SmoothSpan Blog

For Executives, Entrepreneurs, and other Digerati who need to know about SaaS and Web 2.0.

Archive for July, 2007

How Should Businesses Embrace the Web 2.0?

Posted by Bob Warfield on July 27, 2007

Along with SaaS, the other big trend facing businesses is Web 2.0.  If you haven’t heard about it by now, let me refer you to the seminal O’Reilly blog post that really frames the definition of Web 2.0.  In the meantime, think of Web 2.0 as all the ways the web enables collaboration.  This is a big deal, and there are many services out there that are thriving on collaboration.  Good collaboration is participative and it involves your friends and associates.  It is fun to the point of being addictive, which is why it is growing virally.  It involves back and forth, the ability of your co-collaborators to influence you and you them, whether for entertainment, enrichment, or both.  As we will see, it involves a certain loss of control too, which is difficult for many businesses to come to grips with.

What’s a real example?  Trusted Opinion recently added Netflix queuing to their service (and Mashable’s write up too!).  Trusted Opinion is all about collaborating on recommendations for various things.  Imagine how natural to be able to read someone’s opinion about a movie and with one click add that movie to your Netflix queue.  It’s a perfect example of a good application of Web 2.0 to business with just one minor fly in the ointment:  Trusted Opinion had to do all the work themselves because Netflix has no Web 2.0 api.

The Trusted Opinion example brings me to some concrete thoughts about how businesses can embrace the Web 2.0.  One thought is to try to build your own collaborative social network for your community.  That would be classic old school business thinking that’s born out of a need for control.  One of the less comfortable aspects of the Web 2.0 is that it involves relinquishing a lot of control.  Netflix has no control over what folks are saying over at Trusted Opinion, for example.  I don’t necessarily want to discourage having a special community for your users.  I’ve seen cases where this is highly valued, and even cases where the community itself wants to be a closed club only open to folks who do business with the company.  The example I’m thinking of is a CAD/CAM software company whose community consists of machine shop owners who’ve purchased the product.  These shop owners don’t want their own customers to see the kinds of questions they’re asking or the problems they’re having lest they be perceived as incompetent.  They want a closed community for privacy’s sake. 

That frames the trade-off pretty nicely.  If you want the emphasis on control and privacy, create a closed community that your business owns.  If you want the emphasis on growth, openness, getting your customers to be your advocates, and involving people who are not your customers, you will likely do better to enable 3rd party social networks to play in your game.  Some businesses would do well to have both—a special community that only customers join, and as many tendrils as possible to embrace the open communities.

Let’s focus on the open communities.  These are the Facebooks, Twitters, Diggs, MySpaces, and countless others.  How do businesses play in those games and leverage the results for success?  Go back to the Trusted Opinion example.  Does your business have an api that does something interesting for those communities?  Is it possible for talented players in the community to bring you into that community as the Trusted Opinion people did for Netflix?

What about the next step, where you bring your own business into a community?  Let’s take Facebook, which has gotten huge press lately around its platform for creating Facebook widgets.  What sort of Facebook widget would play for your business?  Netflix could’ve created a review widget with a button that adds the movie to the Netflix queue for the user.  Now how to get the word out?  Take that internal community.  Start by getting the word out there.  Some number of your customers are also Facebook users, they have to be given how many users are on Facebook.  Offer them the widget via your community, and get the word out via the traditional tools that Facebook already provides.   The intersection of your community and Facebook will give your widget a real jumpstart over others that don’t start from an existing community.

Pretty shortly you are going to come up against another issue.  A Facebook user may not be immediately recognizable as someone who belongs to your community.  To overcome this problem, your community needs to allow its users to tell you their Facebook identity.  Ideally, you should let them switch to using their Facebook identity instead of the one they have in your community if they want to.  It’s a little thing, but it reduces friction further.  While you’re building this capability into your community, think about leaving it open ended so you can have users give their other identities as well.  Design your Web 2.0 widgets for the open communities to access and use this identity mapping information.  It’s another strength you bring to your users and community.

Now what about other Web 2.0 platforms?  It’s the same story.  Can you embrace their api’s?  Can you cross-reference identities between the two?  Have you published apis that make it easy for those communities to derive benefit from your offerings?  Going back to the Netflix example, can one of your customers Twitter about the movie they just watched and make it easy for their Twitter friends to add the movie to their queue?  Can they Digg those movies?  Can they bookmark the movies on Del.icio.us?  Can bloggers on the popular platforms quickly create movie review and embed a widget that ads the movie to the blog reader’s queue?  What can you give folks to insert into news feeds?  Are you using blogs as a tool to get the word out and building a community around your blog?  And do all these reviews allow the viewer who has already seen the movie to feed back their opinion and have that captured by Netflix too?

You get the idea.  I am by no means picking on Netflix, it’s a great service and I know the founders personally.  They’re some of the brightest folks around.  I’m just using them as an example that nearly every company I know can relate to about what Web 2.0 might offer.  Most companies today are concerned with Google ad words and Search Engine Optimization.  Plugging into the Web 2.0 central nervous system is the next essential step.  Don’t get left behind!

While I’m at it, this is a two-way street.  The big social networks can afford to wait for companies to embrace their apis.  Up and comers should follow Trusted Opinion’s example and think about how their community can benefit if they find ways to tie the network back to other businesses or even other social networks.  The other seed I’ll plant is someone needs to make it easy to embrace these platforms.  Companies can barely deal with blogging and search engine optimization.  Building widgits is a whole order of magnitude more complexity.

Posted in business, Partnering, saas, Web 2.0 | Leave a Comment »

It’s Cheaper for SaaS Companies to Acquire Customers

Posted by Bob Warfield on July 17, 2007

As a continuation of the discussion of “How do SaaS Companies Make Money?”, I wanted to provide just a little of the data I’ve been accumulating about SaaS businesses.  What I have is a clear indication that it is cheaper in terms of Sales and Marketing Expense for SaaS companies to acquire revenue.  Let’s start out with a look at public SaaS companies and what it costs them to acquire $1 of revenue:

The curve fits pretty nicely, and we can see that there is a pronounced knee.  Somewhere in the $20-$50M range, these companies reach critical mass and they start acquiring revenue more cheaply than Sales and Marketing Costs.

Now let’s see what happens if we take the same data and overlay similar sized public Enterprise software companies.  The red boxes represent all public enterprise software companies with less than $350M revenues most recently reported numbers according to EDGAR filings:

 

The red boxes representing the non-SaaS Enterprise world are nearly all to the right of the trend line!  From this, one has to conclude that it costs those companies more to acquire revenue than it costs a SaaS company.  Note that for the really large software companies, these costs of customer acquisition start to subside.  The knee is at about $1B in sales, and we don’t have much to compare there in the SaaS world, so we’ve yet to see how far SaaS keeps its advantage.

Why aren’t SaaS companies more profitable then?

I think it is because they’re in full investment mode spending every bit they can to grow themselves further.  One could throttle Sales and Marketing back to a more profitable stance based on the analysis above, but why do it if you can log growth over 50% or so a year?  Growth in the software world is ephemeral but on the flipside software companies seem to shrink very slowly.  The moral is to strike while the iron is hot and lock in as much growth as possible.

Posted in Marketing, saas, saas business venture | 7 Comments »

How do SaaS companies make money?

Posted by Bob Warfield on July 16, 2007

UnreasonableMen wrote recently with some concern and some great information about the profitability of SaaS companies relative to conventional software companies.  The article is a must read for anyone interested in SaaS, and most of the hard facts may be summarized with the central diagram from a MacKenzie report:

It’s easy to see why the analysis seems alarming.  SaaS vendors only turn in a 13% EBITDA versus the whopping 31% from all traditional software vendors.  The article then focuses on very high SG&A expenses and wonders a bit whether investor interest in SaaS is a bubble waiting to burst with no real returns as witnessed by the low EBITDA.

I don’t think SaaS is a bubble for a whole list of reasons.  One of the responses to the blog post was the comment that SaaS has real demand, where the Internet bubble was characterized by selling a lot of products that nobody wanted.  That’s an excellent obsrvation.  In addition, take a close look at the chart above and you might also conclude there’s really no point in doing software of any kind unless you can reach a scale over $1B–EBITDA is just as low for all intents on traditional software vendors that are small.  This has been true for as long as I can remember in the software world.   Until a company reaches signficant scale, and that scale is usually associated with a monopoly on some segment, software companies don’t make money.  There’s no point getting excited about the problem now–those horses left the barn long ago!

These economies of scale, by the way, are one of the major drivers (along with low cost debt due to low interest rates) behind the LBO and acquisition crazes for software companies. 

When I look at these numbers, I see some basic facts every software company CEO needs to keep in mind.  First, there are economies of scale, so size matters.  Companies that aren’t growing at significant rates need to think about mergers and acquisitions.  Second, fueling that growth is a top priority, hence the emphasis on big spends for marketing and sales.  If you’re lucky enough to have a product and space where you can generate big growth numbers you’d be crazy not to work as hard as you can to grow as quickly as possible. 

Third, COGS is going to be higher because of service costs.  Very large traditional companies are bouyed by huge maintenance streams that are essentially free from a COGS perspective.  Smaller traditional and SaaS companies have a huge service component.  SaaS buries it in the subscription fee, but provides data center and IT services, while traditional companies break it out as part of their professional services business.  The services business is an incredibly important source of calories for today’s software companies.  If there is any doubt about the impact of service costs, take a look at the EBITDA’s for traditional service companies like Accenture and these margins won’t seem so bad.

Another take away is that the desire to spend for growth in SaaS companies, which have a day in the sun where you can actually spend productively for growth, has been charged directly against their ability to do R&D.  This short shrift is compounded because SaaS companies have to build more than traditional software companies because of the nature of SaaS.  Traditional enterprise software has no need of multi-tenancy or a whole host of other things they take for granted but SaaS companies wind up building from scratch.  I think this is a much bigger concern for SaaS because it makes them capital intensive to create and grow, and it leaves them less budget on which to innovate, making them vulnerable to competitors who reinvent the wheel slightly better.

There is a discussion in the blog post as well of a Service Delivery Platform to help ameliorate some of the R&D costs.  I agree a platform is going to be essential to the overall health of the SaaS market, and a true SDP will do well there.  The economic pressures alone will drive its adoption if the SDP can deliver the right stuff.

The last observation I’ll make is that any customer for SaaS ought to view these numbers as an indication that SaaS companies are not taking unfair advantage of them and probably represent a good value for their money.

Posted in business, saas, venture | 2 Comments »

 
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