Trident Capital Blog

Strong Results during 2Q11 for our SaaS Portfolio

Despite the macro trends that continue to be challenging for the US economy, concerns about Europe and Greece’s impact on the continent’s economy, and the continued impasse for an agreement that will raise the US debt ceiling, SaaS companies have been reporting strong performance results for 2Q11.  I got a good feeling for the quarter when our SaaS portfolio company CEOs started to report preliminary positive results before the end of June.  We typically have to send messages asking them to update us on the quarter’s performance.  During 1Q11 only 40% of our SaaS companies achieved their numbers.  It was a different story during 2Q11 when 90% of our SaaS portfolio companies made or exceeded their financial targets. 

The public SaaS companies that have already reported quarterly results (Rightnow, Concur, Netsuite, SPS Commerce, Vocus, AthenaHealth) demonstrated strong performance, meeting or beating expectations.  Salesforce and SuccessFactors will be reporting in the next few days but are expected to turn up strong results.  During the quarter we didn’t see the M&A activity that was exhibited during 1Q11, but there were plenty of private company financings (both initial and follow-on rounds) indicating the continued strong investment interest in the sector.  Most of these rounds commanded valuations that depending on how you see it either defy reason or point to investor bullishness on the strength of the SaaS model; but that’s another story.  Based on the data provided to Trident by the private SaaS companies that sought financing during the quarter we saw strong performance during 2Q11. 

There were several elements of our SaaS portfolio’s performance we liked:

1. Increasing demand for SaaS applications particularly by the larger enterprises where business application updates remain one of the top priorities.  We are seeing similar upmarket movement by several of the public SaaS vendors.
2. The percent of multiyear contracts is growing, with more of the larger customers opting for 3-year contracts.  These customers are prepaying at least the first year which greatly helps SaaS companies with their cash flow needs.
3. As the demand for SaaS applications increases, more systems integrators are starting to support the model and are seeking partnerships with the right application vendors, including private companies.  Our portfolio companies signed more partnership deals during this quarter than ever before.
4. Contract renewals met targets and several customers not only renewed but expanded their usage.  This is the result of continued strong ROI that customers are seeing through the use of our portfolio’s SaaS applications.
5. Interest from international clients, particularly from Europe, continues to increase and several US customers are expanding the use of SaaS applications to their international operations and subsidiaries.
6. While still early for definite conclusions, sales pipelines for 3Q and 4Q are growing generating optimism for strong results during these quarters, assuming the US economy does not stall.

The performance elements we didn’t like include:

1. Higher discounting and more deals signed at the end of the quarter.  The larger customers, particularly those signing multi-year contracts, have continued to hold off until the end of the quarter before they commit.  We have seen a few percentage points increase in the amount of discounting necessary in order to close several of these larger deals, compared to 1Q11.  In addition to the discounting, as can be expected, signing a contract at the end of the quarter had a negative impact on the target MRR for these companies.  However, backlogs grew as expected.
2. Increasing sales and marketing costs.  The move upmarket by several of our SaaS companies, as well as many of the public ones by the way, necessitates a different and more expensive sales and marketing approach.  Several of our companies are establishing additional field sales teams to adequately address customer expectations. This move is negatively impacting margins and challenges the high-leverage SaaS sales model that, at least at Trident as long term investors of this software area, we have come to expect.
3. Some of the larger companies looking to adopt SaaS applications expect hybrid cloud implementations primarily because they want to keep their data behind their firewall.  Thus far private SaaS companies have been resisting this requirement because it will necessitate R&D investments to create hybrid cloud versions of their applications.  It is not clear whether our companies will ultimately be successful in convincing customers, particularly in industries such as financial services, telco and health care, about the adequacy of the public cloud for their application needs.

We hope that the lackluster performance of 1Q11 was this year’s exception and that our SaaS companies during 3Q and 4Q will continue demonstrating the strong performance they exhibited during 2Q11.

Social Business SaaS Applications

A couple of years ago while analyzing the ways SaaS business applications could evolve we started thinking about the social web’s impact on business processes.  At the time, Facebook’s success was accelerating while Twitter and Zynga were emerging. We know that consumer-oriented companies want to engage their customers and prospects in the places they frequent, i.e., the social web.  We also started seeing early signs of consumer-oriented technology adoption by corporations. These realizations made us hypothesize that the social web will figure prominently in the next generation of business applications and that these applications will be built on top of new platforms that have the social web at their core.  To date we have invested in three social application companies: Extole, a company that provides a social marketing application, 8thbridge, a company that provides a social shopping and commerce application, and Jobvite, a company that provides a social recruiting application.

As we examine the characteristics of our three investments as well as those of other relevant companies we have considered investing, we have concluded that the applications developed by such companies:

1. Are delivered over the cloud.
2. Automate businesses processes that target individuals (consumers or employees), e.g., marketing, shopping, recruiting, customer experience management, collaboration.  For example, Starbucks’ 13M Facebook fans or Coke’s 11M Facebook fans do nothing for these brands unless they can somehow demonstrate their engagement with each brand. A couple of weeks ago 8thbridge, working with Paramount Pictures, created the Facebook store for the recent Transformers movie.  In the first two days the store went up in resulted in 900K new fans that, most importantly, generated 77K content interactions and also led to many ticket sales.  As consumers increase their participation in social media, business executives continue to create programs to engage with them. In fact, 70% of interactive marketers are currently piloting processes to drive word-of-mouth marketing through their most vocal consumers, 58% have launched systems encouraging consumers to spread company messages; and 47% have launched social tools that allow consumers to support each other, e.g., forums.
3. Are implemented on new platforms with social networking structures, e.g., enable access and operations on a social graph, and capabilities, e.g., capitalize on the social graph to enable viral distribution, at their core.  In addition, these platforms have global reach, support large partner ecosystems, are device agnostic, support online and mobile communications, advertising and commerce.  Facebook has emerged as the strongest platform with these characteristics, in the same way that Google a few years earlier emerged as a platform for applications that had search at their core.  However, we expect that Google, Microsoft and Apple will soon augment their own web platforms with such features as well.
4. Are data-centric, in that they generate and operate on big data, and use analytics to provide a variety of insights pertinent to the business.  Insights on how a fan uses his social graph to spread a message about a brand, how to improve user engagement around a brand, identify which customers must be nurtured because they are brand influencers or can attract talent to a particular company, which customers or brand fans must be rewarded because they can address product problems, and which consumers shall be offered a reward, e.g., more frequent flier miles, because they can drive a particular group-buying behavior, e.g., organizing a vacation with a group of their Facebook friends and purchasing plane tickets, identify customers that are ready to defect because they are dissatisfied with a company’s service quality.
5. Require significant consulting services as corporations are in the very early stages of trying to determine how to take advantage of the social web and appropriately adjust their business processes and practices.  In general, we are seeing that as much as 50% of these companies’ revenue could come from consulting services.  Unfortunately, the established professional services organizations are not yet able to field the right solutions.  As a result, the social application companies end up offering the services themselves.

We continue to look for additional investment opportunities in early and expansion stage companies whose applications use the social web to address important business processes in unique and valuable ways.  Some application categories are becoming overcrowded with companies that have little differentiation and overfunded by investors.  We, however, are looking for the companies that have developed social applications whose value will not become obvious for another couple of years.

Beyond SaaS; Cloud Computing Update and Investment Opportunities

After being away for a few weeks (vacation and business travel), I returned to the Bay Area and attended GigaOm’s Structure conference and Amazon’s AWS Summit.  I have been attending Structure since the first event but this was my first time attending the AWS Summit.  I was drawn to these conferences for two reasons.  First, while over the past 10 years we have invested and continue to invest heavily in SaaS application companies, we have foregone investment opportunities in companies that provide cloud infrastructure solutions, i.e., PaaS and IaaS.  I have been trying to determine whether we should be considering investments in cloud infrastructure companies today, particularly capitalizing on our extensive experience from SaaS.  Second, I am always interested to hear about cloud computing best practices that can be used by our portfolio companies.

Cloud adoption is growing among corporations of every size but particularly SMBs.  In a report published by Forrester on 4/11 the total size of the public cloud market is pegged at roughly $25B (with the majority today being in SaaS applications) and is projected to grow to $160B by 2020.  A recent (May 2011) survey conducted by Morgan Stanley establishes that the usage of public clouds for a variety of workloads is expected to show a 23% CAGR over at least the next three years, with higher usage rates for SaaS applications compared to cloud-based infrastructure.  SMBs see the use of public clouds as a means of significantly reducing their hardware costs.  Larger enterprises are using the public clouds more for rapidly extending the functionality of internally developed applications, with mobile extensions cited most frequently, as well as for executing compute-intensive workloads like analytics.  There is also a lot more talk about private clouds and hybrid clouds.  Most companies in fact are either using all three types of cloud deployment or state their intent to use them.  Only 37% of companies surveyed indicated that they will only use public cloud deployments.  This means that SaaS application vendors may need to start thinking more seriously about the need to offer versions of their software running on private and hybrid clouds rather than the public cloud options that most, particularly the startups, have today.  For investors this will mean that their SaaS companies may need to invest more in R&D and support as they roll out such options.

Security, interoperability, vendor lock-in, reliability, complexity and data privacy continue to be listed as the top inhibitors to cloud adoption.  However, ironically customers don’t always feel that public clouds are less secure than their own data centers.  But in security they also tend to include regulatory and compliance issues.  Privacy is a different story and one that is viewed differently by the US and Europe. 

In a report released during the Structure conference, with some numbers corroborated by Werner Vogels, CTO of Amazon.com during his address at the AWS Summit, GigaOm ranks Amazon as the largest public cloud provider with 2010 revenue of $500M with Rackspace being second.  In his address Dr. Vogels talked about the investments Amazon has made and continues to make around AWS. Rackspace, Salesforce, Microsoft, Google, IBM, and other large companies that want to be providers of public cloud infrastructure and services, are also making huge investments in order to remain price-competitive and offer the broadest possible set of services.  Based on what I heard during that week, and despite the fact that investments in cloud companies are increasing (64 investments in 2009 totaling $180M, and 93 investments in 2010 totaling $713M) I think that it will be hard, if not impossible, for a startup to compete effectively with the large public cloud computing providers.  Public cloud infrastructure has therefore emerged as the battle of the giants.  I continue to maintain that the SaaS application space offers more opportunity to startup companies and their investors, Trident included.

Cloud continues to be defined by its benefits rather than its technology.  Cloud computing’s benefits that were only stated by vendors, are now validated by customers that have been using such solutions.  Surveyed customers see cloud computing as a way to lower IT costs, increase corporate agility, and provide the foundation for 21^st century architectures with the right levels of abstraction from infrastructure to platform that will result in higher quality systems.  Based on these benefits and what was discussed and reported during the conferences, a few of the best practices that may be of use to SaaS application companies include:

1. The application’s architecture determines the level of success and the overall cost of deploying the solution to a public cloud.  Moreover, the successful use of a public cloud by an application provider requires the continuous collaboration between the cloud provider and the application vendor.
2. Public cloud vendors strive to provide uniform, rather than peak-performance, characteristics across the computing resources they provision. This must be taken into account by the SaaS application vendors as they architect their solutions.
3. While a public cloud provider could offer a SaaS application vendor with a low cost way to develop and launch a new application, scaling costs continue to be high, often leading the application vendor to create its own public cloud.  Of course, companies the size of Zynga and Netflix are able to negotiate special pricing with their public cloud providers, e.g., AWS.  However, for private companies that have not yet reached that scale, the options are more limited.

I expect that this year the number of venture investments and the amount invested in cloud computing companies will surpass last year’s numbers.  I continue to see investment opportunities the following areas:

1. Big Data Analytics.  Analysis of Big Data is starting to become synonymous with cloud computing.  I expect that this trend will continue as public cloud providers offer Hadoop and MapReduce options allowing analysts to send their large workloads to the cloud.  Data movement and “accessibility” of such services by business analysts (you shouldn’t need to be a data scientists just so that you can use such a service) will continue to be issues that will need to be addressed.
2. Enterprise mobile applications. Because of the smartphone proliferation, enterprises are now starting to aggressively adopt mobile applications.   As a first step enterprises are looking to create mobile versions of their mission critical applications, as well as develop mobile applications in completely new, innovative areas.  Public and hybrid clouds are uniquely suited for the rapid development and deployment of these applications.  Therefore, both specific enterprise mobile applications and environments for developing and deploying such applications are of interest for potential investments.
3. Data and application integration.  I have often written about how the proliferation of public and hybrid clouds will increase the need for integrating data to such applications as well as integrating applications.  For example, a cloud-based application may need to access data that is behind the firewall, or two cloud-based applications may need to be integrated to effectively automate a business process.
4. Data marketplaces and API management.  As companies expose more of their data for cloud-based application, the data itself and the APIs through which this access is accomplished will need to be managed.   While I think that we are still in very early stages of data marketplaces and API management, and it is not clear whether either of these areas will emerge into substantial markets and lead to the creation of large companies, there may exist a few interesting investment opportunities to consider.
5. Accelerating data movement. Moving large data sets from data centers to the cloud remains a vexing problem particularly for big data analytics applications.  While cloud-based processing and storage performance are improving, data movement has not yet made corresponding strides and is thus approaches to address this problem are ripe for investment.

I continue to be excited about the prospects offered by cloud computing and delighted by the increasing usage of all its layers (application to infrastructure) by small and large companies.  I don’t feel that we have missed big opportunities by not investing below the cloud’s application layer, but feel that there are at least five areas that represent interesting areas for future investments.