E-Sourcing Forum » SaaS and the Elusive Path to Profitability

SaaS and the Elusive Path to Profitability

April 28th, 2008 at 06:07am David Bush - Iasta

I love writing about the topic of supply management vendors and the SaaS industry. Nothing gets software companies with itchy trigger fingers so tweaked, which creates a flurry of anonymous comments, meant to defend the business practice of losing money. I will have an permanent escort at the ISM conference, so I don’t get shanked in the restroom.

Hence, when I read an article by Bruce Richardson, of AMR, about the difficulty that SaaS companies have in achieving profitability, I found it very interesting. Apparently, this profitability problem is not isolated to supply management. Most on-demand software companies are pouring resources into sales and marketing and losing the battle. He quoted RightNow’s CEO, as describing the strategy, which amounts to loss leading.

When I talked to CEO Greg Gianforte a few weeks ago, he agreed it costs a lot of money to sign new accounts. These high initial costs can be offset by a successful land-and-expand strategy. He said his annual contract value was running $85K for an 18- to 24-month deal, with the average transaction worth $150K. Most customers will spend eight times what they did on the initial transaction by making five or six additional purchases over the next three years. RightNow offers 30 products.

This means every acquired client is a Vegas dice roll, and a pretty unstable model, from my perspective. Everything is riding on - the upsell. It also demonstrates that the point is not to make traditional profits, but rather, to increase perceived “value” of the company. Fortunately, the old days of throwing in everything, with no intention of monetizing it, have mostly faded away. This practice is highly destabilizing to our industry, as it builds buyer conditioning that there are no costs and it should all be “free”.

Also, from a buyer perspective, understand your TCO. Clearly, if your vendor is losing money to work with you, they will eventually try to reclaim those losses. The alternative is worse, from the buyer side - liquidation or acquisition of your vendor. I see some important things that every procurement organization should ask its prospective partner:

How much does it cost to acquire $1 of revenue for your company?

If the number is in line with reasonable costs, your vendor is under control and likely has reasonable goals (yes, Iasta fits this category, and I do know what it costs us for every $1 in sales).

If it does not work out financially for the vendor, more questions must come out:

How long have you been operating under these conditions?
What is the business plan to correct and stabilize this pattern?
What other charges will be incurred by our team later, that are not being described now?
What is going to be the upsell strategy long term with your products?

You cannot forecast everything, but this are very simple indicators which will be directionally accurate.

Entry Filed under: Analysts/Research, General, e-Sourcing Marketplace

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2 Comments Add your own

1. Charles Dominick, SPSM | April 28th, 2008 at 8:38 am

I agree that it is important for buyers to understand the profit strategy of their vendors. It does amaze me that stockholders can make good money on unprofitable companies that are later sold or, at least at some point significant amounts of stock are divested for personal profit. FreeMarkets was the prime example. Great technology and vision. But they never made a penny in profit as a public company. However, the founders made an absolute fortune via their IPO. It obviously takes intelligence to start a company and make it profitable. But I guess it also takes (perhaps even more?) intelligence to find a way to make a fortune for oneself in spite of the fact that the founders can’t lead the company to profitability.
2. Eric Strovink | April 28th, 2008 at 10:56 am

Last time I checked, the point of running a business is to make money. Very few have done so in this space, and relying on up-sell to make a profit some time in the distant future is a fragile strategy indeed.

One of the ways that buying organizations can stay afloat, even if software vendors go under, is to ensure that vendors provide user-accessible flat-file data dump capability in all modules. I’m not talking about the ability to dump mysterious XML files or useless binary data files — I’m talking about dumping well-documented and human-readable CSV files containing every piece of data that’s ever been entered into the system (if it’s relational data, multiple CSV files and a well-documented schema).

For example, suppose that your contracts management system is suddenly shut off (a very real possibility in an SaaS environment). If you had taken flat-file backups of the contracts data on a regular basis, not much will be lost. That backup data can be loaded into an Access database in about 5 minutes, restoring your ability to view it and index it (without the pretty user interface, but you can live without the pretty UI while you find another product).

One of our customers pointed this out to me a while back. He said, “When you buy software, make sure there’s an exit path if the software vendor shuts down, or if you want to change horses. You need to be able to extract your data at all times, in a useful format.”