by Kevin Dobbs

Montclair Advisors, LLC

When advising software clients who are interested in moving to a SaaS business model, one of the areas I really dig into is how are they selling to new customers. Most of us in the SaaS community realize that carefully tracking your Customer Acquisition Costs or CAC, is a critical component in building a successful and profitable company, but I think it is equally important to understand how traditional software sales  and marketing models and SaaS models differ.

Traditional Software Sales & Marketing Model

Over the past 25 years there has been a traditional way to market and sell enterprise software which has been based on key principles such as:

• You need a Large direct sales force including a large support team, or as I used to call them, ‘The Cast of Thousands‘
• Front loaded compensation plans that pay out when deals are sold
  
• High average sales prices, including services, that would almost always be over $500,000
• Long sales cycles, usually 6-12 months, with pursuit costs averaging around $70,000 for every deal the company played in
• Win rates are in the 30-50% range
• Average face-to-face selling time that is around 15%
• Pipeline building using a combination of in-person events (seminars, tradeshows, user group meetings), telemarketing teams (inbound and cold calling) pounding the phones and a lot of paid marketing campaigns
• Lead pipelines that appeared full but always seemed to lack the appropriate level of qualified opportunities
• First generation CRM systems and reports that were produced periodically using Excel

Brings back the good ol’ days doesn’t it.  Many software firms are still using this model and they are finding out that it doesn’t work very well in the new world of Software-as-a-Service sales.  Some of the reasons it doesn’t work is that software buyer preferences are definitely changing, but one big issue is it is very expensive to operate this type of model, especially when you get your revenues paid out over time.

SaaS Sales & Marketing Model

There are several important differences in the SaaS model that make the traditional software sales and marketing model less than effective;

• SaaS customers pay a subscription based on users or usage of the software service over time, usually over three years.  After the recession, this has become the new normal for software sales
• More focused solutions that usually have Average Sales Prices that are typically lower, so reps need to sell more deals to hit the same quota targets
• Key metrics like customer satisfaction, renewals, up-selling and cross selling are even more important for SaaS than they were in the past
• Sales method is more of a “penetrate and radiate” approach
• It takes a long time to build up a recurring revenue stream

Given these differences, then what should your SaaS Sales & Marketing model look like?  Here are some ideas to consider when building out your SaaS sales and marketing plans for 2011 that can help you to build out a low-cost but high-efficiency sales and marketing machine;

Marketing

• Hire experienced marketing leadership and professional
• Evolve a good list of key influencers and industry contact and communicate with them frequently
• Develop a clean prospect database
• Mix paid and free social networking programs
• Build a vibrant customer community and market to them with products like Lithium
• Leverage social media like LinkedIn, Facebook and Twitter to generate interest and leads
• Use Web 2.0 marketing tools like Marketo, Eloqua, Pardot and try drip marketing
• Track everything (see the last Smart SaaS post)

Sales

• Hire experienced SaaS sales leadership and reps
• Your SaaS sales team should be more low touch than your traditional sales team
• Experiment with telesales even with high end enterprise products
• See is using an indirect channel makes sense for your business, if managed correctly these distribution partnerships can dramatically lower your sales costs
• Carefully track your lead hand off between marketing and sales, make sure leads are not falling through the cracks
• Track everything

Metrics like Customer Acquisition Costs and the Magic Number can help your sales and marketing teams see how effective their programs are and can provide insight when to invest and when to continue developing your repeatable sales model.  I would also encourage you to learn more about Mark Leslie’s Sales Learning Curve, because it offers a more scientific approach to cost-effectively building out your SaaS sales team.   Best-in-class firms that have profiled in this blog have adopted many of these techniques to build a scalable but cost-careful sales and marketing organizations.

Stay tuned for Tip #6 Package for Viral Adoption

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Company:            Yammer

Started:                2007

Located:               San Francisco, California

Geography:          North America

Market:                Enterprise Microblogging Platform

Products:            Yammer Desktop, Yammer on your Mobile Device, and Yammer Plug-Ins

Key Customers:  Deloitte, AMD, AAA of Northern California, Nevada and Utah, SMG, Cargill, Thomson Reuters, Sungard, Hill & Knowlton and SunCorp.

Website:               Yammer

Blog:                    Yammer Blog

Twitter:                @Yammer

Recent News:

Yammer is Selected as an MIT Sloan CIO Symposium Innovation Showcase Finalist

Fortune 500 Companies Flock to Yammer

Yammer Secures $10 Million in Series B Funding from Emergence Capital and Previous Investors

I asked David Sacks, Yammer’s Founder, CEO and Chairman of the Board few questions about his business and his view of the SaaS market in 2010.

Did you start out as a Software-as-a-Service company?

Yes, we did start out as a SaaS company. Our company was incubated inside of Geni, which develops family tree software. I was also involved with the consumer Internet with my experience starting PayPal. As both companies scaled, I found it was hard to keep tabs on what everyone was doing, and Yammer was developed to address this challenge. We found that microblogging was a great way to keep current on the status of important projects, individual profiles and information feeds inside of an enterprise.

Then in 2008, we spun out Yammer and that same year won the TechCrunch 50’s Best in Show award.

Initially we were targeting small and medium sized businesses but we are now seeing that Yammer has strong appeal for large enterprises like AAA, AMD, Cargill, Cisco, Deloitte, and Thomson Reuters.

Yammer is very viral because it was very easy for anyone to sign-up, confirm their company’s email address and start using the system. You don’t need to wait for an IT administrator to set up Yammer and you can quickly invite your work colleagues, with the same company email domain, to join in and begin collaborating with you.

When a company wants to claim the network being used by it’s employees, they pay a nominal subscription fee, and then we provide a set of administrative tools that allow them to manage upgrades, security, compliance, deliver premium support, and customize their site.

Part of our initial business model was to base Yammer on the consumer model of software, but make it enterprise-class. We wanted to remove the traditional friction from our software sales process by making our product as easy to use as Facebook.

Why do your customers buy from Yammer?

Our customers never have to pay or upgrade our software unless their employees are using it. This is very attractive, when you compare it to the traditional software selection process where you have to vet vendors, choose one, negotiate the contract, implement the product, pay a lot of money and then no one uses it. Yammer is de-risking the traditional enterprise software value proposition. Employees are valuing it because they use it.

When large companies see thousands of employees using Yammer what do they do? They can do three things - wait and see what happens, shut it down or buy it and we are finding the vast majority of companies are buying Yammer because their employees are being productive and want to collaborate using the software.Our customers also really like our administrative tools for e-discovery, security, directory integration, and network administration.

“If Facebook and Twitter had a baby, it would be Yammer.”

We are like Twitter because we offer a real-time feed of information; you can follow any one, join groups and sort information feeds by hash tags. We are like Facebook because there is no 140-character limit, you can have attachments, threaded replies and we offer a variety of enterprise management tools.

Yammer is a like a virtual office where workers can feel more connected to each other, especially remote workers. We act like the traditional company water cooler for these distributed organizations. As workforces become more mobile, Yammer just make a lot of sense for enterprise collaboration. Today we only offer Yammer in English but we have noticed that there are an increasing number of new customers who are signing up outside of North America. In the near future we will be supporting multiple languages in addition to English.

Customers also like our value-based pricing model. We charge between $3 and $5 per seat per month, depending on the level of support and administrative tools. We also provide volume discounts for our larger customers. This is much more cost attractive than purchasing Chatter from Salesforce.com for $15 per seat, which is quite expensive and most employees don’t want to communicate through the company’s corporate CRM system. Our very fast viral Freemium approach appears to be working, because since we have been live for only the last 18 months we now have over 1 million seats today.

What do you see as the key trend emerging in the SaaS industry?

The first trend is the consumerization of enterprise software; Yammer is a great example of this trend. Real innovation in the technology space over the past 10 years has been on the consumer-side of the software market with products like Facebook and Twitter. At Yammer we want to take these learnings back into the enterprise software world. When I was at PayPal, we were very successful using the Freemium model to promote adoption. This type of approach to software can definitely result in the overall democratization of enterprise software. SaaS is the first step, when the delivery model changed, then there were no upfront costs and the risk is dramatically lower. Using techniques developed by consumer software firms, more and different kinds of buyers can now access enterprise-class software.

The second trend we see is that enterprise software products will be designed more for the end-user than power users or administrators. A good example is how Facebook and Twitter don’t do every possible feature or function and they don’t clutter the user’s screen. This simplified approach to software allow causal users to be more engaged with their products and other users. These types of causal use software products will also appeal to younger employees who have used Facebook and LinkedIn and expect their enterprise software products to be that easy to use.

Social Networking is also a major trend we are seeing. We started thinking about this over the last couple of years, since 2007. Now it seems so obvious, that social networking would grow into an unstoppable trend. The ability to connect workers, to leverage expertise and content all in real-time, which allows everyone to work smarter, just makes a lot of sense. I still think that there is confusion about Enterprise Social Networking, for instance Salesforce sees it as a CRM newsfeed, and we see it as enterprise real-time communication. Eventually we see Enterprise Social Networking replacing corporate email and instant messaging.

What is your outlook for 2010?

In January we raised $10M, led by Emergence, that  provided capital to allow us to expand our team. Our investors liked the fact that we have built a very cost effective business, based on our viral distribution model. Our Q1 sales were greater than all of our sales for last year combined.

The software industry is realizing that Enterprise Collaboration is going to be a huge space. Most software companies will want to get into this market because every company will want one of these collaboration platforms to deploy. The only problem is that most enterprise software firms looks at these types of tools backwards, because they already have multiple different product lines, then they will need to stuff it through their sales channel. At Yammer we have already solved this distribution channel problem and we can actually open up our channel to these companies as a Distribution as a Service model.

We continue to sign up a number of large customers, and this type of adoption makes other large companies comfortable using our technology. Things look great and our traction is accelerating.

Since everyone is interested in SaaS funding and valuations I thought it would be helpful to tell you about an interesting Cloud Computing investor panel I attended at the recent All About the Cloud conference in SF. The session was moderated by Jason Green from Emergence Capital Partners and was joined by Gary Hromadko from Crosslink Capital, Mark McNay from William Blair and Evangelos Simoudis from Trident Capital.

So what did they have to say?

The market has finally changed for the better

2009 was all about survival and the venture community did less than half the investments than in a typical year.

This year is now about growing again and current investments are more focused on companies that have weathered the economic downturn. Their investments are focused on changing the slope of these types of company’s growth curves, by concentrating more on sales and marketing.

SaaS and Cloud companies are leading the way

Consumers have been driving the adoption of easier to use Cloud-based solutions like eBay, iTunes, Facebook, Twitter and LinkedIn. They are viral and can reach critical mass very quickly because there are low barriers to adoption.

With SaaS, the recession has really pushed the advantages of a subscription business model and moving from CapEx to OpEx software investments. It’s like leasing your car rather than buying it.

Lean start-ups are definitely in. Almost all early stage software investments in 2009-10 are Cloud-based because it takes a fair amount of capital to fund SaaS firms and it takes a long time for them to reach profitability. One interesting comment was that later stage on-premise companies are now being asked about what their SaaS/Cloud strategy is for the future, because without it, they may find funding might be difficult.

What the VC’s are looking for

SaaS 1.0 focused on a company’s income statement, expenses and cash flows than GAAP reported financials. One important measurement is a company’s incremental contribution margins (gross margins), which is critical for SaaS. Companies needed to balance capital efficiency with building a business that can scale.

Investors are looking for unique business processes that can only be built or automated through SaaS or the Cloud. Emergence latest investments are pure Cloud-based companies that have viral qualities like YouSendit, the files sharing company and Yammer and the enterprise micro-blogging firm, both of these companies are viral enterprise solutions. Yammer has more than 70,000 customers with at least 1 user and is signing up between 7-10,000 users a month and 10% are turning into paying customers. Crosslink invested in Carbonite, a backup and recovery company, has high margins and is the only other independent player in the category with Mozy, who is owned by EMC. They felt that scarcity of competitors and their ability to manage Customer Acquisition Costs were important in establishing the company’s value.

The panelists also said they are looking for companies that have a rigorous focus on metrics like Customer Lifetime Value and Customer Acquisition Costs. In fact CAC appears to drive business value because it has a lot to do with capital efficiency and the company’s ability to grow their business.

Exits, IPO’s and Valuations

Economy has recovered and CEO’s are ready to start taking on more risk, and it’s a real change in psychology because we are at the beginning of a macro trend that will last more than 10 years.

This is evident by more than 100 M&A transactions last quarter including high profile deals like IBM buying CastIron, Salesforce buying Jigsaw for $142M, Successfactors buying CubeTree for $50M. The current environment is right for deals, especially as SaaS is gaining enterprise momentum with recent deals like SuccessFactors’ mega deal with Walmart for 1.6M users. Transactions like Jigsaw, CubeTree, and CA’s purchase of 3Tera and Nimsoft for $350M all indicate a return to a healthy M&A atmosphere, that will probably last for the next 12-18 months.

Oracle and SAP won’t be aggressive on the M&A front until they come to the realization that they can’t build Cloud solutions internally. Because many SaaS companies have now crossed the $25-30M in recurring revenues threshold, these firms may become quite attractive to these larger ISV’s looking to make the move to the SaaS business model.

But these acquirers don’t want to take on the burn associated with many start-ups so it will be important to stay close to breakeven and you may have to sacrifice growth for profitability. Since the access to capital is still tight, start-ups will have to try and collect cash upfront and continue to tune their business models to improve cash flows.

Companies that seem to own a category have perceived scarcity value which will result in a premium on any transaction, especially if they are perceived to own a segment franchise. VC’s and acquirers are looking for a minimum of 40% CAGR to get a premium valuation.

On the other side of the liquidity front, the IPO window for SaaS companies is beginning to open up and firms like SolarWinds and LogMeIn have now been joined by SPS Commerce and Convio. At least before the recent stock market downturn, these companies had traded up by 15% since their IPOs.

The panel seemed to believe that the market is definitely getting better and that is good news for SaaS and Cloud Computing companies looking for funding or an exit!

There were a number of keynotes at last week’s All About the Cloud conference that focused on Public and Private Clouds and the market. What was interesting is that the typical hype associated with Cloud Computing appears to be calming down. It seems like it is no longer necessary to justify or explain the Cloud, or at least for the audience at that conference. According to Gartner the Cloud Computing market will be $150B in IT spend by 2013 as compared to $56B in 2009 and is the #1 Strategic Technology for CIO’s in 2010

The new Cloud attitude appears to be more about ‘when’ and ‘how’ enterprises will be utilizing Cloud solutions rather than ‘if’.

Coexistence is ‘In’

The other interesting change, which I first noticed at the end of last year at both OracleWorld and Dreamforce, was that everyone seemed to be talking about co-existence or hybrid uses of the Cloud with on-premise assets. This more reasoned approach is going to make more sense to CIO’s and business executives to who have spend millions building out their infrastructure over the past 10 years. Cloud can be complimentary. Starting with fringe or edge applications and then over time becoming more useful for mission critical functions.

The Consumer Cloud

Tuesday’s press panel with [insert names] focused mostly on the use of the Cloud for consumer applications like Facebook, Google, Amazon, eBay and future offerings like iTunes LIVE and Microsoft Office 2010 (launched on May 12^th). Cloud is everywhere but the average consumer doesn’t even know they are in the Cloud. With the advent of ubiquitous broadband access, smart devices and massive data centers, there are all sorts of Cloud based consumer services emerging. But the market is still evolving because the Generation X’ers are plugged into the Cloud but as Kevin O’Brien from Oracle said in his session, ‘My mom still doesn’t know what the Cloud is’, and she is probably isn’t alone.

Private Clouds

There were many sessions that discussed how there is money to be made in the Private Cloud market. You can have many of the advantages of the Public Cloud without the security and control issues. IDC projects that by 2014, $11.8B will be spend on servers to create Private Clouds, considering overall IT spend in the US is approximately $1T, that’s not big percentage today, but it will be in the future.

Scared of the Cloud

Are CIO’s scared of the Cloud because of their potential for loss of control, security issues and resource impacts? Several sessions touched on this aspect of the Cloud Computing market including CIO’s creating hurdles to adoption.

Given the cost and scalability advantages why wouldn’t organizations like the State of California quickly adopt Cloud based solutions? What about the switching costs like decommissioning your own data centers, software and restructuring personnel. If you already own PeopleSoft and it is working, will you really be open to a Workday ‘rip and replace’ scenario? Enterprise organizations are warming up to the idea, just ask Flextronics.

One panelist cited a recent Google Docs deal that went sideways at UC Davis where they scrapped their trial for several thousand users. Maybe there were other considerations than the Cloud but most of the sessions agreed that the benefits of the Cloud outweigh the risks and CIO’s are starting to think in terms of intelligent trade-offs instead of just being against the Cloud. This is probably smart, given the recent economic conditions and every CEO is looking to optimize their IT spend.

Cloud 2010 and Beyond

Cloud is just the new thing. According to Bill McNee at Saugatuck Technologies, their most recent Cloud Computing survey indicated that 86% of the respondents thought that the Cloud would be part of mainstream IT by 2014.

There appears to be reasonable optimism that Cloud Computing is not a fad and its going to happen, it’s just going to be the way people are operating today in the future. The Google Docs business is adding 3,000 new companies a day, that doesn’t seem like a fad. According to Gartner, their Hype Curve for Cloud Computing showed that July 2009 was the peak and it really appears that the market is maturing about the Cloud.

Venture Capital firms are only funding Cloud-based start-ups and large technology companies like Cisco, CA and IBM are buying SaaS and Cloud based companies (like CastIron Systems) because they realize they need to overcome the ‘Innovators Dilemma’ around the Cloud. There will be an increase in successful SaaS and Cloud companies as the market continues to mature, as well as a lot more M&A activity.

As one speaker so aptly described the current market situation for many companies when evaluating Cloud Computing, ‘When a piano falling from the sky, you should be worried more about will it hit you not where it is while it is falling.’

I listened to an interesting panel discussion at the Opsource, SaaS Summit a few days ago and I thought I would share what I heard.

Venture capital panelists were from Intel Capital, Emergence Capital Partners, CrossLink Capital and Hummer Winblad Venture Partners and Merrill Lynch.

New Investments

Seems like there was no agreement from the panel about what stage of investment was the most popular given the downturn.   There were several Series A and Seed investments that were mentioned including Crowd Factory and Zuberance.  One bright spot for investors was the fact that OpenTable has filed for an IPO, which would be a good step in the right direction given 2008’s anemic IPO performance.

Zombie Venture Capitalists

Most of the panelists had done some investments in the past six months but it is clear that SaaS entrepreneurs need to be on the look out for Zombie VC’s, who are still operating but are no longer making investments.  These walking dead  have their lights on, they have websites, and cash to support existing investments but no longer have enough cash to add new portfolio companies.  In writing this post I even discovered that peHUB publishes a list of these Zombie VC’s.  If they haven’t made any new investments during 2008, then I would be careful about wasting any time with these firms.

Flat is the New Up

One phrase that was uttered more than once is that ‘Flat is the New Up’.  Although when it comes to Software as a Service…  it appears that ‘Up is still Up’.  Even in 2008, most publicly traded SaaS companies have bounced back from their lows by an aggregate of 20%, which is much better than the S&P 500.  Apparently Wall Street likes SaaS companies and now are valuing them at 3 to 3.5 times their recurring revenues, unfortunately at the beginning of 2008 that number was closer to 8x.  Keep in mind that this is better than a lot of public firms that are currently trading at their cash values.  Other Wall Street analysts are valuing SaaS firms at 12x their cash flow but it is difficult to understand if there is a consistent valuation metric that firms or investors should be using.

Another interesting development is that Venture firms are now forced to value their private portfolio the same way they would value a portfolio of publicly traded stocks due to new accounting regulations (FASB 157).  Based on the discussion this new regulation, it will only create more company valuation compression on top an already tough market for portfolio companies.

What Does a Good Investment Look Like?

So what are the VC’s looking for in an attractive investment in this market?  Apparently the same things they were looking for in the past; a game changing idea, the team, the product and a big market.   If you are a software company you better be offering a real SaaS solution or be leveraging the Cloud Computing to even be considered.

They are also looking for new portfolio companies to be more conservative about spending their precious cash.  There is now an overt trade-off between the rapid growth rates of the last five years and capital efficiency to provide a longer runway for portfolio companies.  The panelists indicated that they would like to see their new Series A companies, for example those who might raise $4 million, to survive at least for 18-24 months before going out for their next round!  With the difficult market dynamics it is important for SaaS firms to form a strong syndicate when raising capital because your next round will be an insider round.

The panel indicated that they are looking for operating executives who know how to manage cash and scrub expenses.  Another observation was that many of the early stage companies that they are seeing now are much more mature and well run than they were just a few years ago.

There also won’t be any more Salary.com (NASDAQ: SLRY) IPO’s of $15 million companies.  IPO candidates will need to be $50 to $70 million in revenues and ideally profitable before filing their S-1.

For public SaaS companies you are going to see a slow down in the rapid growth rates we were seeing from companies like Salesforce.com (NYSE: CRM) and SuccessFactors (NASDAQ: SFSF).  Public markets want to see profitability first and growth now comes second.  Momentum stocks, those with high growth rates were trading at 8-9 times revenues, like Salesforce and SuccessFactors, are giving way to slower growth companies that are profitable and are given a multiple on cash flows.

Customer Acquisition Costs

When building your SaaS business model, it is important to assume that for every dollar of recurring revenue you will probably need to invest $.50 to $1.00 in your Customer Acquisition Costs (CAC). It is important than ever to have an active program of testing various CAC channels and tactics to maximize your investments.  Then you need to have a smart statistical framework that you can explain to your investors.

Smart firms like EchoSign and YouSendIt are creating leads virally by infecting their customers and they are finding that they are finding 1/3 to 1/2 of all of their leads are generated organically.   It is also important to leverage distribution channels, especially companies that have access to large customer bases like Salesforce.com, Google, and Intuit.  Take more of a focused approach to your customer acquisition efforts by targeting a vertical market and use the power of your customer referrals because ‘word of mouth’ is the least expensive and most effective lead generation engine.  Keep in mind that your sales process needs to be as easy as possible, in other words it needs to be ‘friction-less’.  When your prospects sign up for a trial, it only takes a few minutes and weeks and they can do it without any involvement from your company.  Give them a free trial, a sandbox a free version.

So I came away from this panel discussion with the following advice for companies looking for funding in this environment:

1. You need to still need to have a great idea, product and team but you might need to have reduced risk for your potential investors.
2. Demonstrate your company knows how to stretch a dollar as far as possible.  Fewer employees is better… think Craigslist.
3. Show traction.  Number of transactions, members, customers, revenues, profits.
4. Shop carefully for your potential investors and don’t waste time with Zombies.

Crazy like a fox.

With the economy in such tough shape, with customers on the sidelines with no budget to buy software, maybe now is the perfect time to embrace a Freemium software strategy.  This concept was originally proposed by a venture captialist named Fred Wilson, the founder of Union Square Ventures.

This became really clear to me over the past 6 months that this trend towards free software might be the future.   Initially I read a great article entitled Free! is the Future in Wired magazine (make sure you watch the Chris Anderson video), which I thought presented a very clear argument for free.

Think of all of the free software and services business models that went bust during the Internet Boom.  But then again there have been many businesses that were built using a free business model including Google, Yahoo!, Skype, eBay, and Craigslist just to name a few.  Some of the new kids on the freemium block include Facebook, LinkedIn, SimplyHired, Kijiji, 37signals and many of the open source software players.

My second realization of the power of free was using 37signals BaseCamp project management product.  It was a great example of providing a free product that you liked so much that you had to buy into their paid  version.  If you need a project management tool, this one is worth a subscription and you may end up pulling out your credit card like me.

Then my third reason why I thought freemium could really be the future of software is based on working with a great company, MrTed, who makes Applicant Tracking or ATS software for large companies.  MrTed just recently launched their new Small and Medium business freemium offering, SmartRecruiters, which is an Open SaaS product, which is a mashup of Open Source and SaaS business concepts.  This Open SaaS model was developed by Jerome Ternynck MrTed’s CEO and founder. SmartRecruiters like many other freemium offerings is based on the development of a strong and passionate user community, who ultimately become the revenue engine for these companies. SmartRecruiters will monetize their business model by offering a collection of value-added services that are bundled with their free software.

As companies look at their 2009 business strategies, they need to balance gaining marketshare while keeping customer acquisition costs (CAC) as low as possible.  By deploying a freemium software strategy now you might be considered crazy in 2009 but be laughing all the way in the not too distant future.