Blog: SaaS and Open Source are Good for Customers ... Unfortunately

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There's an (unintentionally) funny article in BusinessWeek online, bewailing the tough business circumstances that SaaS (and open source) face. From the opening paragraph:

"The Internet revolutionized the distribution of software-perhaps a bit too much. The Web brought a new, cheaper method for getting software into the hands of users, but in doing so may have killed one of the best models in Silicon Valley history."

The piece goes on to say that OnDemand companies have problems because their margins are lower and they have to work so hard to get customers.

The author, Sarah Lacy, recounts the story of one CEO, frazzled by so much travel, who is frustrated by how long it takes to grow the business. One analyst says:

"The challenge is you have to spend 50 per cent to 100 per cent plus of revenue in sales and marketing cost," he says. "You need this [limitless] amount of cash to forever feed the growth machine."

Lacy states:

"On-demand software has turned out to be a brutal slog. Software sold "as a service" over the Web doesn't sell itself, even when it's cheaper and actually works."

She also takes a glancing blow at open source:

"Software companies in the open-source space are feeling some of the same Web-induced pressures."

Summed up, her point is that software companies *loved* the old perpetual license business offering, because they got all their money up front, could charge separate yearly maintenance fees, and got an extra-special present in the form of an upgrade fee every few years as well. By contrast, when software is sold as a service, software revenues get spread across a longer time period, and maintenance and upgrades are bundled into the ongoing subscription fee. And this isn't nearly as fun for software companies.

I hear this kind of thing all the time from vendors. Somehow the shift away from lucrative up-front license fees is ... well, unfair. "We don't make as much. It's harder to get rich" goes the mantra of frustrated vendors. Left unrepresented in this bewailing about the injustices of the software business are customers. You know, the people who buy and (putatively) benefit from using the software.

The reality of this new world is vastly different than Lacy paints:

1. SaaS isn't necessarily any less expensive than packaged software. I looked at Salesforce pricing a couple of years ago, and it ran $900/year per user, or $2700 per user over three years. This is pretty comparable to packaged enterprise software. So the argument that somehow SaaS has financially ruined the software business reflects ignorance of actual pricing in the marketplace.
2. One thing that *is* different is the pattern of cash flows. Packaged software attains a significant portion of its lifetime revenue cash flows at time of sale, so there is cash to feed an extensive marketing and saleseffort (Lacy refers to this as the days when "swaggering, elephant hunter-style salesmen would drive up in their gleaming BMWs to close massive orders in the waning days of the quarter"). SaaS receives its revenues much more evenly over the course of the contract, so there is less money received quickly to fund those elephant hunters. In this respect, SaaS resembles a subscription business rather than a product business.
3. The reason why it's harder to grow SaaS reflects the reality of subscription-type businesses. These companies *always* have customer acquisition costs which must be amortized across the life of the contract and which restrict the amount of cash available to invest in growth. The challenge for subscription businesses is to balance growth against cash flow.
# Just because it's harder for vendors doesn't make it wrong, and, in fact, there's an argument to be made that customers are finally getting their due. Just because the packaged software business was a pleasure cruise doesn't mean that the party would last forever. Most businesses are a brutal slog. Software isn't as lucrative a business as it once was. So what? Forcing software vendors to deliver better value is good for customers.