Is SaaS such a great business model? – 19 months later.

Unbelievably I went back and read what I wrote in January of 2010 (link) where I compared BMC and Salesforce in terms of comparable companies (revenue speaking), BMC being a more traditional software vendor and Salesforce being the pure SaaS player.

Let’s look at the evolution of those two companies over the last 19 months

01/2010 SalesForce BMC
Market Cap $8.01B $6.84B
EBITDA $145M $633M
Revenue $1.24B $1.8B

Back then I thought that SaaS was not necesseraly the way to go for a startup, although fundamentally, I was seeing a lot of benefits to this model. Now about 19 months later the same table (looking at the last Balance sheet)

09/2011 SalesForce BMC
Market Cap $15.9B $7B
EBITDA $115M $677M
Revenue $1.94B $2.11B

Do you see what I see?? Salesforce doubled its market cap, increased its revenue by almost 30% and is dwarfing BMC.. That said it still has a small EBITDA. In comparison BMC basically stayed the same, with a slight growth and still a nice Earning number.

Salesforce numbers are impressive in terms of growth but scary in terms of earnings so the question remains: Is SaaS such a great business model?

Hell YES! I made one big mistake in my previous analysis and this post is here to correct it. I did not really look at the stage at which the companies were in their growth. Salesforce is a fast growing startup which has one thing in mind: Growth of the top line. On the other hand, BMC has been a stagnant company and is focused on its bottom line. I should not have compared those two companies in the first place because investment decisions are completely different in those two cases.

So why with only 6% of revenue in EBITDA is SaaS a great business model? The answer is simple: It’s the subscription model of SaaS, and it’s the growth.

If your business is using the SaaS model, you will get no big check when you sell your product, in fact it’s the opposite, you get a big cost. If the customer is big enough or if your reached a certain amount of customers on the same infrastructure, you may have to upgrade it, you will have larger server load, memory usage, bandwidth usage and all this will cost you from day one. Of course you will amortize those costs, and if you priced you offer well, you will collect the benefits of this model in the long run. So for Salesforce, a lot of those costs are applied today (R&D, Sales, Marketing, Infrastructure) which eat the margin (reducing the EBITDA).

The growth is the second factor. Growth is costly, you have to hire, you have to invest, you have to discount to win customers, etc. Marc Benioff said today in a keynote that we are trying to hire as many people as he can and the problem he has is that he cannot find enough people! Especially in sales. For a business, if the strategy is growth, where should you put your dollars? As earnings that will be taxed? distributed to shareholder (who will be taxed as well)? Or into your business to make it grow even bigger? Think about $1 of earning. Take out 30% tax. Distribute it, and take another 25%, this dollars is wasted. Now put this dollars in a business that has doubled its market cap in 19 months.. What makes sense now?

The low EBITDA of Salesforce is nowhere near the sign that the SaaS business model is weak, or that the company is not doing well, it’s the opposite. This business is doing very well, demonstrating how powerful the SaaS model can be. Companies using the SaaS as a business model cannot be evaluated as standard software vendor with on-premise solution. If you are considering SaaS for your own business, it should be very clear in your mind. It should also be very clear that transitioning from an on-premise model to a SaaS model is extremely difficult without significant hits on your revenue which is why SAP, Oracle and other big vendors have so much trouble.

Regarding Salesforce, the fun fact is that as soon as the growth starts slowing down, the earnings will explode through the rough relative to revenue. Funny how things work with SaaS.


is SaaS such a great business model?

I have to admit that I love SaaS (Software as a Service), both from a user perspective and from a supplier perspective., and those are the main reasons why:

SaaS is a new way (granted it’s well over 10 years old but new in most people’s mind) to deliver application over the web. Instead of downloading or buying an application and installing it on your own machine or server, you simply connect to a web site and use the application online. What’s the benefit as a user:

Instant access, no install cost. Using a SaaS solution is basically a matter of creating an account. When you use your gmail or Yahoo mail, it’s email using the SaaS model.. You don’t need to buy a machine.

Pay as you go.. Pricing is usually based on a subscription model: If you use the application (assuming it’s not free), you pay a monthly fee, but if you want to stop using it, just stop paying. The investment required is definitely lower than paying an upfront fee for “On-premise” software.

No Maintenance. when you have a software installed in your enterprise, you have to handle it’s maintenance. Upgrade, problems, extension is needed, etc.. With the SaaS model, your supplier takes care of all of it, including Backups. Upgrade are done seamlessly, on a very frequent basis, bugs are solved faster (no need for a big release), storage is usually expandable at will. All this for your monthly subscription.

One version to deal with. If any problem occurs on the application and you have to deal with your suppliers hotline, you won’t hear the usual: “Upgrade to the latest version and call us back”. You are always using the latest version and support is therefore simplified.

From a Supplier stand point the benefits are also great:

Easy to do trials with customers. As the start up cost is close to zero, it’s easy to push your potential customers to try out your software and hopefully convince them that it works for them and that they should subscribe.

The Subscription model allows for recurring incomes that are more predictable and that add up over time. Every new customer will bring an additional revenue to your business which, over time can become very significant and less dependent on sales effort.

Only one version to support. If you think that companies like SAP can maintain something like 10 versions of the same software, imagine the  hassle (and cost) of development, upgrade, testing (Quality Assurance – QA), and training. Dealing with only one version is fundamentally less costly for a supplier.

Easy to up-sale customers with add-ons. Want extra storage, want a Gold Access to certain features? the user can be one click away from those up-sales by making it very convenient for them to buy. SaaS makes it very easy to come up with version pricing, bundle pricing, and get a little closer to the economist dream of one price per user..

I could go on and on about those benefits and the growth of the SaaS market as a whole has been impressive as a consequence. Gartner projected that  “by 2011, 25 percent of new business software will be delivered as SaaS” and IDC projected that “by 2011, this opportunity will reach $14.8 billion, representing a compound annual growth rate (CAGR) of 32%”. Fast growing market (one of the key point for a successful business) so why isn’t everyone taking that route then? What is hidden behind the scene?

People talk about as one of the biggest company to have achieved a sustainable revenue/profit with SaaS. makes almost $1B a year but if we take a closer look at another company with similar size (at least in terms of market cap): BMC, what do we see?

Some rough numbers first:

SalesForce BMC
Market Cap $8.01B $6.84B
EBITDA $145M $633M
Revenue $1.24B $1.8B

If you look at all the benefits from SaaS, a SaaS company should have way larger margins than any other non SaaS company, but the numbers say otherwise:

SalesForce has a profit margin of 5.96% where BMC shoots at 18.29%, the operaintg margin of Salesforce is 8.53% where BMC flies at 27.62%..  (all data come from Yahoo Finance). BMC has been on the market for a lot longer, so the learning curve for Salesforce might not have allowed them to reach an optimum position yet.

Of course I’m not a financial analyst (call to all my friends who are in the finance sector for a quick analysis that I can add here!!) but there is something wrong in this picture.

Here are a few guesses that would surface in their 10K:

Spending on the sales force itself and on marketing effort must be huge at Salesforce. Despite all the benefits of SaaS large company who can bring large revenue with smaller sales force, are still convinced that (for security/control reasons) they are better off having everything internally. There is a huge need to convince decision maker that SaaS IS safe and that you can trust a third party to host your data, secure it and maintain it, better than you can do yourself and for cheaper.

The SaaS market is still very attractive to Small and Medium businesses too, and reaching those companies requires large sales force (or going through resellers), which is costly..

Another explanation is that Saleforce might not follow the SaaS model as much as it wants. What if trying to gain new customers (especially big ones) they break their own rules and start building custom solutions (different versions that need to be maintained separately..). I wouldn’t be surprised to see that happening.. but doing so on a true SaaS architecture makes it a nightmare (and expensive) to maintain and grow.

The SGA of both company could backup those guesses:

Sales Force SGA: 693M (growing steadily with revenue)

BMC SGA: 739M (stable for the last 3 years with a $400M increase in revenue)

When I look at this more closely I realize that SaaS might not be the major success people think int he coming year. It is a good business model that’s for sure, and startups should definitely consider it, but let’s not take things for granted and think that building a SaaS model over an On-Premise model is the recipe for success. I would go even farther than that and say that a company structured to build on-premise solutions can more seasily build a SaaS offer and maitain it as an extra version that the other way around.

Finance people, I am turning to you for comments.. what’s hidden behind those numbers? is SaaS such a great business model?

Startup Analysis – Part 2: Gliider, can a Browser Plugin have a successful Business Model?

It’s time to focus on the second part of that post about Browser Plugins. I first wanted to thank people who have sent me their comments regarding the post, there are some good insights in there.

I also wanted to say that I actually met Jordan Stolper, the CEO of Gliider and I was impressed by his energy and his flexibility to make things happen for his product. It is great to see such an entrepreneur, passionate and dedicated. Congratulation on what you have achieved so far Jordan! Here is a the link again to his site: Gliider do try to the product, it’s really worth it.

Of course, as many of you have noticed, I was not necessarily criticizing Gliider in particular, but I felt it was a good example of a Firefox plugin and wanted to take it as a business model for others who are considering building some and make money from them. So let’s recap the main finding from the first part of this analysis:

– The plugin basically would need so much install on Firefox that it makes it very hard to reach a potential income level to make the company really sustainable. CTR’s would certainly be too small, and revenue sharing not high enough either.

What can they do to make this work then? I see different path:

1 – More volume through more platform: Gliider doesn’t have to be a Firefox plugin only, and from what I understood talking to Jordan, they are planning other browser’s integration. This is a good way to have a lot more volume.

2 – More applications: Gliider is dedicated to Travel. Such “temporary bookmark” could be very useful as a repository for all kinds of searches. Think job search, healtcare search, real-estate, cars, toys, electronic, anything you can search.. Think about how you do you search when you want to buy something. You go around different sites, look a comparison, gather information in bookmarks, print stuff out, show that to your spouse or friends, ask you buddies on facebook and twitter, etc.. All this search could be gathered into a “Gliider” repository in a sleeker way than anything I have talked about here. I can really view Gliider as something a lot more than Travel and Jordan knows that too.

Some ways to make money would be at first to be a referrer to amazon or similar shopping site (that’s pretty easy with their APIs) and grab commissions on the sells. This is less seasonal than Travel in general.

Another way, would be to aggregate searches around specific subjects and bring those up on a Web site accessible by everyone. Wouldn’t you love to benefit from the searches of others on particular subjects? You are looking at buying a new Google Phone, well maybe (surely) some guy would have put together through their Gliider, a whole bunch of really good content from all over the web that would fasten your own search really well.

The incentive for sharing this on a user side could be some type of Rankings as you see on every forum or reviews. Opening up those searches for comments would allow to create unique content and drive SEO value for the site.

3 – Finding some application that would extend the product for the enterprise. Why the enterprise? Well, it’s a great way to come up with version pricing with a free version for individual/private use, and a paid version for the enterprise. The Paid version would be used for inside intranet/documents found around the internal network. That requires the company to be sufficiently large of course, but there are many of those. The gathering/then sharing feature of a gliider inside a company could also improve overall efficiency (reducing costs) and obviously be a good value proposition (quantifiable).

4 – Custom version. Although I’m not very found of this solution for startups because it requires a lot of specific (custom) work for a particular implementation (that you have to maintain afterward), it is still a good way to kick start the company. If the product is interesting enough so that a particular web site would be interested to use it as a channel to promote its internal content, then Gliider could develop/skin the product to a companies need and let them use it that way. It’s a hard sell, but could have some really good potential (especially for volume). The things to be careful about in those kind of deals are (among many others): Branding, revenue sharing, who hosts what, who has SLA or not, who maintains, who reports, etc, etc.. There are a lot of points to negotiate.

5 – Building many other plugins. In point 2, I was talking about extension of Gliider into other area, but as a Startup, you could imagine building many other plugins and create as much as a market place for your products. With every new plugin comes development time, marketing effort/spending, and maintenance, so it is costly! But isn’t that what every game developers do on iPhone with a portfolio of games – hoping one of them will really make it to pay for all the others.. ;-). This is not my favorite solution, but it is a possibility to consider. You should balance the effort/potential ratio of each of those plugins and take decision accordingly.

6 – One last solution I see is really to keep iterating on it as a side project which would basically make it a very low cost solution. This is not the best either as it implies that people involved would not be focused fully on the product and that slows down things significantly.

I hope that post can help Jordan (or at least give him some things to chew on..) and hopefully will make others think about all those issues before starting a new plugin. A quick number analysis can make or break a decision and people shouldn’t be afraid of giving project a No Go if they find out that it is simply impossible to work. Solution 6 has been employed by many entrepreneurs and it does work in early stages of a company, but try to think farther down the road and look at the big picture. What can our product be when it’s fully deployed and how much money will you need to sustain it?

Startup Analysis: Gliider, can a Browser Plugin have a successful Business Model? – part 1

I recently saw a pitch for a startup called Gliider and was impressed with the product. To make it simple, it’s a Firefox plugin that allows you to store travel information that you find on the web (Hotels, points of interest, Flights, whatever) by a simple drag and drop to the Gliider box. Once you are done, you can print or share you saved stuff.. Usually people will bookmark, print, copy and paste into a word document (at least that’s what I do) which is pretty bad.. Honestly, I really like Gliider.

At the presentation, one of the question after the pitch was: “Do you think this can have a sustainable business model?”. This is what we are going to find out now. I took the liberty to make a few hypothesis of course but I hope to give you an idea of a process that should be applied by every entrepreneurs who wishes to start a business.

First question: How do they make money? They have a “deals tab” in the widget that will send you travel deals (hotels, etc..) according to the saved search. That’s interesting as you can imagine those deals as well targeted.

Second Question: how much do they make per deal sold? That’s an unknown, but they do have a partnership with Expedia (source: Techcrunch) and looking at expedia’s affiliate program, you can easily find that they would make $4 per Flight transaction (which Gliider doesn’t seem to offer yet), and 5.5% to 6% of the transaction on Hotels. That seems pretty high so I’m wondering if it’s the full booking transaction or the gross margin made by expedia (which would be a lot smaller..). Anyway, we’ll stay in wonderland and imagine that it’s the full booking.

A hotel booking can go from something like $60 to an easy $250 (I’m excluding master suits!), for 1 to 5 or 6 nights in general. That ranges the potential gain per room from 5.5% x 1night x $60 = $3.3, to $250 x 6 nights x 6% = $90 commission. Pretty big range and we’ll deal with it. Most probably the transaction commission will fall in the $12 to $20 dollars on average.

Third question: how much do they have to make to be sustainable? That’s along question but I’ll keep it short by just keeping it simple. Gliider is a startup, they are small, probably somewhere around 4 or 5 people, low cost infrastructure, average salary around $90K, a professional web hosting, distribution through Firefox plug-in platform, some benefits (healthcare) and a  little bit of marketing + PR.. Let’s keep it low and say $700K for the year (ok that’s low…). At $700K they can sustain the initial team and maybe improve the business a bit.

Fourth question: For users who have the plugin installed, how many will use the deal section? This is a bit like a CTR (Click Through Rate).. You might play with it after you install it, but then you’ll forget about it until you actually search for your next travel, and out of those they would need to click the Deal tab and see what’s available. I would venture a guess that this number stays in the low %.. Let’s take from 0.5% up to 5% (which would be incredible).

Fifth question: For the users who click on a deal, what would be the conversion rate (user who actually buy after clicking)? This is a classic and I would guess it in the same 0.5% to 6.5% (if the targeting is really great).

Last question: How many Active Users do they need on a monthly basis to make the necessary $700K to be sustainable?

Let’s recap:

  • target revenue: $700K
  • Revenue per transaction: between $12 and $20
  • Users clicking a deal: between 0.5% and 5%
  • Users booking a deal after clicking on it: between 0.5% and 6.5%

We are ready to plug this into Excel and play with the sensitivity parameters:

Those table tell us how many Users of the widget per month they need to have to reach their sustainability:

Ouch… in the best of the best scenario, they would still need to have about 900K users monthly.. and in the worst, 194 million.. That’s a tough call and it brings us to conclude that this model is NOT sustainable (and definitely not interesting for a VC investment). You could do the model yourself and play with different options but honestly, I didn’t find any that would be great…

So the bonus question is: How can they become sustainable? because as entrepreneurs we want to find solutions not just stare at the problem.

I think the post has been long enough for now, but in the next one we’ll talk about ways for Gliider (and probably a lot of other plugins) to reach their goal and succeed.

Any comments are welcome! and by the way: install it and try it, it’s really a good product..

-Antony Passemard