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.


Unlearning your MBA

I started listening (late enough) to podcasts a lot, and the one I’m really fan of: The Stanford Entrepreneurship podcast. It’s really awesome and you should look it up in itunes.. I’m going to post my thoughts about those because they have a capacity of making me react everytime..Wait till I get to the one where Guy Kawasaki talks!

I’m starting with the one about unlearning your MBA where David Heinemeier, one of the creator of Ruby on Rails is speaking. Interestingly enough, Steve Blank is the moderator (a guy I love). If you follow my blog you know that I was pretty harsh about Jason Fried who founded 37 signals (linked to Ruby on Rails), and I was really looking forward to hear David talk to see if I just was stupid in my analysis of what Jason said about a flat organization.. I will split up that post in 4 sections:

  • Unlearn MBA – the main theme of the podcast
  • Shouldn’t Take Venture Capital and spend your own money
  • Working like crazy to build a startup

I was optimistic about that podcast. I wanted it to prove me wrong and unfortunately started pretty poorly… Unlearn your MBA. David started criticizing how bad the MBA he did was and didn’t help him in what he did to build a business.. All his professors were so theoretical in nature, judging on the length of the papers he was handing in, and thinking 1980’s industries value chain and business models. Well, what I think is that the problem is not that people should unlearn their MBA: people should not attend the MBA he went to!! If that is the experience he got from his MBA in Copenhagen, they should really revisit the professors they hired and their curriculum because, excuse me, but David is right: He should unlearn all this.. I’m barely out of the Berkeley Haas MBA, and I have to say that a ton of what I have learned there can be apply to everything business I think about today. My professors were experience entrepreneurs (Steve Blank included), they were lawyers from the field (Mario Rosati), successful people from many startups and their knowledge was immense and relevant at every inch. They taught me to think much broadly than I was able to before the MBA, they taught me to question assumptions, they tough me to test my idea, pitch better, be more confident, challenge the status quo, everything. My view of how to tackle a business today has completely shifted thanks to the MBA and I thank them for putting together such a great program. That actually raises a valid concern if you are considering an MBA: how do you select an MBA that will allow you to NOT have to unlearn it afterward? Vesting your MBA is important, not all of them are equal.. but generalizing like David did is pretty closed minded.

So the podcast went on and David started talking about VC money. He is of the school that VC money is a time bomb on your business. I have to admit, that made me like him better. I agree that taking any kind of VC money could simply kill your business and make you focus on the wrong things. Taking VC money is not the only way to build a business. Spending your own money makes you think differently about what you need to focus on, and I agree with David on a lot of points he made. I would simply extend into the fact that some businesses are doomed to failed without VC money: Capital intensive businesses (clean tech or health care), or  industries where being the first to market is super important and extremely fast growth is needed (where market barriers are very low => think Groupon!). Some businesses, even software businesses (David restricted his comments to software/web) just have bigger chances of success if they are VC backed than if they are not. When do you take VC money, or what stage of the company is a true question that needs to be thought through carefully. Getting VC money is not an end goal, it has to support a growth strategy and make sense for your business and your industry. I think that fundamentally David is right, but again, a bit short sighted. VC money is not all evil, but he is right that many entrepreneurs fall into the bad trap of just looking at the money, not the underlying purpose of getting that money.

At this stage, I was neutral, and then David started talking about the fact that to build a business you didn’t have to work 100 hours a week or you get burned out and you might be much more productive working less and sleeping more. At that point I realized that I could relate to David’s experience. In my two former businesses I worked hard, but not like hell. of course I would spend much more hours on them than I would do for another business where I would be employed but not to the point where I would get burned out. I agree with David, efficiency is more important than quantity. Many people get overwhelmed very quickly and brag about how many hours they spend at work. When I hear that I always feel that those people have two problems: They don’t know how to prioritize correctly, and they are not efficient. Although I already hear some of you screaming that they don’t have enough resources, their deadline as so tight, etc and it is very true for many of you so I shouldn’t generalize. Let’s just say that “often times” those people bragging have those two problems. Prioritization and efficiency are extremely powerful skills that allow you to work on the right stuff, at the right time and get the job done without waste. Thriving for those two skills should be everyone’s goals. I am sure that David has both skills very developed. Good for him!

I started to like him at that point and thought that despite his take on the MBA, which is understandable if he did actually go to a bad MBA, made me think that I had been too harsh about 37 Signals. So I started writing this blog post thinking that I would praise the guy.. (not that anybody cares about who I praise or not by the way..). As I was writing I was hearing the Q&A section of the podcast in the background led by Steve Blank (which I love. Did I already say that?) and Steve asked him about the scalability of a business like 37 signals versus a $1B business. And he killed it.. David thinks he could run a $1B company with 15 people, the way they do today. No correlation. What the Hell?? Is he stupid or what?? 37 Signals is ten years old. I realized it’s like I thought to myself: well you are not a billion dollars company because you are short sighted, and is over a billion dollars company because they have done all thing you have been criticizing during the podcast. But what nailed it is when he started talking about (I didn’t plan this! it just happened!). David said: did you look at their margin, did you look at their P/E ratio, it’s bad and all that stuff, it’s so low (P/E so high), how can a software business make 5% margin. This to me is just the final proof that David doesn’t understand what a growth business is about. reinvests every possible dollars they have into their growth. has had the goal of leading the revolution of enterprise software all along, they made the Cloud and SaaS a reality, they have a long term vision (something that 37 signals doesn’t have as – David’s words: they think 2 weeks ahead), they are buying their growth in a model where if they were to make no sales next year, and I means zero dollars, firing every possible employee, they would probably make over a billion dollars in margin (no cost). That is what the whole SaaS model is about, and that is what is about: Growth! reinvest every penny into the business. If next year announces 40% margin I’ll be pissed! Why didn’t they spend more in hiring, marketing, expending? When is a $5B business I’m guessing the growth potential might slow down a bit and then the margins are going to explode, the P/E will go down from the really high level it is at today. When decide to stop fueling the growth, they will make huge amount of money: that’s the SaaS model, it’s not just software. David doesn’t get it apparently.

I’m coming out of this podcast wondering how 37 Signals is still alive. Basecamp is pretty good, I’ll give you that, but man, with such a management team, I’m surprise they are still here, and I’m starting to really think they have other sources of revenue to keep them alive. Anyway. Interesting podcast to listen to.


Dreamforce 10, the Cloud and Apple iTunes

I spend a bit of time at Dreamforce 2010, the big yearly conference organized by and I was pretty amazed at the size of the event. Salesforce has done so much to democratize the Cloud and the usage of SaaS applications for the last 10 years, and they are still pushing and pushing, embracing changes as it comes.. Here in the bay area, the only things you see on billboard are “Cloud” “Cloud” “Cloud”, and it’s not the weather channel.. Everything and anything is in the cloud now. It almost looks like a rally cry to make this shift happen once and for all.

Among the big announcements:, the database in the Cloud. Salesforce already had that available and it’s been basically rebranded/repackaged to be able to market it better. The idea is simple, instead of having to manage your own database in the cloud with the issues of Scalability, redundancy, maintenance, etc.. now you just put your data in and you don’t have to worry about all this. I can definitely see the value in here.. upgrading and maintaining a database is not trivial, and a slow database that isn’t ready to scale can really kill your product. I’m not going to dive in the details of pricing but it seems small startup can start using based on a  Freemium model (based on usage).

The more interesting announcement was the acquisition of Heroku, a hoster for Ruby on Rails applications.. That one is pretty amazing. Salesforce now has one of the biggest, most efficient Ruby platform that will will be seamlessly integrated with and obviously the rest of the Salesforce clouds. It’s not there yet, but should be pretty shortly. What does it mean from a startup stand point? Well, when I wanted to start effecteev, I really thought about salesforce as a potential development environment but chose not to because of the proprietary language that I had to build it on. Also finding Salesforce developers wasn’t as easy as PHP/Ruby developers so we made the choice of using an open source PHP framework instead. Well if I had the choice again today, I guess I could use Ruby on Rail, with and be perfectly happy with it. My collaboration startup would have been perfectly integrated into any Salesforce customers, and the efficiency that it is providing could have competed with Salesforce Chatter (remember, effecteev was over 2 years ago!!). By acquiring Heroku, Salesforce hopes to drive more developers on the platform and bring to light the value of the ecosystem for SaaS businesses. The success will depend on how the Ruby community reacts though. This is why Salesforce kept the name Heroku, will support existing applications, and will leave the site on its own I guess.

To talk more broadly about the Cloud, what is the major issue for the adoption of the Cloud? Security! Businesses are afraid to have their data in a place they don’t really control and that is a very natural feeling. Having sold security product for many years, and some SaaS Security product as well, this issue comes up every time over and over. It makes sense, and I understand that a cost benefit analysis should be put in play to make the decision to move to the cloud. But who said people are rational? A simple cost benefit is not the only solution: decision makers think about their job, their career, how they are perceived with their hierarchy: What if they decide to go for this new system, in the cloud, and it doesn’t work as well, are they going to be blamed for it? People are risk averse so what is needed is a culture change which is much harder to achieve.

A culture change means that people, all the way up to the top of the company, feel comfortable with the idea of the Cloud for personal things. My belief is that this comfort is something pretty profound that needs to build as a personal experience. This is why I believe that the success of the Cloud will come thanks to consumer products going to the cloud and in particular things like the apple iTunes Cloud for music.

The iTunes Music Cloud seems pretty far off the data of your enterprise but this is how I view things: People already have most of their emails on demand (web based), that has been the case for a while. Now, people are starting to stream video through Netflix or amazon on demand. they feel good about it, and even stop buying DVDs, or even storing movies on their computer.. What is that good for? it’s all available in the Cloud. Music is another level: you access your music much more frequently than movies and people’s interaction with the readily available important data (their music) will make them more and more confident about putting very personal stuff out there. As they realize that the quality of service if actually really good, that they never loose something, that they can access from any device, they will start asking themselves: Why can’t I access my customer data, my presentations, my invoices, my ERP the same way I access my music and my photos all the time? People are going to feel that the level of comfort they have for personal things should be the same for their work stuff.. People have Blackberries, Androids, iPhone, iPads, Laptops, Netbooks, all those stuff are connected devices that they can use to access there Music online, their photos, their videos, theirs documents, etc.. why not corporate stuff?

This is when the real shift is going to happen, when people, not corporation, start feeling uncomfortable not being able to access all their corporate data, anytime, anywhere, in the Cloud. This shift is coming, and apple will play a huge role in it. When an IT manager will decide to not move to the Cloud, his/her boss will start seeing it as a mistake, and by the way, the little cost benefit analysis now is looked at much more carefully because the psychological hurdle is not there anymore.