio of interest to me is the implications which it has for the overall on-demand services market.

As I mentioned, I was a part of a Sequoia Capital-funded company in the 90s. Like Appirio, INS was a professional services company. While Appirio is focused on the on-demand services market, we were focused on the internetworking market. Like Appirio, we followed the 800-pound gorilla in the market at the time, Cisco Systems. Nearly every time Cisco won a big router contract with a service provider or enterprise customer, INS won the deployment contract because Cisco didn’t want to build a costly field service organization. Appirio has built a similar business helping companies develop and deploy solutions based on the salesforce.com and Google platforms because both of these companies have shied away from building their own consulting arms.

The Appirio and INS stories are also similar because they were both smart enough to see an opportunity to convert individual customer engagements into packaged service solutions.

INS’ engineers recognized the shortcomings of traditional network/systems management (NSM) platforms and built a network performance management software solution, EnterprisePRO, which we sold as a subscription service before the application service provider (ASP) and managed service provider (MSP) concepts were borne. Today, Appirio is productizing the end results of its customer engagements and reselling them on salesforce.com’s AppExchange.

Many analysts and trade pub reporters have questioned whether there is a role for consulting and professional services in the SaaS market. There is no question that traditional professional services firms such as Accenture and CAP Gemini are still searching for the right way to scale down their methodologies and costs to fit the on-demand services market. However, Appirio’s revenues have grown more than 400% in the last three months, during which over 1500 customers in 80 countries have adopted its on-demand solutions.

Appirio isn’t alone in experiencing tremendous success in the on-demand consulting business. Astadia, Bluewolf and SaaSpoint have also caught this tiger by the tail and are growing rapidly.

I’m pleased to be moderating a panel at the SIIA’s On-Demand conference in November that will include executives of Appirio, Astadia and SaaSpoint talking about the SaaS and cloud computing markets from their street-level professional services perspectives. I look forward to seeing you there.

Last week’s second annual SIIA On-Demand Conference was a bellwether for the state of the Software-as-a-Service (SaaS) industry. Rather than being composed of the usual suspects of SaaS speakers—Salesforce.com, Microsoft, etc.—the event included an interesting mix of prominent players and start-ups who clearly demonstrated that we are well beyond the ‘why SaaS’ stage and deeply into the ‘how’ phase of this important movement.

The event opened with a packed house of over 300 attendees, many with senior executive titles, and a relatively new name to the SaaS market presenting. Donald Proctor, the Senior Vice President of Cisco Systems’ Collaboration Software Group kicked off the event promoting its vision of the next wave of inter-office SaaS solutions based on WebEx’s collaboration platform which Cisco acquired in March 2007.

Although I might suggest that this wave of inter-office SaaS solutions is well underway and the acquisition slowed WebEx’s Connect ecosystem efforts, Proctor’s SIIA presentation was a clear indication that the networking company plans to put its shoulder firmly behind a renewed campaign to establish WebEx as an important platform for SaaS developers and corporate customers.

Erik Larson, Director of Marketing and Product Management for Adobe Systems’ Business Productivity Business Unit followed the Cisco presentation with Adobe’s stance regarding corporate collaboration via SaaS solutions. He demonstrated Adobe’s enabling technology for SaaS applications, and described its vision for a web-based future.

My colleague, Phil Wainewright, moderated a customer panel which included a cross-section of large (Chevron) and small (Pacific Northwest Economic Region Tourism Division) organizations leveraging SaaS to achieve their business objectives. While their views were timely, Phil and I had hoped to recruit enough customers to fill two panel sessions rather than just one. However, SaaS providers are still having trouble convincing their customers to publicly endorse their solutions in this fashion.

I had the privilege of moderating a panel regarding integration challenges consisting of representatives of Boomi, Informatica, Interweave and Pervasive Software. They all boasted about their individual approaches to delivering integration on-demand and admitted that there is still plenty of customization required.

Three of the most interesting speakers presented on the second day of the conference.

Dr. Werner Vogels, the Vice President and Chief Technology Officer of Amazon.com described how his company has commercialized its internal operations platform to support SaaS companies’ storage and service delivery infrastructure requirements. In my view, Amazon has single-handedly resurrected the utility computing concept, and has made it work for a growing assortment of SaaS vendors and other business users. As a result, Amazon now looms as a major force in the on-demand marketplace, not just as a channel to market but also as an enabling vendor.

Jason Maynard, the software industry analyst for Credit Suisse and the strongest advocate of SaaS on Wall Street, suggested that on-demand solutions could create a new level of value which he called “Software as an Answer”. His concept reinforced the views I’ve espoused in my writings and consulting engagements that SaaS provides an unprecedented opportunity for vendors to aggregate, analyze and distribute data based on application usage patterns and statistics. This data can be used for benchmarking, marketing, sales and operations purposes. It can even create new business opportunities for entrepreneurs.

Anthony Lye, Senior Vice President of Oracle’s CRM OnDemand division, gave the SIIA audience a preview of the company’s new generation of SaaS solutions which will be unveiled at this week’s OpenWorld conference. They include an impressive user-friendly interface which borrows heavily from the best of the Apple iPod Touch, combined with a robust set of social networking and mash-up capabilities.

The most important message from Lye is that Oracle’s enhancements are not aimed at satisfying the needs of small- and mid-size businesses (SMBs), but to meet the growing demands of enterprise customers. This echoed Proctor’s presentation on behalf of Cisco. This shouldn’t be surprising given the recent partner agreement between Cisco and Oracle. Oracle’s PR machine will undoubtedly generate a stream of third-party endorsements of its new on-demand capabilities as part of its OpenWorld festivities, such as today’s announcement of an integration with Xactly.

These were important proclamations for a market where SaaS is too often viewed as a simpler and cheaper solution for SMBs alone. (A misconception reinforced by a recent statement by SAP.) Instead, Oracle and Cisco are confirming my longstanding view that SaaS offers unique capabilities which fit the escalating demands of an increasingly decentralized and financially strained enterprise market.

Ironically, some of the attendees who had not been to previous SIIA events lamented the conference was too focused on the enterprise. While I understand their frustration, I still believe the seriousness of Cisco and Oracle’s efforts to climb onboard the SaaS bandwagon will further legitimize this movement. This will lend greater credibility to SaaS as a viable alternative to traditional, on-premise legacy applications. In turn, SaaS will become that much more attractive to SMBs as well.

However, the SIIA conference also demonstrated that industry best practices regarding service provisioning and delivery, integration, support, sales and marketing are still embryonic. An example of the risks which the SaaS market must still withstand was the extended outage suffered by NaviSite. And an indication of the growing focus on service provisioning was the announcement by Aria Systems as the SIIA conference convened that it had closed a $4.0 million Series A financing round led by Hummer Winblad Venture Partners.