In my previous post I provided my observations around the 2Q09 performance of our SaaS portfolio companies. Two of these observations concerned the overall lengthening of the sales cycles because prospects are starting to take longer to make up their mind, and need more interactions with the sales teams. As a result of these trends the cost of sales is increasing and the margins are decreasing. Furthermore, as organizations feel more comfortable with the use of SaaS applications, and more complex systems and processes are implemented using SaaS models, the implementation of these applications is starting to require more extensive use of services, including professional services, (which have lower margins than packaged software).
As investors we are always very focused on the margins (gross and operating) achieved, and can be achieved, by our portfolio companies. We continue to be attracted to the SaaS model because of our belief that it can result in superior margins (80% or higher) due to short sales cycles and quick implementation cycles.
The previously mentioned trends show that the margins we are projecting for SaaS companies will be unattainable. Our initial diagnosis and repair efforts centered primarily on marketing and sales. We encouraged our companies to try to improve and better focus their lead generation efforts with the rationale being that more and better leads will result in shorter sales cycles, higher-value contracts and, thus, margin improvement. We also encouraged our companies to make their software highly configurable so that their services personnel can customize it quickly and, ideally, remotely, so that services margins can also improve.
As the complexity of SaaS applications increases, such recommendations are easier said than done. In many instances prospective customers want to: test a particular SaaS application using their own data to make sure that it fits their needs and processes, confirm that its adoption would not be disruptive to their operations, make certain that they are comfortable with corporate data being in the cloud, etc. Once they license the software, customers expect that services personnel will come on site to properly integrate the cloud-based software with other, mostly on-premise software they already own, as well as with on-premise databases that feed the SaaS software.
The key to addressing these customer needs and improve margins lies in the use of self-service processes and technology. Today a SaaS company considers that it has a state of the art web site if it can offer canned demonstration of its software. Vendors of rather simple SaaS software, e.g., contact management software, may also allow prospects to try the software on their own for a period of time (typically 30 days) before buying it. However, for more complex software, e.g., a marketing automation SaaS application, today prospects have to interact with the vendor’s sales teams to get a demo of the software, particularly if they require that the demo uses their company’s data. The business and margins of SaaS vendors will benefit greatly if they invest in the development of better and more intuitive user interfaces, data ingestion, integration and management functionality, well-documented and metadata-driven APIs, and technologies that facilitate, expedite and “fool-proof” the provisioning and configuration of their applications. There already exist several successful examples of consumer software, e.g., Intuit’s tax preparation applications, where users with no technical skills are able to test-drive, buy, and effectively use a SaaS application. The best thing we can do as investors is to continue to motivate and guide our SaaS companies to employ the methods and technologies that will allow them to achieve the margins that we believe are possible for this software delivery model.