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Software as a Service (SaaS) Comments
It’s easy for new SaaS firms to get rolling
The SaaS model makes it much easier and less expensive for companies
to build new solutions. By leveraging resources available in the cloud
and agile development techniques, it is usually takes much less money
and less time to develop a new SaaS application than it took to build
a traditional on-premise application. Forget about spending several
million dollars over two or three years. I've seen companies with a
handful of clever developers bring highly-functional products to market
in a few months.
It’s growing a customer base that’s difficult
But getting a functional product out the door is just the start. Once
the solution is ready for market, there’s lots of difficult and
expensive work still to be done - namely, acquiring and retaining customers.
Look at any of the well-established SaaS firms and you’ll see
that customer acquisition expenses far exceed product development expenses.
According to financial statements of nine large SaaS companies, sales
and marketing expenses average 44% of annual subscription revenues.
By contrast, product development expenses average only 12% of annual
subscription revenues.
In customer acquisition, size matters
In the effort to acquire and retain customers, size matters. For SaaS
companies, being bigger has several advantages:
1. Bigger usually means deeper pockets.
To acquire customers, SaaS providers have relatively large expenses for sales
and marketing people and programs, and most important, these expenses
are incurred up-front. But the payback occurs over the life of the
subscription.
SaaS providers need to pay for sales and marketing now, while they’re
waiting for revenue later. They need resources, notably cash, to bridge
this gap.
Larger companies with greater resources can usually cover a larger
gap. They can wait longer for revenue and cash flow than smaller companies.
2. There are economies of scale.
Even with effective inbound marketing and the availability of relatively
low-cost vehicles like webinars, electronic newsletters, blogs and
other social media outlets, marketing can be expensive. These new
tools and techniques still require resources: people to set them up,
develop content, assess impact, convert leads into qualified prospects
into customers, etc.
But it’s usually more cost-effective for larger companies to
use these tools and techniques than small companies. Why? Because
the marginal cost of reaching additional prospects can be low or even
zero.
What this means is that larger providers can spread the sales and
marketing costs over a large base. In effect, they have a lower average
customer acquisition cost. Low average customer acquisition cost/customer
lifetime value is a formula for SaaS success.
3. Credibility matters.
When customers purchase a SaaS solution, they’re not just buying
a product; they’re buying a promise. They are entrusting the
SaaS provider to deliver a reliable, high-value, frequently-enhanced
solution over the life of the subscription.
And because buyers are committing to a long-term relationship, they
are particularly scrupulous in assessing the reputation and credibility
of the SaaS provider. In general, buyers are more comfortable acquiring
solutions and entering relationships with larger, more established,
better financed providers. It may not be fair, but that’s how
it goes.
The SaaS business model favors consolidation
The economics of the SaaS business model and the advantages of size help
explain the inclination toward consolidation in the SaaS market. We’ll
continue to see plenty of small SaaS companies come to market, and some
will get large enough, fast enough to go it alone.
But as they try to grow and finance the cost of acquiring customers,
many of these companies will find that it makes more sense for them to
be part of a larger company, and they’ll get bought.
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