Prasad, co-author of the Startable blog and CEO of Pixily asked me to expand on why I feel that SaaS is not cheap. Rather than just post a comment, thought I’d post the response here as well.
There are two main reasons why SaaS is an expensive (but still great) business model:
1.) Distribution of revenues: Monthly vs. up front one time. This has immediate cash implications due to revenue timing, but also means you need to staff both dev and outward facing roles to fight for retention. In a traditional licensing model, you hope your customers use your stuff, but ultimately it does not matter (obviously in the long run, if your product is irrelevant, you’re in trouble, but the point still stands).
2.) Operating costs: Amazon is a great way to start and you can run for a while on it. However, I will bet that if you graph the cost curves of cloud vs. running your own network that you hit an inflection point where buying your own gear becomes cheaper. Also, if you run a big enteprise service with service level agreements you likely want to control your network.
Of the two points, the 1st is the biggie. Customer acquisition costs are the single biggest barrier to growth and in a World where customers churn out (stop paying you) before you would have earned the equivelent of what you would have charged with a traditional licensing model then you need more to capital to acquire more customers to generate the same revenue.
I love SaaS, both as a buyer and a vendor, its a great business model. But I often hear people say that their business is capital efficient because its a SaaS model. This is just wrong. SaaS is a great low cost way to get started. No upfront capex. Scale your backend as your business grows. Pay Amazon a few bucks a month. All good. But, to achieve true scale, SaaS businesses require serious capital.
Take Adaptive Planning as just one example. This company offers big ticket financial planning software as a service to mid market public companies. They have raised $ 33M to date and are looking for more. They are still not cashflow positive.
Most startups do not achieve the kind of scale that Adaptive Planning, Netsuite, Salesforce and other big SaaS companies enjoy. For this reason, SaaS can be a great way to get going. But to be clear, if you plan on building a truly global market leader in your space, expect to raise a lot of capital.
As Chris from iNovia says: “SAAS is clearly capital intensive. Company exchanges upfront license payments for smaller monthly recurring revenue”.
For more on SaaS and VC, check out Bessemer’s pages on this. They have a real focus and expertise in this space.
A member of our YourStartupCFO community posted a great question about SaaS billing options. The question and my answer are below. I know many people are looking at this exact topic, so thought I’d share it here. Do you have anything else to add? Did I miss anything the member should be thinking about?
We’re currently building a SaaS offering and I wanted to get your take on various billing options we’re thinking of. Like many services out there we’re using cloud platform (Amazon AWS). This means we’re paying for compute and storage resources as they are being used by our customers.
Continue reading SaaS billing Options