The Future of SaaS*

November 30, 2008

ExperCEO has had a number of interesting discussions on a variety of topics that impact CEOs.  One that I have found most useful is titled “The future of SaaS*” (Software as a Service).  In it, a member, who is the CEO of a venture-backed software company, poses the following (paraphrased by me):

“The basic economics of the software business are the same today as they’ve always been (development complexity and costs, sales and marketing and administrative costs).  In the past, corporate buyers covered these expenses by paying for the lifetime value of the product up front via an enterprise software sale.  However, the customers now want to pay periodic subscription fees rather than the enterprise license fees. In the early stages of a software company with a SaaS business model, there is a funding gap.  This gap is the additional cash required while the reoccurring revenue stream from the SaaS customers builds to the point of cashflow breakeven.  How does the entrepreneur deal with this “gap” while not giving away the store to outside investors?”

During the “bubble”, and even as of a few months ago, the venture capital community poured funding into SaaS businesses because they valued the predictability of their reoccurring revenues; and the VCs were willing to invest at a high enough valuation, so that the gap could be bridged and there would be enough equity left to provide a strong financial incentive for the entire management team. Salesforce.com and Netsuite, two high profile, successful companies offering SaaS solutions, each received about $100 million in investment prior to their IPO.  The stakes are high.

The venture capital market has changed, and while VCs still profess to like the SaaS business model valuations have been reduced dramatically along with funding levels.  The entrepreneur must be more creative in order to build a successful SaaS company and reach cash flow breakeven.

What are some of the ways this can be accomplished?  Here are some of the key concepts discussed on ExpertCEO:

  • Services revenue: Heavy reliance on profitable, professional services which brings in cash flow up front – it’s a services company, after all.
  • Streamline customer acquisition: An extremely efficient customer acquisition process using Internet tools such as  Salesforce.com, Marketo, Insideview and Webex, etc.
  • Cost savings:  Reduce development costs with effective off-shoring relationships, new development tools and methodologies.
  • Eat their own dog food:  Make use of other SaaS companies for efficient accounting and administration such as Netsuite, intacct and Adaptive Planning.
  • Up-front payment: Selling multi-year subscription agreements with a significant discount for up-front payment

The SaaS business model is not a new concept.  In the 1970’s and early 80’s it was called “Computer Timesharing”.  The technology has changed dramatically, but the fundamentals haven’t.  The first company I founded, Ross Systems, had a highly profitable business without any venture capital, and we did it with a combination of services and premium pricing.

Until now, most SaaS companies wanted to keep prices low in order build their customer base and, like Milo Minderbender in catch 22, it would be made up with volume – and the investors would bridge the gap.  This was great for customers but hard on the cash flow.  With the new realities of funding, business models may be changing.  Perhaps prices will need to rise or other factors like those listed above may need to come into play so that customers can gain the benefits of SaaS while entrepreneurs can retain enough financial upside to make their efforts worthwhile.

 

*Wikipedia – Software as a Service (SaaS) is a model of software deployment where an application is hosted as a service provided to customers across the Internet. By eliminating the need to install and run the application on the customer’s own computer, SaaS alleviates the customer’s burden of software maintenance, ongoing operation, and support. Conversely, customers relinquish control over software versions or changing requirements; moreover, costs to use the service become a continuous expense, rather than a single expense at time of purchase. Using SaaS also can conceivably reduce that up-front expense of software purchases, through less costly, on-demand pricing. From the software vendor’s standpoint, SaaS has the attraction of providing stronger protection of its intellectual property and establishing an ongoing revenue stream. The SaaS software vendor may host the application on its own web server, or this function may be handled by a third-party application service provider (ASP). This way, end users may reduce their investment on server hardware too.

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Book Review: Entrepreneur Journeys

November 17, 2008

Wise entrepreneurs learn from both the failures and the successes of their peers, so I was glad to hear about Sramana Mitra’s latest project, a book called Entrepreneur Journeys. Sramana writes a column for Forbes, runs a strategy consultancy and blogs about the intersection of technology and entrepreneurship, so she had a lot of raw material from which to craft this collection of interviews with successful CEOs.

In her book, Mitra draws on her strengths and experiences as the founder of three tech companies, as well as relationships she’s built over more than a decade with successful start-up executives, venture capitalists and journalists.  Entrepreneur Journeys details her conversations with a number of company founders, melding their stories with her analysis of common themes and key strategies or decisions that were critical to their ultimate success.  The anecdotes in this book are grouped by topics nearly every CEO can relate to, such as:

•    Bootstrapping vs. institutional funding:  Sridhar Vembu, CEO of AdventNet, and Jerry Rawls, CEO of Finisar

•    Taking on industry giants:  Steve Hafner, CEO of Kayak; Gautam Godhwant, CEO of SimplyHired; and Russ Fradin, CEO of Adify

•    Distruptive business models:  Philippe Courtot, CEO of Qualys, and Steve Singh, CEO of Concur

I won’t spoil the read—you can find Entrepreneur Journeys at Amazon.  For those of you who are veteran CEOs, you find resonant material and much to admire in the paths of the determined, and ultimately victorious, executives whose tales fill this first volume of a planned series.  If you’re contemplating a technology start-up, or in the early phases, there is much to digest, consider, and leverage.

A few takeaway messages:

•    For most early stage start-ups, MItra believes bootstrapping, rather than venture funding, is preferable.  My reaction is that, while this may often be the case, financing strategy is a difficult and sometimes dangerous thing about which to generalize.  I agree entirely that the process of competing for venture capital is a) arduous; b) requires a willingness to have one’s bedrock assumptions challenged, and c) may not always lead to the same long-term outcome as if a business is built and grown with severely constrained capital.

•    Each of the individuals profiled could be described as an “unconventional mind”—someone who displayed a willingness to buck the system, whether taking on the established category killer, traditional notions of industry economics, etc.  I note that many were in one way or another outsiders, whether immigrants or just plain geeks.  Perhaps a critical factor in these success stories is a level of comfort operating without the implicit societal approval, in order to imagine and then achieve an outrageous goal.

This essence of entrepreneurship—an unshakable belief in the art of the possible—has obviously fueled the companies and executives profiled in Entrepreneur Journeys.  A myriad of others—ours and yours–have stories yet to be written.

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The Power of the Peer Group

November 13, 2008

I invited one of my employees at ExpertCEO, Nathalee Ghafouri, to be a guest blogger.  Nathalee is ExpertCEO’s Marketing Manager and she is an integral part of our organization.  In this entry, she shares her passion for social networking and how it can apply to both the academic and professional world.

Back in high school, my sister used to tease me for having “study parties” to prepare for AP physics exams.  She called me a nerd, and

Whether for executives or students, peer groups can be powerful.

Whether for executives or students, peer groups can be powerful. From: Flickr UBC Library Graphics.

maybe I was, but I also knew that without those “study parties” I would be lost.  I knew that I could handle the concepts of physics, but that I was awful at the math.  By meeting with my classmates, I could explain the theory, and they could explain the calculations.  It was all about give and take.  I’ve understood the value of peer groups for a long time, so I am really passionate about building the community at ExpertCEO, an online network for senior executives and the community that inspired this blog.

Harnessing the power of the crowd is one of the chief tenants of Web 2.0 and even as we progress into Web 3.0 (or whatever is next), user-generated content is no passing fad.  The world has definitely realized that the combination of peer groups and the Internet makes socializing easier and more fun-hence the explosion of social networks-but business networking online is just starting to become the norm.  With LinkedIn profiles now ubiquitous, Yammer being named the king of the TechCrunch 50 and more and more companies taking advantage of Facebook and Twitter, the time is right for senior-level executives to put the trend to work in their everyday decision-making.

To go back to the study group example, imagine you’re at a physics study group, but of the five people there, no one knows how to solve a certain problem.  If this was 15 years ago, you’d be stuck without an answer, or you’d have to wait for the teacher’s office hours.  But with the rise of communities on essentially any topic, I’m confident that today you could find the answer by asking a peer online.  The power to share knowledge is infinite.  It’s this concept that drives ExpertCEO-if you can’t get the answer from your intimate peer group (or maybe you’re embarrassed to ask), you can capture the wisdom of the crowd.

Using advice from the site, ExpertCEO members have improved cash flow, avoided legal trouble and gotten advice on how to weather this current economic storm.  The power of the peer group has been proven by students and is working for ExpertCEO members.  Can you put it to work for you?

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What Keeps CEOs Awake at Night?

November 6, 2008

A lot has been written about the financial crisis, and even more about what companies should do. The layoffs have begun; discretionary spending is being slashed, as plans are getting revised with an eye on cash conservation , and those with liquid resources are eagerly identifying potentially opportunistic acquisitions.

I attended the Venture Beat event on October 29 where these tactics were discussed at length by investors and by entrepreneurs.  This kind of talk is very focused on process and doesn’t really convey the intense emotional issues that confront a CEO having to manage in this difficult environment.

Last week, we at ExpertCEO decided to try and put a human face on these discussions, so we polled our members to find out “what keeps them awake at night.”  Not surprisingly, “running out of cash” was the number one response with 56% of respondents indicating that this was their worst fear.

Why is this so scary?  Because the results that could ensue are far greater than simply the financial impact on the company. Many CEOs have spent years building a company and have a large percentage of their net worth, not to mention identity, tied up in it. The employees of these companies have families, mortgages, tuitions and careers that will be directly affected by these decisions.  Running out of cash results in cascade of events–a complex process of laying off respected people who rely on employment to meet their obligations, letting down customers who may depend on a company or its product, and possibly acrimonious negotiations with investors, landlords, lawyers, etc.
Here are the results of the poll:

What keeps you up at night (check all that apply)

My own job security (4%)
Laying off employees/poor morale (34%)
Missing the sales forecast (43%)
Running out of cash (67%)
Competition (15%)
Nothing, I sleep like a baby (14%)
Other (16%)

Which of these concerns you the most

My own job security (7%)
Laying off employees/poor morale (10%)
Missing the sales forecast (18%)
Running out of cash (56%)
Competition (4%)
Other (5%)

Conclusions: The fact that so many CEOs are worried about running out of cash (and missing their sales forecast which is related) indicates the state of mind of our CEO member community.  It also confirms their likely actions – cost reductions, layoffs, deferred purchases; with the resultant impact on the economy.  This poll is just another piece of corroborating evidence of the financial crisis.

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