Why Software Vendors move to SaaS

Software vendors see their growth opportunities in SaaS.  New software companies are based on SaaS, mobile, or big data — not on-premise software.  These new companies such as Salesforce, NetSuite, and Workday are the darlings of the software business by virtue of their technology, high growth, and rapid innovation .  They will erode the market share of their on-premise competitors until the legacy vendors strike back with superior SaaS products.   While it is hard to make the transition from an on-premise to a SaaS model as discussed in Bruce Cleveland’s blog, the innovative ISVs will make the transition.

Top 5 reasons why Software Vendors are moving to SaaS

1) Market benefits drive software vendors to SaaS

In competitive markets, SaaS vendors enjoy better market positioning.  As discussed in my prior post, customers are moving vendors to providing cloud solutions.

  • SaaS opens new sales opportunities to prospects with SaaS requirements
  • SaaS has “buzz” and positions the company as an innovator, not a laggard
  • SaaS provides the ability to expand with new channel partners looking to jump on the SaaS bandwagon
  • SaaS vendors are much closer to their customers than on-premise vendors since they are an integral part of their customers’ daily operation allowing the ability to continually market to them.

2) The business benefits of SaaS are compelling

  • The win ratio for new business is higher for SaaS companies — NetSuite and Salesforce both have higher close ratios than their on-premise competitors
  • The sales cycles for selling SaaS is generally half of an on-premise solution since the customer commitment is less and they are looking at a shorter implementation time
  • Development cycles are shorter for SaaS companies enhancing the company’s ability to deliver market leading products before their on-premise competitors
  • The overhead to support prior software revisions are eliminated for pure-play SaaS companies reducing development costs

3)  Big software companies now get it

  • The traditional software vendors such as Microsoft, Oracle, and Sage see the SaaS imperative and are investing heavily to support SaaS products.  These companies see their greatest growth coming from the cloud and are investing commensurately.   .
  • These large companies are investing in SaaS growth with their ISV partner community by acquisition and by marketing/co-marketing spending.  Some Microsoft products have a co-marketing budget of five times their on-premise products per dollar of revenue.  There is a big opportunity for ISVs to leverage the Cloud investments of the software behemoths.

4)  We finally understand how the SaaS model (should) work

While many SaaS companies have had a tough time reaching profitability and becoming cash flow positive, the elements to make a SaaS company financially solid are becoming better understood.  The promise of SaaS is to build the flywheel of a reoccurring revenue stream while keeping the upfront costs (sales) low enough to generate sufficient operating margin to pay the company’s operating expenses.

We know the essential four KPIs to make the enterprise SaaS companies viable:

  1. Cost of Sales expressed as the number of months of contribution margin for the deal
  2. Gross Profit of the Monthly Reoccurring Revenue (MRR) (after cost of service)
  3. Attrition
  4. Monthly growth in MRR & Contracted Revenue

If you show me these four metrics and their trends, I can tell a lot about the viability of the business.

There are a huge number of other important factors including other fixed cost (like development costs) and cash flow both which can sink a company.  Joel York provides a good reference to the most critical SaaS metrics.  David Skok provides an excellent guide to SaaS financial goals.

This is a very complex topic, but there is much less risk today in SaaS businesses because we understand how we need to perform to make them successful.

5) Avoiding death is a good thing

While people can debate the timing, the software industry is moving to the Cloud.  The speed of the transition will vary greatly depending on the specific market and size of companies served.  Clearly there will be long term requirements for on-premise software just like there is still a market for mainframe software years after its peak.  I’m not so sure there will be any real activity in client/server systems by the end of the decade beyond sustaining efforts (after all, COBOL and RPG still exists).

I just wouldn’t want to be running those legacy businesses.

Coming Next — Part V, “VARs and System Integrators get on board”