Trident Capital Blog

Criteria for Determining a Company’s SaaSyness

On a couple of separate occasions last week I was asked to write about my list of characteristics that define true SaaS application companies.  Establishing these characteristics is becoming important now that there is so much interest in cloud computing and is getting easier to confuse SaaS applications with cloud-based applications.  Coincidentally, there are a couple of recent posts and active discussions on this topic taking place in different forums (here, here and here).

As you can imagine, I spend a considerable amount of time every week with our SaaS portfolio companies, as well as talking to the management teams of SaaS companies seeking investment from our firm.  The continued interest of venture investors in SaaS, and more recently in cloud computing, is resulting in management teams trying to position every company that uses the cloud as a SaaS company.

Let me start with a definition of a cloud-based application so that we may be able to better distinguish it from a SaaS application.  Any application that can be deployed in a cloud (public, private, or hybrid) is a cloud-based application.  Let’s consider a couple of cloud-based application examples.  A company like Goldman Sachs using its own application developers can create a proprietary application and deploy it in its private cloud (that resides in its own data centers). Alternatively, Goldman may contract an IT services provider, like IBM, to develop a proprietary application and deploy it in the private cloud that the provider, in this case IBM, runs for Goldman. According to the above definition, these two are examples of single tenant cloud-based applications.  But they are not SaaS applications.

A true SaaS application company has the following characteristics:

1. Product:
1. Offers an application using a single instance multi-tenant architecture
2. Simultaneously runs at most three versions of the application (the current version and the two previous versions) in its data center.
3. The application supports cloud-specific functionality such as social networking among users, rich collaboration among users, presence, and activity streams.
4. Uses processes and the associated software tools for data and application integration so that data from other cloud-based and/or on-premise applications can be moved to the SaaS application, and the SaaS application can communicate with other relevant applications.

1 (a) and (b) are important because they impact the company’s costs of doing business and ultimately its margins.  While not necessary, 1 (c) is very important because it allows true SaaS companies to offer value and further differentiate themselves from their on-premise counterparts (some of which are aggressively moving their applications to the cloud).  Finally, 1 (d) is important since no application is an island but needs to be integratable into each customer’s application fabric.

2. Business Model: The software license model is subscription-based.  Furthermore, no more than 30% of the company’s revenue is coming from professional services.
3. Services: Application customization only through configuration changes rather than programming.  Example configuration changes include the simple activation (or deactivation) of certain application modules or menu-driven changes to the application's look and feel.  Application onboarding should be accomplishable through the web and not require extensive on-site presence.
4. Sales: Extensive use of self-service processes.  I have written more extensively about this topic here and here
5. Support: Extensive use of self-service processes.  I have written more extensively about this topic here.
6. Marketing: Broad use of the web for lead generation, and market reach.
7. Operations: The performance of every aspect of the business such as customer acquisition costs, lifetime value, cost per lead, uptime, etc. must be measured constantly. Relevant posts on metrics can be found here and here.

During the first meeting or call with the management team of a prospective SaaS investment we want to make sure that the company possesses the above characteristics before we can move into further due diligence.  Finally, as you can already figure out, while all SaaS applications are cloud-based applications, the reverse is not true.

Trident Capital Internet Portfolio Company Summit

On Friday my partners and I hosted in our office in Palo Alto a meeting with the executives of our online advertising and ecommerce companies.  Executives from Syndero, HomeAway, Zeo, AccountNow, Advanced Payment Solutions, Turn, Sojern and Tellapal participated in the meeting.  The purpose of the daylong meeting was to enable the participants to exchange information and best practices for customer acquisition and improving lifetime value (LTV).  Below are some of the major points that were made during the day:

1. Being best in class on customer acquisition implies combining the right people, an efficient process, and best in class tools.  The process typically being used involves: creating a control group, hypothesizing a particular behavior of this group that will be capitalized during the marketing campaign, testing the hypothesis on the desired customer touch points (email, search, display, affiliates, etc.), analyzing the test results, learning from the analysis and optimizing, forming a new hypothesis, repeating.  As one of the participating CEOs mentioned “every minute, some aspect of a customer acquisition campaign is being optimized.”
2. Social media is becoming an increasingly important channel for generating interest in a category but once a company starts promoting their particular brand through the social channel, user engagement appears to drop.  Word of mouth is important but it has not yet been integrated effectively with social media.  This is an area that holds great promise and where the participating companies will be investing over the next 12 months.
3. Test and measure every parameter that goes into customer acquisition.  Best in class companies can manage very complex test matrices.  It is important to be able to quickly hypothesize and test offers, creative, etc.
4. The right analytics around the data being collected define best in class companies with the lowest customer acquisition and retention numbers.  Our portfolio companies, by constantly sharing best practices, have moved beyond measuring the effectiveness of customer acquisition campaigns in terms of clicks, and impressions, i.e., website analytics.  Instead they are now measuring the impact of each customer interaction on a particular outcome. 
5. While companies are investing heavily on improving the quality and the uses of the data they capture through their customer interactions, they were less definitive about the impact of data they purchase from data exchanges.
6. A good off-the-shelf software platform for direct response/branded response doesn’t exist (investment opportunity?).  The portfolio companies have created such platforms by manually integrating stand-alone applications.  As a result, the operational complexity of working with multiple applications rather than a single platform presents a big challenge for marketers.  Good direct response software platforms can be used not only to improve the effectiveness of customer acquisition and customer retention of existing products, but they can also be used to effectively test the likely success of new products before introducing them to the market. 
7. Success with online channels is leading our ecommerce companies to start experimenting with offline channels such as Direct Response TV.  Every test associated with an online customer acquisition campaign can become a leading indicating for the effectiveness of a corresponding offline campaign.
8. The companies are being proactive about data privacy issues.  They are using services, including legal services, on how to best safeguard and use the data they collect and what to include in the creative they test for customer acquisition.
9. Metrics on how to calculate lifetime value per customer are still evolving.

Not only were the executives able to share best practices and share ideas about how to improve the operations of their respective companies, but after the meeting ended several stayed behind working on business deals between their companies.  A great way to end the week!

Conferences … Conferences

Another busy week attending conferences.  Goldman Sachs held its annual 3-day Technology and Internet conference.  That was following by Pacific Crest’s Emerging Technology Summit that had a SaaS, Mobility and Cleantech tracks. 

Highlights from the Goldman conference:

1. More large software companies are embracing SaaS. I sat through a few of the public company presentations and noted that Adobe, and Intuit are starting to talk more about their SaaS initiatives.  In addition SAP talked about its SaaS initiatives, i.e., the next version of Business by Design that is due next summery and the recent introduction of on-demand BI through Business Objects.
2. Increasing interest for acquisitions.  Several companies mentioned their intent to be active acquirers particularly around software.  There is appetite for both large acquisitions as well as smaller technology-driven acquisitions.
3. Improving IT spending environment.  Overall IT spending in the Global 2000 is stabilizing and there is more confident talk about the PC and server refresh cycle (noted by both Intel and Microsoft).  There is also increased IT spending from China and India whose companies are trying to upgrade their infrastructures to be compete internationally.  Companies are also starting to use services more extensively to catch up with projects they had put on hold during the past 12 months (research reported by Goldman Sachs).  New software initiatives (with the exception of server virtualization) not a top priority during 2010. 
4. Social networking panel.  No significant increase in budgets around social initiatives yet.  Investments are campaign based.  Companies are trying to figure out how to get hold of the collected data and use it for marketing.  The panelists expect significant market consolidation to take place during the next 5 years.  Data privacy is a big concern and the panelists all recommended that the industry starts self-regulating on this issue.  Email continues to be a big channel for driving new users to social networks. 
5. CIO panel.  IT budgets will be moderately up in 2010.  The consensus is around 5% but this will not be uniform.  In some industries the IT budgets may remain flat while others may have higher than 5% increases.  The panelists also indicated that while the larger companies will increase their budgets, the SMB will lag behind.  In terms of spending priorities
1. Infrastructure optimization around areas such as high availability and redundancy.
2. Migration of more business processes online.
3. ERP implementations.
4. Server virtualization.

The CIOs agreed that it will be easier adopting SaaS applications than cloud-based infrastructure.  They are aggressively moving low risk applications to the cloud (both by re-implementing on-premise applications to their on-demand equivalent, and by acquiring packaged SaaS applications).  Use of the cloud to address demand spikes (to address processing needs or storage needs) is of great interest to the CIOs.  Cloud portability of workloads is an issue.

Highlights from the Pacific Crest conference:

1. SaaS survey results.  Pacific Crest regularly conducts a survey on the usage of SaaS applications.
1. Over 50 of the survey participants expect that SaaS usage within their organizations will increase over the next 12 months. 
2. Sentiment on SaaS is improving with close to 40% of those surveyed indicating that they are anywhere from satisfied to very satisfied with the SaaS solutions they are using and are therefore likely to recommend the use of SaaS applications to other organizations.
3. Over 25% of the survey participants indicated that they will spend around 30% of their IT budgets on SaaS applications and that number is projected to grow to over 30% in 2011.
4. Close to 30% of those surveyed indicated that they expect to realize 10-20% cost savings from the use of a SaaS application compared to its on-premise equivalent with the savings being almost equally distributed across hardware, software installation, software maintenance, upgrades and services.
5. Top benefits of SaaS: faster implementation, lower TCO, better system reliability, lower internal IT costs, and better scalability.
2. SaaS BI panel. All companies represented in the panel (Pivotlink, Cloud9, Jaspersoft, and Adaptive Planning) are growing well indicating that SaaS BI is catching on.  Pivotlink and Jaspersoft spoke about how their customers are coming from across the corporate spectrum (Global 2000 and SMBs).  Pervasive use, viral adoption, and collaboration are three areas that clearly distinguish SaaS BI from on-premise BI.  Vendors are starting to focus on creating new paradigms for extracting data from operational systems (cloud-based or behind the firewall) and moving it to the cloud.  They agreed that the traditional ETL paradigm cannot work in SaaS BI.  All panelists agreed that the way to successful adoption of SaaS BI is to offer more solutions and applications rather than just platforms.  Offering platforms will limit them to selling to IT organizations (something which nobody appears to want) with cost and personnel reduction as their primary value propositions (which everybody admitted are tough sells).
3. Benioff’s presentation.  Marc Benioff, CEO of Salesforce.com, gave one of the keynotes. Using Chatter as an example, his company’s latest product, Benioff talked about the next evolution of SaaS applications that will be driven by real-time collaboration and social networking functionality which in turn is expected to result in better communication among employees and higher productivity.  The demo, that was part of his presentation, showed the integration of social applications and social data around Salesforce’s platform.

This was the first SaaS conference I attended where I heard application vendors talking about, or in the case of Salesforce demonstrating, functionality that can only be delivered because these applications are cloud-based.  In other conferences, SaaS was justified as a superior model for delivering software.  Now we are starting to hear about applications whose “cloudness” enables them to have unique functionality making SaaS giving more reasons for customers to be attracted to SaaS.

This week I’ll be attending the Morgan Stanley technology conference and the SMX West conference.

Panel Discussion on SaaS Sales

Last Thursday I moderated a panel discussion on sales process and metrics for SaaS application software.  The discussion, part of Dealmaker Media’s Strategy Series, was held at our office in Palo Alto.  We had 35 guests and 3 great panelists: Tom Dibble, chief revenue officer at Aria Systems, Jon Miller, VP marketing at Marketo, and David Vonk, SVP of sales and business development at Pivotlink.  My goal for the panel was to explore the sales models that are getting the most traction in SaaS application companies and to better understand the costs associated with the sale of SaaS applications.  Some of major points that were made during the conversation:

• Sales organization. The panelists indicated that they employ a two-tier sales organization: an inside sales group that is responsible for opportunities with ACV of up $100K, and a field sales group that is responsible for larger opportunities.  In addition, all 3 companies have established a lead qualification group, working between the sales and marketing groups, whose goal is to qualify the leads generated by the marketing group.  We couldn't get a good indication if and when it is necessary to split the sales into "hunters," i.e., sales people that are responsible for the acquisition of new customers, and "farmers," i.e., sales people that are responsible for renewals and upsells.

• Lead generation channels.  The sales teams are responsible for generating 40-50% of the new leads with the rest of the leads generated by the marketing group.  The panelists identified the following lead generation channels in order of efficiency: virtual trade shows because participants have the opportunity to interact with peers and simultaneously compare several vendors, online advertising, (SEM/SEO and PPC) since the inbound inquiries the result in are better than the leads generated through outbound calling, and social media outreach since word of mouth is becoming very important for customer acquisition.  The panelists also acknowledged the importance of educating prospects by providing a variety of relevant and frequently updated content on their companies’ web sites.  Prospects must feel that they are receiving value from the vendor even before they license the application.  As one panelist put it “the prospect must feel they are getting more value from your company’s web site than they feel they get through Google search.”

• The importance of acquiring branded customers.  Even though SaaS companies tend to focus on the SMB market, the panelists admitted that they try hard to acquire enterprise clients for two reasons.  First, because they typically sign contracts of higher ACV thus providing higher return on the vendor’s sales investment (cost per lead, pre-sales personnel costs, partner referral costs, etc).  Second, because of their brand recognition which aids overall sales and often results in the reduction of the costs associated with the acquisition of smaller customers.  As one panelist said “while it’s important to have hundreds of SMB clients, it’s even more important to have logos such as Nike, Coke and P&G in your customer list.”

• Key Sales Performance metrics. Constantly measure Monthly Recurring Revenue (MRR), Customer Acquisition Cost (CAC), Lifetime Value (LTV), churn rate, and pipeline conversion rates.
  

• Measure the amount that each sale adds to the MRR.
• Shorten the time to cash.  Self provisioning may work well in some cases but in general the panelists found that it doesn’t shorten the time to cash.  For this reason they found it important to use post-sales services to expedite the customer on-boarding and optimize the value the customer is receiving from the SaaS application.  They advocate productizing (or templetizing) the service delivery.
• Close SMB prospects within 30 days.  Prospects that are not willing to sign a contract within this period typically are not ready to buy.
• Minimum license price of $1K/month and minimum contract term of 1 year.  Other pricing and term models the panelists tried (e.g., freemium, pay as you go subscription with no minimum contract, etc) have not worked as well for the applications their companies are selling.  Presumably they have also determined that the minimum license price and contract term allows them to recover the CAC.  Make sure that the LTV can become larger than the CAC and adjust accordingly.  These testimonials show why it is very important to align the expected Customer Acquisition Costs with the monetization strategy.

• Little (less than 10% on 1-year contracts) or no discounting.  It is easy to quickly demonstrate the value of SaaS applications, often even during the pre-sales process.  As a result, it is not necessary to offer discounts in order to close a deal.  By contrast, on-premise software vendors typically have to discount heavily because the value associated with their applications often comes several months (or even years) after the initial installation.

• The role of partners.  The companies are now investing aggressively around partners in order to grow faster than the overall market and continue to reduce the customer acquisition and customer support costs.  Marketo gets 20% of the business today through partners.  The panelists advised the participants to create a compelling integration strategy between the vendor and its ISV and OEM partners, as well as to try not to compete with the services channel partners.

We had a lot of fun hosting the event and were glad to see the level of interaction between the panelists and the participants.  We want the thank Dealmaker Media for their efforts in making this event successful and look forward to hosting additional such Strategy Series events.

The Talks at the Brandeis Business School

Last week I spent a few days at the Brandeis International School of Business at the invitation of Professor Charles Reed.  While on campus I gave three talks (in addition to embedding them here I have also made them available through Slideshare on my blog’s home page) about venture capital and entrepreneurship; two that were lectures in classes taught by Professor Reed and one that was part of the business school’s invited speaker series.

Because of its international orientation, the Brandeis business school provides a rather unique environment for talking about venture capital and entrepreneurship.  The majority of its students come from foreign countries with little or no exposure to venture capital, but strong entrepreneurial roots.  During its 10 years of operation the business school has produced 15 startups, several of which are doing quite well.  One has to remember that Brandeis is a small school (it has a little over 2000 students) with no engineering or medical schools.

I gave the first talk (Download Lecutre 1) in the Entrepreneurship and Innovation undergraduate course.  I wanted to accomplish two goals with this talk.  First, I wanted to provide an introduction on how VCs work.  I covered how VCs raise a new fund, how they create a pipeline of deals to consider investing (the so called “deal flow”), how they conduct due diligence in prospective investment opportunities, and how they participate in corporate boards in order to manage the investments they make.  Second, as an ex-CEO of startups, I wanted to provide a framework around which to start thinking of the first 18 months of a startup’s life, a period which typically includes a couple of rounds of venture funding.

I gave the second talk (Download Lecture 2) in the Entrepreneurial Finance and Business Plans graduate course.  My goal for this talk was to talk about the conclusions my Trident partners and I reached based on our work with our portfolio companies during the past 12, very difficult months.  I spoke about how we managed our portfolio, including how we made difficult decisions when it became necessary.  I then switched gears and talked about how to create a business plan and how to present to a venture investor, taking into account the stage of a company seeking funding.  We went through a few real examples of business plans I have seen (and liked).

The final talk (Download Lecture 3 )was for a more general audience and provided my take on trends in the venture capital industry from both an investor’s perspective and an entrepreneur’s perspective.

All three talks generated lively discussion (and subsequent email interactions) with the students, something which I found very rewarding.  I hadn’t taught since 1992 and forgot how energizing the experience can be (but in moderation).  I look forward to returning to the Brandeis campus and work with these students in some of the business plans they are now in the process of writing.

SaaS Challenges to Address During 2010

The first month of the year is already out.  A couple of weeks ago I wrote about where I expect to see innovations in SaaS applications during this year.  Before we get too far into this new year I thought I’d write a few words about the challenges that SaaS applications must address during 2010.  We need to make headway towards these challenges to be addressed, not only for the adoption of SaaS applications to broaden but also in order for these applications to be considered for replacement of on-premise mission-critical applications.

In a recent Goldman Sachs survey, published on 1/10/10, CIOs listed the following concerns with SaaS and cloud computing (in priority order): security, solution maturity, Total Cost of Ownership (TCO), solution complexity, and solution reliability.  Interestingly the priority order of the concerns was identical in the similar survey that Goldman conducted at the end of 2008.  CIOs, however, perceive that that during 2009 SaaS vendors have made progress on all but the TCO area.  In particular, while 84% of the surveyed CIOs identified security as the top issue, the corresponding 2009 number was 52%.  While the difference between the 2008 and 2009 numbers for the TCO issue is not significant, statistically the number is the same, it is interesting to note that the in every other area there has been progress except in the area of addressing TCO.

Based on my conversations with executives of our SaaS portfolio companies and other SaaS companies we considered investing, as well as direct discussions with CIOs and business executives in companies that have licensed or are considering SaaS applications, my list of challenges includes:

1.       Security. The recent attacks on Google’s infrastructure and Gmail showcased the risks that SaaS users would want addressed before they feel comfortable migrating mission-critical on-premise applications and data to the cloud.  I feel that vendors are starting to make solid inroads in addressing regulatory and corporate governance standards but cyber security is another matter.

2.       Application reliability/uptime.  We are seeing requirements moving from 3-nines uptime (99.9%) to 4-nines uptime (99.99%).  Obviously the more mission-critical the application, the higher the necessary reliability.  Salesforce’s recent outages showcased the need for improved reliability.  Meeting this requirement will require more advanced data center architectures, an issue that smaller SaaS companies have not started to address yet by and large.

3.       Data integrity.  The data that leaves a company’s data center to move to the cloud must not be corrupted en route.  I would imagine that data integrity has to be at 5-nines. This issue is particularly important as customers are now asking for the integration of data from several applications, some of which reside behind their firewall and others reside in application vendor clouds.  Achieving this level of integrity will also require that SaaS vendors rely on each other to individually achieve this level of data integrity.

4.       Application performance.  The application’s performance should not degrade as more users access the application.  Also, as applications become more popular within organizations we find that users are no longer willing to tolerate slower applications.  They are now starting to expect identical response to the corresponding on-premise applications.  I expect that once this issue is addressed improving the application onboarding process will be the next user challenge.

5.       Data movement/throughput.  Customers are moving increasingly larger data quantities (now at the low-terabyte level) to the cloud.  This has been particularly evident in SaaS BI applications.  SaaS companies must address this issue whether they use their own infrastructures or IaaS like Amazon’s.

6.       TCO. Thus far SaaS application vendors have been able to demonstrate qualitatively the lower TCO of their solution over corresponding on-premise solutions.  This was due to the lack of detailed and extensive history operating SaaS applications.  However, now more data exists and SaaS vendors should be able to easily demonstrate the superior TCO of their application.

I look forward to creating a scorecard at the end of the year detailing whether and by how much these challenges were addressed.