Trident Capital Blog

Notes from the 2010 Pacific Crest Technology Conference (Part 2)

Last week I provided my notes on the SaaS workshop that was organized as part of the recent Pacific Crest technology conference in Vail.  Today I’ll talk about online advertising which was another major theme at the conference.

• Online advertising continues to grow in spurts.  Ad budgets remain volatile even though the presenters at the conference talked about a 10% online ad budget growth during 2010.  Spending looks better for 4Q10 and into 1Q11, assuming that the economy doesn’t continue to decelerate.  Campaign planning continues to be on a quarter by quarter basis.  The online display ad market will grow by 20% this year, faster than search advertising (12-15%).  This is one of the highest growth rates of all types of online advertising.  Only social advertising surpasses with an annual growth of over 30% but the social advertising market is much smaller.  These growth rates corroborate the 17% growth rate that Forrester recently provided for that market.  Mobile and social are becoming increasingly important drivers.
• Today 14% of the total ad dollars are going to online. Advertisers continue to cancel their print buys and move their budgets to online.  Larger companies are moving to online faster than in previous years.  TV planners are trying to determine how to move money to online video.  Most online ad programs are coming from agencies rather than directly from advertisers.
• In late 2009 and early 2010 the display market moved away from ad networks and towards Demand Side Platforms (DSPs) and ad exchanges because marketers wanted to be efficient and consumers demonstrated that they wanted to visit multiple sites to find the most appropriate content.  Data will play an increasingly important role in the rapidly evolving display ad technology.  Its use will lead to improved targeting and higher accuracy in bidding.  Today even though Real Time Bidding (RTB) is consuming much of the discussion around display ad technology, none of the DSPs are real time yet.  Marketers don’t perceive a significant difference in the ad effectiveness of the Yahoo and Google ad exchanges though the two exchanges employ different bidding strategies.  Search is still the best suited method for performance-based selling, lead and generation.
• While the technology panelists who sat on the future technology trends panel identified mobile internet as the top trend to watch for (the other being cloud-based application delivery) the advertising executives in the online advertising panel and workshop claimed that the next two years the shift from print to mobile will not be as fast as the shift from print to desktop online.  However, the shift to mobile will continue gaining steam.  There are several issues resulting in the slower move to mobile including the problem with redeeming coupons through mobile devices. Ad tech is viewed as a means to improve the margins of online advertising.

The information presented at the conference’s online advertising panels has the following implication for Trident:

1. Ad tech for display advertising will continue to evolve rapidly with new Demand Side and Supply Side platforms emerging.  Online advertising agencies are racing to develop the right infrastructures to take full advantage of the emerging technology.  Turn (www.turn.com), one of our portfolio companies, is emerging as one of the key DSPs.
2. Data will be playing an increasingly important role in ad targeting and pricing decisions. 
3. Mobile advertising in its various forms (in-app, in-game, in-browser) continues to move from experimentation to mainstream though still the budgets are not reaching the projected levels.
4. Advertising in social media is attracting strong attention and budgets are increasing rapidly.  We have invested in Extole (www.extole.com) that is developing a SaaS social marketing platform and is becoming the system of record for its customers’ social graph.

Notes from the 2010 Pacific Crest Technology Conference (Part 1)

I was on the road for almost two weeks.  During the early part of last week I was in Vail to attend Pacific Crest’s annual technology conference.  I’ll consolidate my notes around three topics of personal and investment interest that were covered in the conference: SaaS, online advertising and future technology trends.  This week I’ll cover SaaS and next week online advertising and future technology trends.

The SaaS workshop had 60 attendees (private company executives and venture investors).  The discussion was motivated by two surveys that Pacific Crest conducted.  The first was a survey of 80 CIOs and IT executives that Pacific Crest conducts annually for the past 3 years.  The second was a survey of 80 private SaaS companies which they conducted for the first time this year. 

1. Corporations are increasing their use of SaaS applications.  The biggest reason for the use of SaaS is ease of deployment and integration.  Security is becoming less of a concern.  According to the Pacific Crest's CIO survey, during 2010 and 2011 60% of the budgets for new software acquisitions will be allocated to SaaS and cloud computing, with over 50% going specifically towards applications.   These are similar trends to what was reported on a Goldman Sachs research note that was published on 8/17 by Sarah Friar.  CRM, HCM and collaboration are the top three SaaS applications in terms of new licenses and renewals.  CRM, excluding sales force automation, has been the top application choice, 3 years running in the surveys conducted by Pacific Crest.  The optimism of the CIO survey was also reflected in the SaaS company survey where it was reported the median YoY revenue growth during 2010 will be over 40%.  However, the survey also showed that the majority of the SaaS pureplay vendors still don’t make it to the CIOs’ radar screen.  While this realization may not be of great concern to SaaS vendors, since they tend to sell to LOB executives rather than IT executives, we are seeing IT playing an increasingly prominent role in SaaS licensing decisions, particularly in F1000 companies.
2. Increasingly SaaS companies are being asked by their customers to use all the data in their disposal to provide benchmarking services allowing each customer to compare to its peers.  It appears that companies are switching from being concerned about their data being stored in the cloud and, moreover, in the same database with data from other companies (some of which may be their direct competitors) to trying to gain insights about their business through the analysis of all the data managed by the SaaS vendor.
3. Most of the surveyed SaaS companies whose applications command ACV that is higher than $25K are adopting hybrid sales models (inside and field sales).  Few such companies appear to use a self service-only sales strategy effectively.  According to the survey results, the self-service sales model is more effective with products that have ACV of $5-10K.  These results are consistent with what we see in our relevant portfolio companies.  However, for the stage of companies that were surveyed, the reported CAC ($0.75 in CAC for every $1 of first year license) is too low, compared to what we are seeing in our portfolio companies, as well as in SaaS companies that are asking for investments. 
4. In terms of operational metrics, most surveyed companies expect to realize 70% gross margin and 12% operating margin by the time they have reached $50M in annual recurring revenue.  The companies sign one year contracts with more regularity and most are now able to get paid for the entire subscription upfront.
5. By the time companies reach expansion stage, i.e., revenues of $15-20M, they will most likely need another $10-20M in investment to achieve breakeven, implying $35-45M in total investment from inception to breakeven.  Those of the surveyed companies with revenues that are below $40M expect to be acquired by either a SaaS or an on-premise software company rather than go public.

The results of these surveys have four implications for Trident:

1. Our firm’s overall SaaS investment thesis should remain intact.  In fact the results of these surveys, (combined with the solid quarterly performance of our SaaS portfolio companies, which I have been reporting on this blog, and the performance of the public SaaS companies) further strengthen our SaaS investment thesis.
2. Our SaaS portfolio companies must continue to aggressively educate IT organizations about SaaS and cloud computing.
3. We must continue to encourage our SaaS companies to make better use of the data they capture to provide business insights to their customers and help them constantly improve their businesses.
4. We need to pay more attention to amount of funding SaaS companies will ultimately require as a result of the higher costs and smaller margins associated with the use of hybrid sales models, compared to self service or inside sales-only models.
   

The discussions on online advertising and ad tech were very interesting and will write about them in my next post, along with my comments from the panel on future technology trends.

2Q10 Proved Harder than Expected but SaaS still Comes Through

We are in the midst of the reporting season.  Several public SaaS companies have already reported the results of their 2Q10 financial performance and a few more will do the same in the following days.  These reports continue to tell a very positive story for SaaS companies as the majority of the companies met their financial targets demonstrating a 10-30% revenue growth with the majority in the mid teens.  During a series of board meetings and calls over the past 2 weeks, our own SaaS portfolio companies also reported their 2Q10 performance.  This quarter was more challenging for our portfolio companies than 1Q10 (see the 1Q10 analysis here).  A summary of our conclusions from these meetings:

1. The same number of companies made their numbers as in 1Q10.  However, new deals were harder to close and many of them came at the end (last 2 weeks) of the quarter.  In past quarter we were able to see a better “pacing” with deals closing every month. 
2. QoQ revenue growth in the 5-10% range.  However, after the performance of 1Q10, we were expecting revenue growth in the 20-30% range.  Peeling the onion we saw the following:
1. While the US market appears to have been slower during the quarter, the international markets for SaaS are starting to open up.  Even our smaller companies are starting to receive inbound leads from European and Asian corporations that are now considering SaaS solutions.
2. Upsell targets were met or oftentimes exceeded as existing customers expanded their use of SaaS applications.  Furthermore, renewals and upsells were done on time compared to new deals that, as I mentioned, closed at the end of the quarter, implying that customers continue to see strong value with SaaS
3. SaaS adoption by larger companies continues to accelerate while the small businesses continue to struggle as they try to exit from the recession.  Over 60% of the deals closed by our SaaS portfolio on the aggregate are now coming from larger corporations (with over $300M in annual revenues).
4. Larger companies signing annual and multiyear contracts, rather than going month to month or six-month contracts, implying that they are embracing SaaS quickly and their comfort with the use of SaaS applications continues to increase.  This corroborates data recently reported by Gartner and IDC.
5. International markets are coming on strong.  Many of our smaller SaaS companies are starting to sign deals with international customers.  They have also started receiving inbound interest from international partners.
3. Social media and word of mouth are playing a more prominent role in demand generation, much more than I had expected for enterprise software.  During the quarter, webinars proved again the most effective lead generation channel.
4. Continued growing emphasis on field sales.  Prospects are asking for more elaborate and company-specific evaluations of the SaaS applications requiring more touch.  As a result of the increasing emphasis on field sales, the gross margins continue to be negatively impacted. 
5. Partners are becoming more engaged with SaaS application companies and are initiating more sales opportunities for our portfolio companies than in the past 3 quarters, i.e., it’s becoming easier for our portfolio companies to sign up partners and the partners become effective faster than before because they see market demand and are figuring out how to make money through the model.

The results of 1Q10 had left us particularly enthusiastic about the prospects of our SaaS portfolio companies for the remaining the year.  While the 2Q10 results tempered the enthusiasm they continued to validate the power of the SaaS model.  Because of the overall macroeconomic trends, particularly in the US, our partnership and our management teams realize that achieving the budgeted financial targets will require even harder work than we had thought at the end 1Q10.

Second Annual SaaS Portfolio CEO Meeting

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About a week ago I hosted the second annual meeting of our SaaS portfolio companies’ CEOs.  Like last year, we met in our office in Palo Alto to share relevant experiences from the past twelve months, and exchange ideas relating to sales, marketing and product development initiatives.  In addition to our CEOs, I also invited David Spitz, MD at Pacific Crest to provide us with his perspective on the public markets.  Below are the major points made during the meeting:

Sales

• More of the companies have established separate sales teams to acquire new customers and to cultivate/expand existing customers.  Our companies are starting to use of Success Managers for customer cultivation/expansion.  These individuals are part of the inside sales team and become involved after a customer has been acquired and onboarded.  Typically each Success Manager is assigned 30-40 customers. The first goal of a Success Manager is to ensure each customer uses the product correctly and gets the maximum benefit from the product.  In the process, the Success Manager at the minimum assures that the customer will be willing to renew the contract at the right time.  More importantly, however, the Success Manager cultivates the customer for an upgrade/upsell.
• There is a more concerted effort by our portfolio companies to further develop the self-service channel in order to reduce sales costs.  But, as SaaS is being aggressively adopted by the Global 2000, our companies find it necessary to also establish field sales teams.  However, they require the field sales people to engage only if a minimum deal size is established (typically $100K).
• One of our CEOs eliminated his entire field sales effort but now regrets letting the best of his field sales people go because he thinks that based on the opportunities his company is pursuing, they would have been able to perform very well even working as inside sales capacity.
• The sales process is becoming more complicated, particularly with larger companies.  Now our sales people need to “sell” to more executives from different organizations within each such prospective customer.
• Quickly and frequently experimenting with different pricing and terms and conditions is viewed as important by all CEOs.  They believe that only through such experimentation they can maximize the results of their sales efforts, particularly in today’s market environment.

Marketing

• SEO is more effective than SEM for lead generation.  In addition, emails combined with inside sales outreach efforts are very effective for lead generation.  Quick and frequent experimentation of various approaches to lead generation is very important.
• The companies are not adequately leveraging social media in their lead generation efforts.  We have urged them to start doing so.  We pointed to the fact that User Generated Content (UGC) is ranked higher by search engines.  For this reason companies such be using more UGC in their marketing efforts.  The companies should also try to not only use the communities they have started building but also partner communities.
• The comprehension of the SaaS model and market by the industry analysts is improving by the month.  The CEOs mentioned the analyst firms they think “get” SaaS and the ones that remain skeptical about the model.  Interestingly, none of the participants considered any of the analyst firms to be thought leaders today in SaaS.  They believe the SaaS thought leaders are independents.

Market conditions (David Spitz’s comments with additional commentary from our CEOs)

• SaaS companies are benefiting disproportionately from the recovery, though not all SaaS are performing in the same way.  The public SaaS companies tracked by Pacific Crest demonstrated strong growth over the past two quarters with companies either meeting or exceeding their 1Q10 targets (as I had also written here).
• Company growth is very important even if the company doesn’t generate much free cashflow (FCF).  But in general the markets are looking at growth rate, revenue, and FCF. Investment analysts are also starting to pay close attention to the bookings of SaaS companies and to the additional net new subscribers per reporting period.  Investors are becoming savvier about SaaS and are now able to analyze the relationship between Customer Acquisition Cost (CAC) and customer Lifetime Value (LTV).  However, it is unclear whether these metrics really matter to corporate development executives looking into acquisitions of SaaS companies in addition to the three metrics mentioned above.  Financial buyers, e.g., private equity firms, are also becoming interested in SaaS because of the recurring revenue model.
• More private company financings are getting done, more acquisitions are being contemplated, including some larger deals, and companies are more open to filing to go public (with the strong encouragement of investment bankers).  SaaS companies with at least 15-20% YoY growth and at least $15M in Annual Recurring Revenue (ARR) are of particular interest since they show that they can achieve scale.

Time for SaaS M&A

The recent acquisition activity by public IT companies provides just an initial taste of what will be a very active year for cloud-based vendors.  To recap, IBM bought CastIron to improve its capability in data integration among SaaS applications as well between on-premise and SaaS applications, SuccessFactors bought CubeTree to improve its cloud-based collaboration capabilities, Salesforce bought Jigsaw to enhance its sales force automation offering with cloud-based sales-related content, CA bought 3Tera and Nimsoft so that it can start offering cloud computing solutions, and VMWare bought GemStone to provide data management for the applications developed under SpringSource.  There are several reasons for my conclusion:

1. Improving macroeconomic environment.  The recovery appears to be taking hold, and companies are investing in IT again (we continue to expect a 5% growth in this year’s IT budgets).  Public IT companies are reporting strong results.
2. Cloud computing is considered the next IT platform.  SaaS applications are demonstrating significant successes and they are now being adopted aggressively even by Global 1000 companies.  The move to cloud computing is considered inevitable.  Companies are starting to spend disproportionately for SaaS applications than for on-premise applications.  CIOs expect that at least 10% of IT workloads will be running in the cloud by 2013.  During the recession, corporations have been impressed with the lower TCO they achieved through the use of SaaS applications.
3. Public IT companies, e.g., IBM, Microsoft, Google, have large cash reserves and are getting low returns from the interest this cash is earning.  For example, Cisco has $39.5B in cash, Microsoft has $36B, Google has $26B, and IBM has $14B.  In addition, over the last 6 months 4 of the 5 public SaaS consolidators have raised over $1.1B (Concur $250M, SFDC $600M, Taleo $150M, and SuccessFactors $200M).  Salesforce and SuccessFactors are obviously starting to put this money to use.  I’m sure Google is thinking that it will need to improve Google Apps through a combination of internal development, partnerships and acquisitions.  Microsoft could also use some of its cash for acquisitions aimed at further rounding out Azure.
4. Based on their 1Q10 financial results and subsequent stock movements, the public markets are rewarding SaaS that have reached scale and have strong growth rates.  However, the markets still don’t reward (as they used to) IT companies with less than $100M in annual revenues that are going public.  Furthermore, the management teams and investors of such private companies realize that it takes a long time to build a SaaS company of scale.  As a result, the bigger and higher growth SaaS companies will aim at getting bigger “inorganically, and, for the right price, private companies would prefer to be acquired rather than attempt to go public, providing liquidity to their investors and employees.

The anticipated M&A wave will be led by the SaaS vendors.  IT vendors primarily with on-premise solutions, e.g., Oracle, SAP will not be as aggressive for another 12-18, i.e., until they determine that they cannot transition to cloud computing on their own but will need to acquire the right DNA.  CA provided an early example of such a strategy, through its acquisition of 3Tera and Nimsoft.  Over the past year Adobe, Compuware and the SAS Institute had shown a similar approach with their acquisitions of Omniture, Gomez and IDEAS respectively.  Applications, analytics, data management, and security are some of the areas that will attract the acquirers’ attention.  I can tell that management teams, venture investors and investment bankers are all getting ready for a very busy year.

The 1Q10 is Done. Good Reasons for SaaS Companies to Remain Optimistic

Several public SaaS companies (Netsuite, Concur, SuccessFactors) reported their quarterly results and they were positive.  Our own SaaS portfolio companies did the same (over the last week and during this coming week my partners and I are participating in a long series of board meetings) and the results are from positive (companies met their quarterly financial targets) to exceeding expectations (companies beat their quarterly targets).  Obviously this is very good news.  But beyond the good news, here’s what we are learning from the information we are receiving from our portfolio companies:

1. Corporations are investing in applications in general but SaaS is winning more than its fair share of opportunities.  The majority of our SaaS companies won most of their deals this quarter against on-premise vendors as opposed to other SaaS vendors, i.e., they are winning in situations where the customer may not know upfront whether a SaaS application will be chosen.  Gartner had predicted earlier in 1Q10 that spending in SaaS applications will be 5x higher than spending for on-premise applications over the next 5 years.
2. Large companies (over $500M in annual sales) are adopting SaaS applications faster than smaller ones (I believe that smaller companies are still reeling from the effects of the Great Recession).  In our SaaS portfolio over 60% of the wins came from such large companies.  Furthermore, the 2Q10 sales pipelines of these companies reflect a similar mix of prospects.  So much so that a few of our SaaS companies are starting to hire additional sales people and my sense is that, if this trend continues, we will see more hiring by the end of 2Q10.
3. While the impact of the Great Recession on corporations of every size has been brutal, subscription renewals during the quarter remained over 95%, indicating both the importance of these applications to the business of these corporations, as well as the high value they are receiving from using these applications (otherwise, why renew?).
4. Upsells were also on target, either because companies are moving from experimentation to broader adoption of SaaS applications, or because they have been satisfied enough with the SaaS application(s) to expand the usage to additional organizations within the same company.
5. Some of our SaaS companies raised their license prices during the quarter and didn’t see any slowdown in the sales cycle, again indicating that customers consider SaaS applications to be a great value even at a higher price.
6. Customers are evolving.  Rather than seeing SaaS applications simply as a more convenient and better value alternative to on-premise applications, they are now starting to ask for features that only cloud-based applications can deliver, e.g., social computing and community, collaboration, quicker release cycles and faster upgrades.

We are getting ready for the next meeting of our SaaS portfolio companies that will take place on 5/14.  In addition to spending time to elaborate on the points above, we will be delving into the ways the sales models of these companies are evolving (particularly around lead generation and customer lifetime value).  We are also going to discuss how SaaS applications will evolve as a result of the broad adoption of tablet computers in general and the iPad in particular.  Will these platforms enable SaaS vendors to offer applications in a way that will cause companies such as Apple to start claiming that “there is an enterprise app for that?”

Panel Discussion at the AlwaysOn OnDemand Conference

Yesterday I participated in a panel discussion on how the startup model has changed in the era of open source, Amazon’s cloud infrastructure and SaaS.  The panel was part of the AlwaysOn OnDemand conference.  Three of Trident's SaaS portfolio companies made it to the AlwaysOn OnDemand 100, the list of the top 100 SaaS companies: Host Analytics, Pivotlink, and Tricipher.  Other panelists included Gordon Ritter of Emergence Capital, Ravi Mohan of Shasta Ventures, Mark Gorenberg of Hummer Winblad and Sanjiv Parikh a venture advisor.  Because of the participants the discussion delved primarily on the strengths and staying power of the SaaS model, the characteristics investors are looking for in SaaS companies, and areas of new investment opportunity.  Below are some of the discussion’s highlights:

• In its purest form, cloud computing represents a fundamental platform shift in that allows everything to be offered over the internet as a service, elastically/dynamically, and paid ratably.  Many companies (mostly large vendors of on-premise software solutions), are either trying to marginalize this shift by calling it a fad, e.g., Oracle, or are trying to leverage the recent hype around cloud computing to position their products as cloud-based because they feel that in this way they will remain relevant.  At Trident we have a well-defined set of criteria that allow us to determine whether a company has a true SaaS product and the associated business model and practices.  The other investors participating in the discussion have similar criteria

• The panelists agreed that corporations are adopting SaaS applications because they provide a) their employees with universal access to the solution (anytime, anywhere), b) quicker time to value, c) reduced Total Cost of Ownership (TCO), compared to equivalent on-premise applications, and d) unique and needed functionality that is enabled only by the cloud, most importantly collaboration.  These adoption factors were most recently also validated through a survey conducted by InformationWeek.  To continue providing superior TCO, SaaS companies must continue to rapidly evolve their products, business models and distribution models.  Customers must feel that they are getting something of value immediately (even if they are just testing the free version of a SaaS product) thus creating the right conditions for future upselling opportunities.  Cloud-based infrastructures enable the rapid iteration through product offerings and models.

• Strong teams with knowledge of the SaaS the model is a top characteristic of the SaaS companies seeking investment.  Technological and business model innovation is another top characteristic.  What type of technological and business model innovation does the cloud enable, other than a delivery mechanism, that will cause a customer or a partner adopt a SaaS solution? By understanding the target customer’s pain-points investors are also trying to determine whether a SaaS company is trying to automate an important business process that can be uniquely automated through a cloud-based solution or whether the SaaS solution will just replace an existing on-premise solution by introducing additional efficiency.  Understanding of the target market (as investors we don’t want to hear that a SaaS company is targeting the generic SMB market; instead we expect a more sophisticated segmentation of a company’s target market since the purchasing and adoption criteria of a mid-size enterprise are completely different than those of a small company).  Finally, there was a brief discussion regarding the metrics a company must have achieved to be considered an ideal candidate investment, such as MRR, LTV, and CAC.

• Regarding new areas of investment interest we mentioned vertical SaaS applications particularly in industries such as health care and pharma even though security and compliance of data were identified as potential impediments to broad and quick adoption of such solutions.  I mentioned that my personal investment interests are around SaaS applications that automate Internet process in the areas of online advertising and e-commerce as well as in analytic applications and cloud-based infrastructure that address big data problems.  Identifying applications that utilize the data captured by SaaS applications was mentioned as another promising investment opportunity.  The panel touched upon the investment opportunity for a new generation of SaaS applications and cloud-based infrastructure created by smart phones and the new generation of tablets.

Real-Time Analytics

Last Friday I attended SDForum’s The Analytics Revolution Conference.  The presenters were startup public and private company executives and investors.  The presentations were mostly around real-time analytics.  For the past few years Gartner analysts have been writing and talking about the Real Time Enterprise.  Gartner sees the analysis of the data that is generated by various enterprise applications such as an ERP and residing behind the corporate firewall and an important ingredient to achieving the Real Time Enterprise.  However, Friday’s presentations brought to focus that the impetus for real-time analytics is not the faster analysis of enterprise data, but of the Big Data captured on the Web (structured and unstructured social data, activity logs, data coming from mobile applications, geolocation data, data mashups, the interactions during the lifecycle of the captured data, etc).  This data is orders of magnitude larger and more complex than the data currently stored in the enterprise data warehouses.  I had written that Internet SaaS applications will drive the SaaS innovation agenda.  Friday’s presentations provided more examples and additional justification for this conviction.

Companies like Facebook, eBay, LinkedIn and Zynga that presented at the conference are interested in making analytics-driven decisions in Internet speed and cheaper than it is currently possible with the existing data warehousing and analytics technologies. They want to use their data to continuously optimize their businesses, simulate the effect of decisions on business processes, and forecast the impact of actions.  Making decisions based on reports that summarize and find trends in data that is a week or a month old simply won’t do.

To take advantage of emerging opportunity of real-time analytics of big data, we are considering investments in the following three areas:

1. Infrastructures of next-generation data management systems, including open source systems like Hadoop and derivatives, and systems for creating OLAP cubes in real time.
2. Horizontal and vertical analytic applications, examples of which are listed here.  Additionally, these applications will need to find a way to monetize on the data they capture, not only on the data they process.  See, for example, how internet data exchanges like BlueKai are able to monetize the cookie data they capture.
3. Analytic services offered around the captured big data, e.g., the services offered around big mobile data by companies like Ground Truth, and Flurry.

My underlying hypothesis (driving one of my investment theses, and shared by several of the investors present at the conference) is that cloud computing will make big data analysis faster and cheaper.

I am convinced that over the next few years, investments in each of these three areas will result in several strong exits.  I don’t believe that the established on-premise data warehousing, BI and analytics vendors will be able to create adequate technological and business model innovations around real-time analytics.  The results of a survey conducted by InformationWeek and published on March 27, 2010 make it clear that more enterprises are looking to cloud computing to address the perceived shortcomings of on-premise applications, with SaaS BI being one of the top areas of interest.  Finally, as stated here, incumbent on-premise software vendors will continue to face the innovator’s dilemma that won’t allow them to move fast to offer the novel solutions for real-time analytics that the market needs and is starting to demand. 

SaaS Multi-tenancy Economics

In response to my post on the criteria of determining a company’s SaaSyness I received several messages asking for further elaboration on why I consider multi-tenancy to be such an important criterion.  I want to provide an investor’s view on the importance of multi-tenancy.

First a little background so that we can all be on the same page.  After a spirited discussion in the LinkedIn SaaS group Alok Misra wrote an article on multi-tenancy explaining why it matters to SaaS applications, and Nati Shalom followed with a great post explaining the technical aspects and challenges of multi-tenant architectures.  In an earlier post Mike Krigsman touched upon how multi-tenancy impacts the business model of a SaaS vendor.

There are two ways to achieve multi-tenancy: 1) build on top of a PaaS that offers it, e.g., Force.com, or 2) implement it yourself (as most SaaS vendors).  As Nati states, broadly there are two approaches to multi-tenancy: 1) the fine-grained approach exemplified by Salesforce.com, and 2) the coarse-grained approach exemplified by vendors offering a hosted application service.

From a user’s perspective multi-tenancy doesn’t mean much as an architectural construct unless it impacts:

1. The SaaS application’s total cost of ownership (TCO),
2. Data security, and
3. The ability to customize the application.

By far the biggest impact of multi-tenant architectures, and the reason I use multi-tenancy as one of the decision criteria prior to investing in SaaS companies, is on the vendor’s business model.  Before embarking on the implementation of a SaaS application under a particular multi-tenant architecture, the vendor must understand the impact of the architectural choice on product development, product maintenance, customer onboarding, and customer lifecycle management.  Understanding the architecture’s impact along these dimensions will also help the vendor understand the application’s TCO and whether the company’s business model will be winning scalable or whether it will need to be revised.  For this reason during the due diligence process I try to answer the following questions along each of these dimensions:

• Product development.  Are there any regulatory or legal reasons that will inhibit the adoption of a particular type of multi-tenant architecture?  For vendors converting an existing on-premise application to its on-demand equivalent I want to find out whether the original application imposes restrictions to the type of multi-tenant architecture that can be used.  How much will it cost and how long will it take to implement the selected architecture?  For example, the economic benefits to the vendor resulting from the use of a fine-grained multi-tenant architecture may be negligible compared to the cost of implementing such architecture.
• Product maintenance.  What does it cost to maintain a product implemented under a particular multi-tenant architecture?  Does the product’s maintenance require senior (and thus more expensive) engineers and database administrators? How long does it take and what is involved to apply software patches and data model changes?  For example, does the entire application need to be brought down in order to apply a patch that may impact only a single customer?  Are there penalties associated with application uptime?  In other words, does the vendor need to pay a penalty to the customer if the application does not achieve a particular uptime Service Level Agreement (SLA)?
• Customer onboarding.  What type of database administrators (senior, junior) does the vendor need to employ for customer onboarding and what is the ratio of administrators to customers?  For example, if the multi-tenant architecture requires complex modifications to the application’s database then the vendor will most likely need to use senior database administrators for customer onboarding?  Will junior services personnel be able to configure the application to the customer’s needs or will more senior personnel be needed?  The seniority of the required personnel of course impacts the cost of the onboard process.
• Customer lifecycle management.  How easy will it be for the application to meet a customer’s growing usage (number of transactions processed by the application per unit time, size of the data, diversity of usage and number of organizations from the same company using the application)?  Will the vendor need to make changes to the database or to other components of the application as the usage increases?  How expensive are the optimizations the vendor needs to perform in order to keep the application running properly and how frequently do they need to be performed?  How expensive is each such potential change?  What will it cost to the vendor each time a customer leaves the service (in addition to the lost recurring revenue)?

I’m certain that there are several other questions related to multi-tenant architectures whose answers impact the economics of running a SaaS business.  However, I hope I have been able to provide you with a glimpse on how we as investors look at multi-tenancy and its impact on a SaaS company’s business model.

Cloudnotes

I’ve been meaning to post these notes a couple of weeks ago but extensive travel and due diligence on two companies kept me otherwise occupied.  Let’s start with a positive statement: The future for SaaS applications is getting brighter.  Discussions I had with the CIOs and business unit executives of the companies I recently visited support that the majority of applications used today by mid- and large-size companies can be delivered via the cloud.  They use the following rationale to arrive to this conclusion: Of the applications used in a corporation, 15% are either company-specific, reflecting proprietary business processes, or need to adhere to particular regulatory requirements.  As a result, these must be on-premise applications.  The remaining 85% of business processes can be automated using off-the-shelf, packaged applications.  Of these packaged applications, 80% can be delivered through SaaS, i.e., they are based on single instance multi-tenant architectures, or, at the very least, they can be cloud-based applications delivered over private, public or hybrid clouds.  The type of cloud used depends on the customer’s customization and on-boarding requirements.  The remaining 20% must be delivered using off-the-shelf on-premise applications.  Getting this message across will require IT vendors to continue educating the market and offering their SaaS applications in pieces that are easily “consumable” by corporate users.  Issues such as security, and application and data integration, about which I wrote in the past, will still need to be addressed before cloud computing in general and SaaS applications in particular can be broadly adopted.

Let me now switch to last week’s Google announcement on the launch of its Application Marketplace and why I thought it is worth commenting about. 

1. The launch of the Marketplace demonstrates Google’s continued interest in business applications (the Marketplace launched with applications from the 50 vendors, such as Concur’s and Appirio’s).  With the App Marketplace Google has the opportunity to innovate and clearly differentiate itself from Salesforce, whose AppExchange is a Marketplace competitor, if it can incorporate lessons from its Android App Store.  For example, Google can provide additional services to the marketplace participants such as billing, analytics and potentially even an alternative business model by trading annual license fees for ads displayed inside the applications.  I have been writing about the upward trend in the Customer Acquisition Cost (CAC) of SaaS applications.  These marketplaces have the opportunity to become low-friction sales channels and better rein in such costs.
2. Participation in the Marketplace will provide an additional forcing function for SaaS application and data integration, since, at the very least, the applications must be integrated with Google Apps.
3. Now that Microsoft is becoming serious about cloud computing, I expect that it will start thinking seriously about establishing a similar cloud-based sales channel for its partners. Competition among these marketplaces, including AppExchange, will be good for the dissemination of SaaS applications and in general and will improve the sales economics for such applications.

The final note stemmed from the recent acquisition of 3tera, a company I considered investing over a year ago, by CA for a rumored $100M price (approximately 30x trailing revenues).  The acquisition made me think whether Trident should re-consider its position and try to invest in PaaS/IaaS companies.  We have stayed away from this part of the cloud computing stack because we believe that

1. Private PaaS and IaaS companies are not capital efficient as will require significant investment to remain competitive with large IT vendors introducing cloud-based solutions.  For example, it is reported that Amazon has invested hundreds of millions around its EC2 IaaS service so that it can offer processing at a fraction of ¢1 per hour per server).
2. Enterprises considering moving any part of their IT infrastructure to the cloud would use a large IT vendor rather than a small private company.  Two recent presentations delivered by Microsoft and IBM executives reinforced these thoughts that PaaS and IaaS may difficult areas for venture investments.  For example, IBM recently surveyed 1100 of its customers regarding their cloud computing plans.  The survey showed that most of these customers still don’t understand where and how to apply cloud computing.  Furthermore, 60% of the surveyed companies stated that they will use large IT vendors to move workloads to private clouds but are more hesitant about using public clouds.
3. While CA bought 3tera for an eye-popping multiple, I doubt other IT vendors will follow suit and be willing to pay similar multiples for cloud computing companies.  CA bought 3tera in order to acquire its technology and, most importantly, in order to access 3tera’s cloud computing expertise.  CA needs to catch up quickly in cloud computing.  Telcos, particularly European ones, and Indian IT outsourcing companies may also need to acquire cloud computing expertise but these types of companies are not known for being aggressive IT acquirers.

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, 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.

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.

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.

Panel discussion on SaaS Sales Metrics

On 2/18 I will be moderating a panel discussion on SaaS sales metrics.  The event, that will take place at our office in Palo Alto, is part of Dealmaker Media's Strategy Series.  We will be bringing together 3-4 sales executives to talk about sales cycles, sales costs, and sales metrics for SaaS applications. 

If you have specific questions you want to pose to the panelists please email them to me directly or post them as comments.

Go here for more details on the event.

Go here to register for the event.

Discussions with CIOs About 2010 IT Budgets

There is a lot of optimism among private and public IT vendors about the growth of IT budgets during 2010.  Private discussions I had with CIOs in our network lead me to believe that during 2010 IT budgets will increase by an average of only 1-3%.  Moreover, this increase won’t be uniform across all industries and geographies.  Government, financial services, and healthcare are three industries that are expected to have higher budget increases.  IT budgets in Asia/Pacific, Latin America and US will increase but not in Europe. Therefore, while we are guardedly optimistic about 2010, we advise our portfolio companies, particularly those serving industries that are not expected to increase their IT budgets, to still be thoughtful in their spending since IT budgets won’t approximate those of 2007 or early 2008.

The relatively small budget increases won’t leave room for many new IT initiatives.  Though everybody is expecting 2010 to be the first year of a multiyear hardware upgrade cycle, the feedback I have received from CIOs indicates that software will fare better than hardware.  Within software the high priorities include:

• Applications, including internet applications, BI and business analytics.
• Security, including cybersecurity, and compliance.
• Server virtualization. 

This budget climate continues to favor the adoption, particularly by large companies, of SaaS applications and, to a certain extent, cloud computing infrastructures.  CIOs indicate that companies are interested in buying solutions in “smaller chunks.”  A note of caution: the industries with the biggest budget increases have not been aggressive adopters of SaaS and cloud computing.  As a result, I expect that the majority of application software deployments will continue to be on premise.  SMBs are still facing a tough economic climate, particularly because credit remains constrained, so their 2010 IT spending will be tight.   SaaS vendors will, most likely, increase their focus on larger customers which could have implications on sales process changes and increased costs.

Some of the facts fueling the observations above:

1. The economic outlook and confidence are improving.  More countries are reporting that are out of the recession and countries like China, India, Brazil, Australia are reporting solid quarterly growth.
2. Public companies are starting to report decent 4Q09 results, the recent stock sellout notwithstanding.
3. IT spending surveys reported by Gartner and Morgan Stanley over the last week indicate that IT spending priorities are moving from cost control initiatives to business growth initiatives

But,

1. Credit markets remain constrained.

2. US unemployment remains stuck at 10%.

3. Consumer spending is still tentative.

Innovation in SaaS Applications

Since the start of the new year I have been going through the SaaS, cloud computing and internet investment opportunities we considered during the past 18 months, as well as the companies we met in conferences and other venues, to select the ones we should continue following.  Looking through the set I was struck by the realization that the most exciting of these opportunities come for SaaS application companies automating Internet-related processes, primarily online advertising and ecommerce. This realization reinforced a belief I formed early last year that SaaS application innovation is now driven by the automation of internet processes, e.g., online ad optimization, rather than of enterprise processes, e.g., human capital management.  We should be spending more of our time looking for investment opportunities in companies that develop this type of SaaS applications.

I compared and contrasted the SaaS companies that target “traditional” enterprise processes, e.g., spend management, let me call them enterprise SaaS application companies even if they may not always target Global 2000 enterprises, with those that target internet processes, e.g., search engine marketing optimization, which I will call Internet SaaS application companies.  The former typically automate a business process that has already been automated by an on-premise software application.  As such, enterprise SaaS applications innovate through the model the application is delivered (as a service), and the higher ROI and lower TCO this model affords because of the use of the cloud and of multi-tenant architectures.  Internet SaaS applications, on the other hand, automate processes that haven’t been previously automated, so the opportunity for innovation is higher.  You’d be surprised at how many companies, for example, still manage their search keywords in giant spreadsheets and manually perform search engine marketing.  Several Internet SaaS applications integrate very large data sets (I have written here about the data volumes processed by the new generation of analytic applications), with novel and sophisticated algorithms (for example, Turn’s Internet SaaS application that is used for ad optimization must decide which ad to show to which user at the millisecond level), and innovative user interfaces that borrow the best of consumer applications’ look and feel.  Successful Internet SaaS applications have already been developed for ad optimization, social media analytics, search engine optimization, publisher yield optimization, customer engagement marketing, etc.

The move from offline to online channels will continue accelerating.  The stakes around online advertising and ecommerce are high as these sectors routinely experience double-digit annual growth.  Business processes in online advertising and ecommerce are now being formalized and many of them have not yet been automated.  The opportunity presented by new Internet SaaS applications is large.  The pace of innovation in this sector will remain strong as existing companies compete for market leadership and new companies enter the market.  Finally, as these companies are either being acquired or go public, their engineers and executives will look to start new ventures ensuring a strong pipeline of continued innovation.

By and large, private Internet SaaS application companies are now growing faster and are achieving profitability easier than enterprise SaaS application companies.  We’ve heard that from the CEOs of the companies we considered investing and we can see it from the 2009 results posted by own portfolio companies (Turn, Sojern, Elucido).  Technology innovation combined with strong growth and strong financial results bode well for attractive exit opportunities.  Many of Internet SaaS application companies are already becoming acquisition targets or even IPO candidates.  As a result, companies in this category that were funded over the past 12 months achieved valuations that were unaffected by the difficult economic environment.  So, we are as we redouble our efforts to find the next Salesforce we start to realize that it likely come from the Internet rather than the enterprise space.

The Big Picture: Investment Trends and Themes

Last Wednesday I presented at an event organized by Janney Montgomery Scott, an investment bank, about the investment trends we are following and investing on.  l spoke about three large trends:

1.       The shift from offline to online in advertising and commerce

2.       The shift from on-premise to on-demand, or cloud-based, software

3.       The desire of corporations to utilize the data they generate or must access to.  This is big data

Oftentimes these areas intermix.  For example, some of the better campaign management applications used by online marketers are SaaS.  Online businesses are some of the largest data generators.

Within Internet we have been focusing on 2 areas: e-commerce and performance-based advertising.  The current economic environment favors the further growth of e-commerce globally.  We have continued to make investments in an area we call branded response that combines the sophisticated use of analytics to achieve low-cost customer acquisition and high per customer retention and Lifetime Value.  Thus far we have invested in 5 such companies in the US and China (Syndero, AccountNow, Zeo, Profex and Advanced Payment Solutions).  Even during the difficult past 12 months these companies have exceeded their financial targets and have grown by over 100% YOY.  For this reason we continue to look for companies that offer data, products or services that facilitate e-commerce. 

We perceive a huge demand for increasing the effectiveness of online marketing and advertising.  Online advertising is global, targeted, personalized and measured in ways that no other form of advertising can. Portfolio companies such as HomeAway, Turn and Sojern here in the US, as well as Elucido in India have been growing quickly because they provide differentiated and technologically advanced platforms.  We plan to continue investing in this sector looking for solutions that allow corporations to optimize their online advertising decisions and address post-sales customer engagement.

Cloud computing in all its incarnations (SaaS, PaaS and IaaS) and virtualization (of various layers in the IT stack) represent fundamental enterprise IT platform shifts and are attracting significant attention from corporations and investors.  SaaS applications, in particular, are being adopted by smaller and large enterprises because they provide superior TCO, faster deployment, and better overall value than their corresponding on-premise counterparts.  We have invested behind horizontal SaaS applications, for example business intelligence applications, and IaaS solutions such as Qualys.  More recently we started shifting our investment strategy towards vertical applications, particularly those offered by later stage companies.  For example, working with our healthcare IT team we have been looking for SaaS applications that allow payers to reduce costs, allow providers to enhance their revenue, and applications aimed at consumers.  Other verticals of interest include: energy, particularly applications that utilize the data generated by smart grids, logistics, and financial services and insurance.

Because the large IT vendors (Microsoft, IBM, SAP, EMC, etc.) are making significant investments  in cloud computing, we hesitate to aggressively invest in companies whose products will compete directly with those of the large vendors.  Private companies that develop cloud management solutions are of interest but today we see the space as being overfunded.  As it happened with other IT platform shifts, we anticipate that it will take a few years for cloud computing platforms to become established enough that will necessitate the appropriate management tools.

We monitor the adoption of server virtualization technology with great interest though we see few opportunities for new investments.  Despite the broad adoption of netbooks (particularly during 2009) we are skeptical about investments in client-side virtualization.  We believe that database and application virtualization may provide only selective investment opportunities.  However, we invested in Hytrust, a company that is developing security solutions for virtualized environments, because it combines security where we have been investing for several years and where we continue to see interesting opportunities with virtualization.

Data is becoming strategically important to enterprises as they become performance-driven.  It is also being generated in unprecedented volumes, particularly by internet portals, ad networks social networks, like Facebook, and e-commerce companies.  As a result, we are interested both in companies that can address the management and analysis of big data, as well as data companies that use technology to allow their clients to make better business decisions particularly in the areas of online marketing and advertising.

We have built broad experience (executive, client and partner networks, business models, technology models, etc.) in all these areas.  We will continue leveraging this experience in new investments we will be making in order to build them into successful and enduring companies.

Interest in New Analytic Applications

Gartner’s 2010 top technologies list is out and, as expected, cloud computing is at the top.  I say “as expected” because in the last few months we and several of our SaaS portfolio companies, e.g., Host Analytics, Pivotlink, Qualys, Tricipher, have noticed that Gartner analysts are being more receptive to cloud-based solutions and even recommend SaaS applications to their customers.  What I, at least, didn’t expect was to see analytics, or “advanced analytics” as Gartner calls it, to be second in that list.  For years Gartner preferred to focus on business intelligence (data warehousing, reporting, OLAP), which was second in last year’s list, but viewed analytics as some more nichey.

By “advanced analytics” Gartner refers to analytic applications that can effectively and efficiently extract information from the new types of data of the mega data sets being generated.  Gartner’s recognition of the need for advanced analytics and analytic applications is consistent with recent presentations on cloud-based analytic applications being developed by drug companies such as Eli Lilly particularly around the area of drug discovery, as well as what we heard at the Hadoop Summit where companies, such as IBM, Visa, and Visible Technologies, described their efforts around Hadoop and MapReduce to analyze large data sets.

For some time now I’ve been thinking about new SaaS-based analytic applications I find intriguing and exciting enough to want to invest.  Not surprisingly these are vertical applications.  There already exist plenty of horizontal applications for CRM, ERP, BI, etc.  Here is my list:

• Healthcare.  Disease management and patient care, healthcare provider analytics including patient cost and revenue analysis, Electronic Medical Record analytics, drug discovery.
• Cleantech/environment. Energy grid management (making the grid smarter and more efficient), climate analytics, green data center analytics, natural resource (e.g., water) management.
• E-commerce. Social commerce analytics, keyword bid management and optimization, channel optimization, campaign management applications integrating SEM/SEO, applications for branded response and continuity program marketing.
• Online advertising.  Applications for referral marketing, new media analytic applications (including mobile application analytics, streaming media analytics, new forms of web analytics), analytics for ad networks.

All these application areas are characterized by very large data sets of structured and unstructured data generated continuously, where information has to be formulated and consumed in a timely manner because its relevance expires quickly.  I look forward to receiving your feedback on these analytic application ideas as well as other ideas that need to be added to the list above.

SaaS Portfolio 3Q Sales Performance Analysis

We have entered the quarterly reporting season. Based on the IT companies that have already announced their quarterly results, it appears that the worse of the economic slowdown may be behind us.  Not only 3Q results are coming in on or above target, but CEOs of IT companies and analysts are more confident about the 4Q results.  Moreover, in some recently published surveys, CIOs and business unit executives stated that during the 2H09 they will start investing again around their IT initiatives, and are forecasting modest growth of their 2010 IT budget.

In this environment public SaaS companies, regardless of size, are doing particularly well and their stock performance is outperforming the broader market.  A recent report published by Saugatuck Research (see graph below) highlights that a) after several quarters of revenue declines, SaaS companies will start experiencing revenue growth again during 4Q and b) the revenue growth of SaaS vendors, even during the recent tumultuous quarters, has outpaced that of their on-premise competitors. 

Let’s now turn to the 3Q09 performance of Trident’s SaaS portfolio.  While we measure the performance of our SaaS portfolio companies using a variety of Key Performance Indicators, e.g., MRR, for the purpose of sales performance analysis we look at the following metrics:

1. Renewal rates, i.e., what percent of the customers that were supposed to renew during the quarter actually did so.
2. Upsells to existing customers, in the form of expanding the use of an existing solution (for example, adding seats), buying additional modules of a solution, or buying a new solution.
3. Sales to brand new customers.
4. Contract terms, including payment terms since they impact cash flow.   We monitor whether the customer accepts the vendor’s contract terms or whether custom contracts are created.  For example, is the customer signing a one-year or a multi-year contract?  Is the customer willing to pay for the term in one installment, two, or more?
5. Sales and marketing costs, and sales cycle.  What was the cost/lead?  What did it take to convert a lead to an opportunity and how much did it cost?  What did it take to convert the opportunity into a sale?  Did it require custom demos, lengthy and costly evaluation periods, on-site visits?
6. Sales forecast accuracy.  Was the sales force able to close the accounts it projected every month of the quarter? Were the wins as large as had been anticipated?
7. Pipeline coverage needed to achieve the monthly and quarterly targets.

Our observations were:

1. Renewal rates, taking into account churn, were achieved and after mid-August they were more predictable.  This time the customers were not waiting until the very end of the quarter before they renewed.  Moreover, renewals, by and large, didn’t require as many calls as in the recent past.  However, our portfolio companies’ assumptions on churn came on the higher end of the range.   Since the beginning of the year our companies have been assuming 15% annual churn, whereas as investors we consider 8-10% annual churn as the right target.
2. Surprisingly, upsells during the quarter were more challenging than new sales.  This is the reverse of what our companies experienced during 2Q.  We believe that unfortunately this is due to the continued layoffs in several companies, implying that application usage is not expanding.
3. Smaller companies (less than $200M in annual revenues) were making purchasing decisions faster than mid-size companies ($300-800M in annual revenues).  In fact, it also appears that there was more inbound interest from the smaller companies during the quarter.  More customers opted for longer term contracts (2- and 3-year contracts).  This is a complete reversal than what we saw during 2Q when several customers were opting for annual contracts with monthly billing.
4. For 4Q opportunities the sales executives continue to feel more comfortable with 4x pipeline coverage (i.e., the pipeline must contain qualified opportunities that are valued at 4x the quarterly sales target), same as in the 3Q.
5. Sales and marketing costs per sale continue to increase.  Companies are staying within budget by being frugal in R&D and G&A.  The former is not sustainable as our companies will need to continue investing in their products to stay ahead of the competition and attract customers from additional segments and industries.

During 3Q our SaaS companies continued to perform particularly well and are poised for start growing more aggressively during 4Q and 2010.  Based on anecdotal input we have received from corporate executives as well as the data that is being reported from broader market surveys, we expect that during 2010 the revenue of our SaaS companies will be able to grow by at least 30%.

Developing the Channel for SaaS Companies

In previous posts I have written about various aspects of sales in SaaS models including the importance of the collaboration between sales and marketing, the role of inside sales operations, controlling customer acquisition costs, and the role of self-service processes in sales and support.  Today I briefly wanted to touch upon business development.  The management teams of young SaaS companies that come to present to our firm often mention that upon raising their round they will hire a business development executive to help them grow channel sales.  These companies tend to have 20-50 direct customers and have raised either one institutional round of funding or are bootstrapped.  It always strikes me as odd that after acquiring only 20 or so customers, management feels that they thoroughly understand their solution’s direct sales process and the costs associated with this process to the point where they feel ready starting on channel sales.

I would have thought, and continue to hope, that the management of such early stage companies would want to devote more resources in better understanding the direct sales process associated with their solution so that they can optimize it and reduce the costs associated with it, before embarking on creating and optimizing the corresponding channel sales process.  By the way, we typically respond to such statements with a healthy dose of skepticism and never make an investment decision in an early stage company whose primary success must come from direct sales, based on the promised success of channel sales.  Our skepticism regarding channel sales is almost always validated once we invest in such early stage companies.  We usually find enough immediate opportunities for improvement around the direct sales process that we invariably delay the management team’s immediate plans to expand into channel sales.  I’ve recently read this post which summarizes so crisply the issues we have with attempts by early companies to expand in channel sales that I thought of sharing it along with my commentary.

The Magic Number provides an additional way to evaluate whether the direct sales model is working and the startup is ready to invest in the development of the channel. Will Price in his blog posted the graph below which comes courtesy of Josh James, CEO of Omniture. The graph correlates the magic number score to a company's growth stage. Don't try to overanalyze it. Just another perspective around the type of attention that needs to be paid around getting one sales model right before adding another model.

SaaS Application Development Platforms

Let me start today’s post with the news that Salesforce.com (NYSE: CRM) posted better than expected quarterly results.  Salesforce’s results provide one more indication that SaaS companies are able to weather the recent financial storm better than their on-premise software counterparts.  They also give further credence to the statement in last week’s Pacific Crest conference that the 2008 recession will prove to be a boon to SaaS companies in the same way that the 2001 recession was a boon to the Indian outsourcing companies.

Now onto the main topic.  I’ve written in the past about ways to improve the capital requirements of the SaaS companies through the use of self service approaches for sales and services, the re-thinking of how to market the software and generate leads, and the use of open source components (as exemplified by the LAMP stack) for product development.  Over the past few weeks I’ve participated in several very interesting discussions with existing portfolio companies as well as companies I’m considering for an investment on whether the three cloud-based application development platforms (Amazon’s EC2, Google’s App Engine, and Salesforce’s Force) are ready to serve as the foundation of robust, “enterprise class,” scalable SaaS applications.  I should note that Azure is eagerly anticipated because of Microsoft’s claims for its flexibility and scalability.

Why the interest all of a sudden?  Many of the companies that built their first generation of SaaS applications on the LAMP stack have come to realize that in the process they have implemented mini-platforms.  Maintaining this infrastructure is becoming costly particularly as the applications incorporate more sophisticated functionality and they need to be integrated into complex enterprise IT architectures.  Shifting the platform’s development and support onto a “platform specialist” can save development time and money, in a manner similar to past application architecture paradigm shifts, e.g., 3-tier architectures.  Today it wouldn’t be unreasonable for a private company developing an enterprise SaaS application, for example an industry-specific ERP system, to spend more than $10M just on the development of a platform on top of which the actual application is built.  I’m sure applications with broader scope, such NetSuite’s ERP, are implemented upon platforms that required an even higher investment.  So, why wouldn’t a SaaS applications company pay, let’s say, 10% of the annual license fee it charges for its software for a robust third-party platform?

The short answer is that for prototyping any type of SaaS application or the development of transactional SaaS applications that are not mission-critical the available cloud-based platforms are more than adequate.  EC2 and Google abstract hardware resources but require a lot of programming. This means that they may not yet provide enough of a benefit to the developer of a substantial enterprise SaaS application.  In Google’s case this programming is done using Pearl and PHP which again appears to present a problem for the development of enterprise applications.  However, developers are anticipating the App Engine’s upcoming support of Java.  Force also uses a declarative language that is proprietary to Salesforce. The platform provides several application building blocks but application architects told me that are concerned about its scalability.  Most of the SaaS application company executives I spoke with agreed that they would be ready to utilize one of these three platforms, or Microsoft’s Azure, as soon as they feel that they will realize productivity and cost benefits.

Of course there are SaaS application companies that regardless of the cloud-based platform’s cost benefit and functionality richness they will still not use it.  The reasons I heard most frequently for such a decision included:

1. Better control over the application’s and the platform’s scalability, software fixes and. SLAs, e.g., uptime.
2. Customer ownership, i.e., since the platform itself is cloud-based they don’t want the third-party platform’s owner to have any access to the application company’s customers.
3. Data ownership and data usage, i.e., the application’s owner doesn’t want the platform’s owner to have access to any of the data used by the application or be able to use that data for any other application.
4. Speed of innovation, i.e., by developing a platform specific to the application, the application’s owner will be able to innovate at the platform level faster than the platform specialist which must ensure that the platform will be suitable for many different applications.

Cloud-based platforms will continue improving and Azure will only up the ante.  While not yet ready to serve as the foundation of every SaaS application, particularly not the enterprise class mission-critical applications, in EC2, Google App Engine and Force we have three platforms that warrant serious consideration by companies that are looking for new ways to cut the costs of developing, supporting and maintaining their on-demand applications.

The Importance of Self-Service Operations for SaaS Companies

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.

 

SaaS Portfolio Sales Performance Analysis

With the end of the second quarter we again took the pulse of our portfolio companies to see how they are progressing in these difficult economic times.  Of particular interest were the SaaS companies because, as I’ve written in the past, they had demonstrated impressive resilience to the deteriorating market conditions between 3Q08 and 1Q09 and were even exploiting the economic environment to make inroads with Global 2000 customers.  The bottom line is that 2Q09 was tougher for all our software companies including the ones with SaaS solutions.  This situation is not unlike what we hear from public SaaS companies about their performance during 2Q09.

The backdrop for 2Q09’’s purchasing environment was the state of the IT budgets.  Through our own informal CIO and business unit executive interactions as well as from analyst reports we determined that during 2Q09 companies of all sizes continued to cut their IT budgets.  Fortunately, very recent data shows that the IT budget-cutting bottomed out during 2Q09 and budgets are expected to remain stable for the remainder of the year.  I believe that this stability will make corporate executives more comfortable spending around IT solutions during the 2H09.

But let’s return to the 2Q09 performance.  We measure the performance of our SaaS portfolio companies using a variety of Key Performance Indicators, e.g., MRR.  However, for the purpose of sales performance analysis we look at the following metrics:

1. Renewal rates, i.e., what percent of the customers that were supposed to renew during the quarter actually did so.
2. Upsells to existing customers, in the form of expanding the use of an existing solution (for example, adding seats), buying additional modules of a solution, or buying a new solution.
3. Sales to brand new customers.
4. Contract terms, including payment terms since they impact cash flow.   We monitor whether the customer accepts the vendor’s contract terms or whether custom contracts are created.  For example, is the customer signing a one-year or a multi-year contract?  Is the customer willing to pay for the term in one installment, two, or more?
5. Sales and marketing costs, and sales cycle.  What was the cost/lead?  What did it take to convert a lead to an opportunity and how much did it cost?  What did it take to convert the opportunity into a sale?  Did it require custom demos, lengthy and costly evaluation periods, on-site visits?
6. Sales forecast accuracy.  Was the sales force able to close the accounts it projected every month of the quarter? Were the wins as large as had been anticipated?
7. Pipeline coverage needed to achieve the monthly and quarterly targets. 

 Our observations were:

1. Renewal rates were achieved but more customers waited until the end of the quarter to sign.  This may be because they were waiting for quarterly application usage statistics so that they can decide if they may be able to renew with fewer seats (and therefore for a lesser amount), or because they were trying to delay as much as possible having to pay for the renewal, i.e.., cash management.
2. Upsells became a larger piece of the new quarterly sales than sales to brand new customers.  First, this trend caused sales forecasts to become inaccurate.  Second, prospects remained engaged but dragged out their decisions.  Some delays were just to the end of the quarter (literally the last day of the quarter, bringing back memories from on-premise enterprise software sales cycles).  Other delays were to later in the year.  During the quarter our companies also saw more involvement from IT organizations during the sales cycle even if the solution was targeting a business unit.  Some of that involvement may have been expected since, increasingly, more Global 2000 companies are interested in on-demand software and IT tends to provide a necessary input to these purchasing decisions.
3. Along with the lengthening sales cycles we also saw the need for more interactions between sales team and prospect, which of course added to the cost of sales.
4. We heard from several sales executives that even with strong qualification criteria after what they encountered during 2Q09 they now feel more comfortable with 4x pipeline coverage (i.e., the pipeline must contain qualified opportunities that are valued at 4x the quarterly sales target) compared to the 2.5x coverage they were using during the 1H08.
5. Particularly the smaller customers opted for annual contracts with monthly billing rather than bi-annual or even quarterly billing, as was the norm before particularly for the larger vendors.  This will make cash management for the vendors even more challenging.  Fewer customers chose multi-year contracts even after being offered discounts.
6. While lead generation is improving as the awareness and interest for on-demand software are increasing, conversion rates (leads to opportunities, opportunities to sales) deteriorated during 2Q09.

Our SaaS companies continue to weather the storm relatively well.  Customers with “pants on fire” problems continue to buy software solutions that can address them and they appear to opt for on-demand software over on-premise solutions because of all the benefits SaaS offers.  However, during 2Q09 we saw the negative impact of the economy being felt by the SaaS companies in earnest.  We don’t know yet whether the 2H09 offers any reasons for optimism so we continue to manage each company very conservatively.

I'd be interested in feedback from SaaS companies on what sales performance they saw during 1H09 in general and 2Q09 in particular.

 

The Impact of Google’s OS to SaaS Applications and Cloud Computing

In the last 24 hours a lot has been written about Google’s announcement to offer a web-based operating system.  While the announcement was short on details, the commentary and speculation more than made up for it.  The majority of the discussion thus far has been centered on the impact to Microsoft’s OS and Office businesses.  This may be well-justified because of the importance of these businesses to Microsoft.  However, Chrome OS will also a big impact to SaaS and cloud computing.

Business users are continuously increasing their use of SaaS and cloud computing.  In addition to the data I receive from our own SaaS portfolio companies and the SaaS companies we consider investing that is providing evidence of increasing usage, a recent survey published by CIOZone showed that over the next two years users are expecting to increase the number (up to 20%+) of workloads they run on cloud-based platforms.  When only new workloads are considered the number of workloads that users would consider running on cloud-based platforms increases even further.  Business and corporate IT users list security, response speed, ease of deployment as the top issues that inhibit the even broader adoption of SaaS applications. Windows at the client side is responsible in part for these three issues. Google’s announcement states the Chrome OS is being built from the ground up on a web-centric architecture to address exactly these three issues.  I’m also certain that the experience Google has gained developing, deploying and supporting its suite of Google Apps (Gmail, Google Docs, Google Calendar, Google Talk) that are now used by over 1.5 million companies will be reflected in Chrome OS.  All this means that Chrome OS has the potential of providing a superior environment for running SaaS applications and deploying cloud-based infrastructures.  Google should be advised to invite SaaS application developers into its development and testing program not only in order to benefit from their experience while building the operating system but also to ensure that enough such applications will be available on Chrome OS from the get-go.

Google’s choice of netbooks as the initial deployment platform for the Chrome OS may also be a particularly appropriate one.  Netbooks are the fastest growing hardware segment in 2008 (growing by 185%), and will represent 15% of all computers sold in 2010.  Microsoft has not been paying as much attention to netbooks because of Vista’s issues and hardware requirements though this may change with Windows 7.  But netbooks are not only popular with consumers.  They are becoming increasingly interesting to corporate IT because when combined with server-side virtualization they represent a key technology that enables CIOs to further cut IT costs and improve their control over the user desktops.  They achieve this because a) they are cheaper devices than the full-fledged PCs, and b) once on a corporate network they can be made to only run the internet- and intranet-based applications approved by the IT organization.  Cheaper desktops implies that hardware upgrade cycles can be expedited and more money can be freed for other IT initiatives, such as the purchase of additional applications.  Many netbooks run on Linux today.  While Chrome OS will also be based on Linux, it has the opportunity to be better tailored to netbooks than “raw Linux” (since it is being architected from the ground up with such devices in mind). So, Chrome OS will not only provide a more controllable environment but one that runs SaaS applications faster and more securely.  Having less expensive desktops, exerting better control over these desktops, and knowing that these desktops are less vulnerable to security problems and run web applications better will make IT further accelerate the deployment of SaaS applications.

Within a day Chrome OS has succeeded in capturing peoples’ imagination about the computing opportunities it will enable.  Let’s hope that it will be delivered on time and that it will be robust enough for CIOs to feel comfortable using it effectively in their corporate environments.  Then I expect to see the beginning of an even stronger cycle of SaaS and cloud computing innovation.

 

Data Warehousing in the Cloud

Companies that provide on-premise BI solutions, like Business Objects, Microstrategy etc. connect to data warehouses that are built on top of third-party databases like Oracle, DB2, SQLServer, PostgressSQL and MySQL.  These database management systems, as well as data warehouse engines such as Teradata’s, provide the functionality and utilities for the creation, access, and management of a data warehouse or data mart.  The current generation of on-demand BI solutions like those offered by Pivotlink, Lucidera and Birst depart from this model by integrating a query application with a database management system both of which reside in the cloud.  More recently, data warehouse appliance vendors such as Aster Data, and Vertica started offering cloud-based options of their appliances.  Through these options they allow companies to develop data warehouses and data marts completely in the cloud and access them via on-premise or on-demand query applications. 

Cloud-based BI solutions that integrate a query application with a data mart are not entirely new.  Data marts containing web analytics data have been offered almost exclusively as cloud-based solutions by companies like Omniture and Google.  Corporations using these SaaS solutions are storing increasingly more complex and mission-critical data in these data marts, including customer data. Should on-demand BI vendors continue offering solutions that integrate the query application with their own data management system, or should they start partnering with the vendors that offer cloud-based data management systems which can be used to be standalone data warehouses in the cloud?  The answer to this question depends on your point of view regarding on-demand BI and data warehousing.  I’ll consider three perspectives: the on-demand BI solution vendor’s, the end user’s, and the IT user’s.

 The On-Demand BI Solution Vendor

For the on-demand BI solution vendor this is not an easy question to answer.  Having full control of both the application layer and the database layer offers its advantages but also has drawbacks.  The major advantage comes from the vendor’s ability to better control how data is loaded to the data warehouse, how it is organized and how it is queried. 

The ability to load data quickly allows the vendor to work with larger data sets during smaller time windows as dictated by the customer, as well as service more customers at any one time.  While smaller companies may only refresh the data in their data mart weekly, larger customers typically refresh data daily.  Moreover, the transactional database of such larger customers can only stay offline for short time periods during which data must be transferred to the data marts.  For example, a retailer may only provide a 3-4 hour window daily during which sales data can be uploaded to a data mart.  If such an operation has to be performed for hundreds of the SaaS BI vendor’s customers, then one can appreciate the importance of fast data loading. 

Data loaded in the data warehouse has to be organized in the best possible way to enable the optimal execution of queries.  The managers of on-premise data warehouses and marts constantly look at the queries executed against their databases to determine how to best organize the data to achieve best query execution times.  Some of these optimizations can be performed automatically by the database management system but most require manual intervention.  Having full control of the database management system enables the SaaS BI vendor to better optimize the organization of the stored data.

Finally, the expressiveness of the language used to query the data mart determines the range of analyses that can be performed and reports that can be created by the BI application, and also contributes to the speed with which queries are executed.  Even though SQL is a standard all database management vendors implement their own extensions, including several that are specific to data warehousing, in order to add to the language’s expressiveness.

Creating a strong database management system to support data warehouses and data marts for a variety of analytical applications is hard.  The areas mentioned above such as data loading, query optimization, query management, etc. are difficult to address and require specialized knowledge.  As many database management vendors have shown over the years (from Teradata to Red Brick, Netezza and Aster Data) good database implementations require significant R&D investments.  By decoupling the database from the application, the on-demand BI vendor will be able to focus on improving the application’s functionality without having to worry about the underlying database system.  However, despite the higher investment necessary, I think that in the short term (at least the next 2-3 years) it will be difficult for on-demand BI vendors to decouple their applications from the databases and go with a third-party offering.  In order to provide strong ROI to their customers, on-demand BI vendors will need full control of the stack as they learn about the application areas where on-demand BI will provide a strong alternative to its on-premise equivalent. 

The End User

An end user subscribes to on-demand BI applications either because his organization doesn’t have an in-house BI solution and developing such a solution internally is deemed as too expensive and requiring too much time, or it does but the solution is hard to access.  Such a user doesn’t care whether the data is stored in the cloud-based data warehouse of the vendor who provides the on-demand solution, or in a third-party’s cloud-based data warehouse.

The end user cares about convenience and analysis effectiveness.  “Convenience” means that the end user would prefer an on-demand vendor that provides a one-stop to BI.  “Effectiveness” means that the user is interested in quickly analyzing data to achieve a specific goal, e.g., determining which merchandize to discount in which regions and for what time period.  During the analysis task the user is concerned about securely loading the right data to the data warehouse, quickly and easily interacting with that data to produce the desired results and reports, and keeping the data stored safely for as long as it’s necessary. 

The on-demand BI solutions available to date have been developed with such a user in mind.

The IT User

The IT user has only recently started entering the conversation around on-demand BI solutions.  This is happening as more of the larger companies that actually have IT organizations have started using SaaS BI solutions in conjunction with (or some times instead of) their on-premise ones.  IT organizations worry about the security of the data that moves from their companies’ internal databases to the on-demand vendor’s data warehouse, the integrity of the data sent to the vendor, since they must guarantee that the data stored in a company’s internal databases is always synchronized with the corporate data stored in SaaS vendor’s data warehouse, and their ability to take back the data when the need arises.   

IT must feel confident that the on-demand BI vendor uses the strongest possible security measures to safeguard the data in the warehouse.  The SaaS vendor is expected to perform at a higher standard than the IT organization itself when it comes to security.  CIOs are starting to fear that as SaaS vendors become better established with growing client rosters that include prominent corporations, they will become prime targets for hackers (individuals or groups, independent or government-sponsored), who would want to exploit the existence of large databases with prized corporate data in a single place.

Today every on-demand BI vendor requires that they be provided either with behind the firewall access to corporate databases so that they can extract data as necessary, or with the appropriate data sets to load into their cloud-based data warehouse.  Most corporations provide the SaaS vendors with data extracts because it’s safer than giving them access to the corporate databases.  However, this approach, while safer, results in multiple copies of the corporate data.  Keeping this data updated and synchronized, so that the analyses resulting from the extracts can be impactful, can become a hard and expensive task that further taxes IT resources. 

Finally, IT must ensure that the corporate data will not become hostage of the on-demand BI vendor.  To this end, the vendor must make it easy for the customer to take back its entire data set either because of deciding to switch on-demand BI vendors, or because the vendor is going out of business.  An approach to addressing this problem may be provided by Cloudkick.  In addition, the on-demand BI vendor must make it easy for the customer to obtain subsets of the data stored in the cloud-based data mart to use it with other applications.

I wouldn’t be surprised if the majority of IT users would prefer a cloud-based BI application that accesses data stored behind the corporate firewall and doesn’t move the data permanently to the cloud.

The growing success of on-demand BI applications will lead to a lively dialog among these three constituencies on how such applications should be partitioned among the various types of cloud-based vendors and the clients themselves.

 

The Case for On-Demand BI Solutions (Part 2)

I have been a bullish investor of companies that provide on-demand BI solutions (to date I invested in Pivotlink and Host Analytics).  After being involved with BI for over two decades I see SaaS as a fundamentally transformational model whose benefits outweigh the adoption issues I described in my last posting.  Moreover, these issues are not “show stoppers.”

 The value and uniqueness of on-demand BI is coming from the following areas:

1. Cloud-enabled collaboration. Collaborative BI can effectively be enabled through cloud computing.  Companies want to collaborate through data.  Employees want to collaborate with other colleagues and partners by looking together at a single view of internal and external data that impacts daily their business “ecosystem.” Today the only decisions that are effective are those based on data blended from inside and outside the company.
2. More efficient analysis paradigm.  On-demand BI transforms the "traditional" ETLA (Extract Transform Load Analyze) process found in most data warehousing/BI environments, to an ELA process (Extract Load Analyze) process. This doesn't simply mean that you are removing a costly step (Transform) from the process, but that you are changing the entire analysis paradigm. Because on-demand BI applications make Extraction and Loading very cheap, the user of an "ELA environment" doesn't have to be extremely thoughtful on what data to include in the warehouse (or data mart) and how to transform it in order to improve the analysis results. Instead he can load a bunch of data and "experiment" with it. If the experimentation goes well then he continues. If it doesn't go well then he "throws the loaded data away" and load some more without delay or guilt. On-demand BI companies like Pivotlink have been developing extremely fast data extractors and loaders in order to better support the ELA paradigm for an expanding set of cases.
3. Social networking/Community.  Social networking and other social media applications have demonstrated the power of communities and are now moving from personal use to enterprise use.   Community-based tools built around on-demand BI solutions can increase a BI solution’s adoption, reduce service delivery costs and, through the established dialog between users and the solution provider, improve the application’s feature set and performance.  Imagine, for example, through a presence tool, such as Microsoft Messenger, a user determines that another user who is an expert on inventory analysis is online.  By looking up this user’s profile he finds out that the user has received good recommendations from co-workers and customers about his ability to create inventory analysis reports.  A real-time dialog can begin and lead to collaborative problem-solving.
4. Better maintenance of the application and the data. Because the application/reports and the database/data warehouse are located in the vendor’s data center, software updates, database maintenance for optimal query performance, report organization and other tasks associated with the support of a properly running BI solution are managed and performed centrally by the vendor.  This activity results in optimally running BI solutions enjoyed by all users.  The performance of on-premise BI solutions is dependent on the IT organization’s abilities to a) devote the right resources to address the above mentioned tasks along with software updates and patches coming from the vendor and b) develop local expertise to optimize the performance of each BI solution being used.  This may be possible in certain companies with large and sophisticated IT organizations but, unfortunately, it is not found in every company that uses on-premise BI solutions.  For example, a recent Oracle critical patch bundle included 16 updates for Oracle Database Server, 12 updates for Oracle Application Server, 3 updates for Oracle Applications, 4 updates for Oracle PeopleSoft and JDEdwards Suite, and 8 updates for BEA Products Suite.
5. Usage optimizations. By monitoring the on-demand BI solution’s usage, the vendor can a) dynamically make optimizations to improve its performance, and b) determine which features are being used effectively, which features are not being used at all, which features present difficulty to the user (even though they are perceived as useful) and also make improvements as appropriate.  There is a bigger point here relating to a vendor’s monitoring a SaaS application’s usage.  It should first be noted that this type of monitoring cannot be accomplished for on-premise applications.  The vendors of such applications don’t know how their software is being used.  On-demand application vendors have the opportunity to closely monitor usage to identify: a) if the application is used as expected, b) which parts of the application are being used the most (not unlike how a web analytics package reports on which web site pages are being visited), and c) even provide cross user statistics in the way Nielsen and comScore report various types of audience metrics.
6. Easier to avoid vendor lock-in particularly now that the major on-premise BI vendors (Cognos, Business Objects, Hyperion) have been consolidated. Because of how critical BI is to every corporation, customers should always try to select the BI vendor with the most-suitable solution rather than the vendor that offered them "a great deal" on BI by bundling it with a bigger IT contract, as the major IT vendors are likely to do.
7. Innovation.  The consolidation of the major on-premise BI companies can also result in slower innovation since they are now divisions of larger IT vendors that may have different overall objectives than to provide innovative BI solutions.

 Areas that are impacting the TCO of an on-demand BI solution:

1. Fewer personnel needed to support the application.  Moreover these personnel don’t have to possess specialized knowledge in the way that personnel that support on-premise BI solutions must have.  BI solutions have been particularly personnel-intensive (database designers and administrators for the data warehouse, programmers and analysts to create and maintain reports, data analysts to extract information from the collected data).
2. No upgrades to hardware.  The dissemination of on-premise BI solutions within the enterprise has been frequently stymied by the need for upgrades so that client machines can satisfy the processing needs of BI tools.  On-demand BI solutions are not only accessed through a web browser obviating the need for hardware upgrades but also resulting in fast deployments of these solutions.
3. Cheaper implementation of a data warehouse/data mart because using a standard data model is faster and can benefit from the improvements (functional, architectural, implementation) performed by the vendor’s dedicated staff for all customers.
4. No hidden costs in terms of solution upgrades, customizations, systems and data integration.
5. Dedicated vendor personnel keeping the data warehouse in top shape (through data model refinements, data utilization, additional aggregations, etc.) and disaster recovery.  When considering the cost benefits of SaaS, many companies do not include the value of transparent and immediate upgrades to the latest software version.  Companies deploying traditional on premise solutions must account for the ongoing cost of planning, implementing and supporting new software upgrades and bug fixes.  This can easily cost from tens to hundreds of thousands of dollars in professional services, IT resources and duplicate hardware and it usually involves running parallel applications during the implementation, testing and acceptance period. It is not surprising that the average ERP implementation is typically 2-3 versions behind the latest software update.

 BI continues to score high as an important corporate solution even during this time of shrinking IT budgets.  On-demand BI addresses many of the issues that had plagued on-premise BI solutions and offers some unique advantages making such solutions possible for more and larger segments of the market.  As such it warrants serious consideration by small and large companies alike.

 

The Case for On-Demand BI Solutions (Part 1)

In recently published CIO surveys conducted by Morgan Stanley (see below), Gartner, and Forrester, BI consistently scores high as a must-have solution and likely to experience little or no cuts in the current environment.

 

After participating in discussions on new BI solutions (here and here) I walked away thinking that while the interest in on-demand BI solutions is increasing, the SaaS delivery model for BI is not yet broadly accepted.  Five issues are perceived as obstacles to the adoption of on-demand BI:

• Data security.  Because BI can involve the analysis of sensitive data, e.g., personnel data, companies hesitate moving this data outside their firewall.
• Total Cost of Ownership (TCO).  The TCO of on-demand BI solutions is not significantly lower than that of corresponding on-premise solutions.
• Application uptime.  On-demand BI applications are not as reliable as their on-premise counterparts to support operational decision-making.
• Data uploading speed.  State of practice communication infrastructures don’t allow large quantities of data to be uploaded to the cloud fast enough to enable, through the use of BI tools, the creation of necessary insights in a timely manner.
• Application sophistication. The on-premise reporting tools, e.g., Cognos, Business Objects, provide richer functionality than their on-demand counterparts.

 

As the data from a recent Goldman Sachs CIO survey indicates (see below), the first three of these issues (security, TCO, and application uptime) are customer concerns for every other on-demand application, and are not specific to on-demand BI.

Source: Goldman Sachs CIO Survey

 

Data uploading speed impacts BI solutions more specifically since such solutions are by nature data-intensive and, in order to be effective, applications such as price optimization, markdown analysis and others require quick turnaround of data.  Finally, functionality comparisons between on-premise and on-demand equivalents have been offered as arguments against the use of any type of on-demand application, from word processing to ERP.

 

Yet all these issues have not slowed down the rapid adoption of SaaS applications.  For example, the growing popularity of Human Capital Management SaaS applications, like Workday and Success Factors, indicate that the companies of every size are satisfied with the ways such application providers address data security.  Similarly, the growth of on-demand ERP systems, such as NetSuite’s, points to the customer acceptance of the uptime performance of these mission-critical applications.  Successful on-demand price optimization applications, like DemandTec’s, show that uploading large data sets is being addressed effectively by at least some on-demand BI vendors.  It is true that certain power users of on-premise reporting and analysis tools may find that the on-demand BI tools lack some functionality.  However, the majority of the users will find that the on-demand BI tools have all the functionality that is necessary to enable them to work effectively. 

 

More and larger companies are increasingly relying on SaaS applications to run critical parts of their businesses.  The adoption trends we initially observed with on-demand CRM and productivity applications and later with ERP applications we are now starting to see with on-demand BI applications.  In the next post I will discuss the value and uniqueness of on-demand BI and of the areas that are impacting the TCO of such solutions.