Archive for January, 2009

SaaS: More Power To The Entrepreneur

There are many misconceptions about Software As A Service (SaaS).  Many of those misconceptions come forth from the investment and venture capital community.  While SaaS is not the answer to every problem, it is a sound solution in may instances and offers many advantages to entrepreneurs.

Investors in technology and software often times have an uneasy feeling about SaaS products.  This article describes many common concerns and misconceptions investors have regarding SaaS.  The perspective is largely from that of the investor and venture capitalist.  Typical objections are:

– SaaS is an unproven business model.  The article suggestions that “SaaS is unlike any business model they’ve [VCs] analyzed”.

– SaaS products require larger initial investment.  The implication is that the perpetual software license brings in more revenue. There may also be greater initial outlay in server infrastructure for SaaS.

– Funding for a SaaS may be more difficult to come by because venture capitalists are wary of SaaS.

These misconceptions will be addressed below.  In the process, some benefits of SaaS will arise as well as possible reasons why large investors don’t find SaaS appealing.  Some additional benefits will also be presented.

The fact that the VC community does not feel comfortable with SaaS is largely irrelevant to the viability of SaaS.  The VC community (including angel investors) has largely been mutually exclusive with innovation and risk for the past decade.  If VCs have little understanding of SaaS, then it is due to their own negligence.  Service to consumers has been in existence since the milk man and diaper service, over fifty years ago.  Services provided to businesses have been around even longer, as lawyers, accountants, insurance, internet/broadband, telecommunications, and more have been provided as services for years.

There have also been some very successful applications provided as a service.  One of the most successful is Salesforce.  Smaller solutions such as Basecamp, a project management tool have thrived.  Such applications have been widely accepted by business.  One tremendous benefit is that they bring capabilities to small business, that only large businesses could afford at one time.

Perhaps the reason SaaS is not appealing to VCs and other large investors is because it lessens the need for their “services” and provides more leverage to the entrepreneur.  How?  Let’s address the next misconception and come back to this.

Many investors believe the perpetual software license is more financially feasible.  The case here is that charging an initial fee for software is better than a recurring fee as the service is used.  There are two problems with this thinking.  How do software companies continue to improve there product(s) after the initial purchase?  They’ve received the large initial payment, which will likely spent shortly thereafter.   To address this, many software companies charge “maintenance fees”.  Typically these fees are 15% to 20% of the initial license fee, on an annual basis.

How is this different from software as a service?  It isn’t.  The customer is paying a fee (called a maintenance fee) as long as they wish to use the software.  In essence, the distribution (ratio) of the initial fee and the maintenance fee are different between perpetual license and SaaS.

This “perpetual” model has led to some harsh feelings between businesses and  software vendors over the years.  Businesses questioned why they needed to pay anything after the initial purchase.  Initially maintenance fees were low.  Just five years ago they were in the 10% to 15% range.

Why is SaaS better than the perpetual software pricing model:
1) SaaS allows more flexibility (charge per user, per use, per output, etc).  In the end, customers feel they are getting better value.
2) SaaS removes the large initial cost of perpetual licensing, which can in many cases remove a barrier to entry, especially to smaller companies.
3) Recurring payments of SaaS allow the vendor to continually investment in improving the product.

Another objection to SaaS is that there is a greater initial cost in setting up (hardware/software) infrastructure.  That is also another misconception.  Hardware, software, broadband, and hosting costs have dropped dramatically over the years.  Virtualization has also been a significant contribution to lower infrastructure costs.

But the biggest development has largely gone unnoticed.  It is not surprising that the investment community is in the dark.  Application services are currently being offered that may drastically change the landscape of computing, such as Amazon’s EC2 and Google’s App Engine (there are others too).  While in their infancy, these application engines provide for complete web application and web service environments (often referred to as Cloud Computing), using the same infrastructure that Amazon’s and Google’s own applications run on!  Scalability and redundancy, which are typically quite costly to achieve for a new venture, are built in to these services.  Costs are also very reasonable and based on usage.  In effect, a small, growing venture can build its application on the same platform as Amazon and Google, while costs scale with revenue.

And the last objection to SaaS is that funding may be difficult to come by, particularly via venture capitalists.  This has largely been addressed.  Due to low barrier to entry and affordable infrastructure,  the need for VC is lessened.  And that may be the real reason why the VC community doesn’t particularly care for SaaS.

SaaS opens up greater opportunity to the entrepreneur.  It minimizes the need for large capital outlay – and the dependency on outside investment.  It allows more value to be developed in the early stages and to prove a concept with little risk.  As the aforementioned article discusses, other options, such as partnerships or having software development costs shared with early customers are good options.  All of which lessen or remove the dependency on the VC community.

So, while some may perceive SaaS to be untested or unappealing, consider the source of those negative reports.  Innovation is a quality of the entrepreneur not the investor.  Investors may have alterior motives.  SaaS provides the enterpreneur with more leverage and opportunity.  With SaaS the success is based more on the idea, commitment, and persistence – and less on the financing.

January 30, 2009 at 11:23 pm Leave a comment


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