The Expert CEO

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.