The buying habits of software buyers over the past couple of years has really shifted. The way software was sold in the recent past was by promoting its revenue-producing benefits or the Return On Investment (ROI). This changed when the Great Recession hit the broader software market and buyers started thinking less about ROI and more about reducing or controlling their overall operational costs.

Between 2008-2009 this was a natural reaction by most businesses because their revenues began to dry up and they needed to reduce costs, payrolls and other investments in order to survive.   This was when SaaS all of sudden made a lot of sense to software buyers because:

• They could try the software before they bought it
• Pay for the software through a subscription, usually out of the company’s operating budget
• Only buy the software functionality they were going to use
• The SaaS provider paid for and managed all of the required infrastructure
• It was possible to get the software up and running very quickly

Depending on who you listen to, things are either recovering slowly, or we are slipping back into a recession. It can be argued that for most software companies, if you are selling a SaaS-based solution then it shouldn’t affect your business very much. In fact, as the economy gets tighter for buyers, SaaS solutions even make more sense for forward thinking businesses who are focusing on innovation and cost controls.

During the Great Recession we saw that traditional software companies experienced a net decline in their revenues and in some cases their revenues went down by nearly 50% year-over-year between 2008-2010. In big part this was because traditional software customers no longer had available the necessary capital dollars to spend on their perpetual license-based products and the banks were no longer lending.

These traditional software companies had also hastened their revenue decline by raising their annual maintenance rates, which put more pricing pressure on their customers at a time when they could least afford it. So their customers started taking a hard look at SaaS solutions as potential alternatives to traditional on-premise software.

Recession Accelerates SaaS Adoption

It wasn’t that SaaS solutions hadn’t been around for many years, it was that for many large software buyers, they hadn’t felt comfortable with software that was being managed by another companies. There were a lot of questions: Where was their data being housed, was it safe, what if they can’t handle our requirements? These were legitimate questions but many SaaS value propositions began to win over these large, skeptical customers:

• You could try their software before you buy it
• Get can get this software up and running quickly
• Only buy the functionality that you need
• If you don’t like their software, for any reason, cancel your subscription
• The software’s performance and availability is guaranteed
• Pay though a subscription, a big lump sum payment is not required
• No more upgrades, this type of software is always current
• Less or even no staff required to manage their software
• Lower total cost of ownership

These types of on-line solutions started resonating not only with the small and medium-sized company buyer but also with the very large, global enterprises as well. Over the last couple of years we have seen well-known organizations like Siemens, Walmart, Flextronics, Thomson Reuters and even the US government adopt SaaS and Cloud-based solutions.

It’s About Innovation Not Reducing Costs

Businesses during the last recession were primarily trying to reduce costs, which resulted in large scale layoffs. These firms were trying to ‘do more with less’.  This was the reason that many of these companies continued to buy software because they not only wanted to streamline operations, but also they needed to continue to innovate their business.

By deploying the latest in software technology, these innovative companies are looking to move into new markets, provide state-of-the-art tools to their employees, and optimize their supply chains.   This required them to get smarter about their businesses, markets and competitors, and solutions like SaaS-based business intelligence products were also really in high demand.  Given the flexibility and affordability of SaaS products compared to their on-premise predecessors, it is no wonder that most SaaS companies grew at more than 30% year-over-year even during the worst part of the recession.

There are SaaS solutions for almost every enterprise need including ERP, Financials, CRM, Marketing, Human Resources, Talent Management and even specific specialized vertical solutions.  Click on this link to access Montclair Advisors Public SaaS Index to see which firms offer leading SaaS solutions.

In the next 12-18 months we may be either headed for very slow growth in the economy or even another recession, but SaaS companies will continue to grow quickly because most companies are still looking for ways to lower their total cost of operations and improve their ability to innovate and increase their overall competitiveness.  As long as SaaS providers continue to deliver on their Cloud-based value propositions, they will experience rapid growth even if the economy continues to be tight throughout 2012.

By Kevin Dobbs

Montclair Advisors, LLC

One of the questions that I get quite often from firms that are starting down the path towards selling SaaS solutions, ‘should we use the same sales team to sell both our on-premise and SaaS solutions?‘ It seems like this would be easy and you should be able to definitely leverage your existing sales team to penetrate not only prospective accounts but also with existing customers.

No one wants to re-invent or re-invest in building out a new SaaS-specific sales team but this is critical to building out a successful SaaS business.  What many executives overlook is that SaaS is not just a delivery model but it is really a truly different business model.  I thought it might be helpful to use this table to illustrate those business model differences and why creating a specialized sales team is necessary.

Let’s review some of these important differences in each sales approach and how it affects the typical software sales rep:

Value Proposition: Traditional software is sold to solve a targeted business requirement and then customized to meet the specific needs of a customer.

SaaS takes a different approach.  It is usually sold with the promise of lower costs, more rapid time-to-value and ease of use.  This is accomplished using a standard system and configuration that is not tailored or customized for each customer. These are two very different value propositions and would be hard to expect every sales rep to be able to master both sales strategies.  Keep in mind that these two value propositions also appeal to two very different buyers; business buyers and IT.

Procurement:  Similiar to the value proposition, positioning the value of of a subscription purchase versus the actual purchasing of a software license are quite different.   After the recession, and part of our new normal economy, most organizations are now leading with a the requirement of subscribing to software instead owning it.  This allows customers to keep their more cash on their balance sheets and longer term, save on hiring staff to manage their internal systems inside of their own data centers.

Sales Cycles: Customers are also looking for just enough software to get the job done and are not usually looking to purchase a lifetime’s worth of functionality anymore.  They want to purchase a small piece of functionality now and then grow their relationship with their software provider over time, once they know the software works and they are comfortable with this relationship.  This means that SaaS sales cycles are going to be much shorter than traditional, on-premise software sales transactions.

Transaction Sizes:  Because of the different buying behaviors associated with SaaS from traditional software, SaaS transactions tend to be much smaller.  This means that a SaaS sales rep is going to need to close more deals, more frequently in order to make the same quota target that a perpetual license sales rep is assigned.

Pricing:  Putting together proposals are always difficult, but asking a sales rep, or even sales management, to offer both license and subscription options is really complex.  I think this is also not a great idea because it ultimately confuses the customer, since they will try and normalize the pricing for both options, which is hard to do.  Comparing a SaaS solution to an on-premise perpetual license is like comparing apples to oranges, and your sales team needs to pick one of these solutions and really learn how to sell it.

Methodologies/Touch:  Best-in-class SaaS sales organizations is a laser focus on Customer Acquisition Costs (CAC).  Living with the reality that the majority of your revenues will come in over the life of any contract, it is imperative to keep your sales costs low.  A SaaS model doesn’t lend itself to using the high-touch sales model, or engaging the ‘cast of thousands‘, to come in and get deals done.  Most SaaS firms operate a lower-touch model using tele-sales, remote demonstrations, and many automated self-service tools to assist the sales team in getting deals done quickly.

Channels: Effective use of indirect channels is another way of lowering customer acquisition costs.  Although some traditional software companies use channel partners to sell their products, it appears that the use of channels is really gaining popularity among SaaS providers.  Many SaaS firms are complimenting not only their tele-sales capablities but also using partners to deliver value-added services as well.

Demos:  Another way of reducing the cost of sales is to be more selective and smart about how customers are exposed to a software providers’ solutions.  This is usually accomplished by showing the software either using a Web-based conferencing service or some type of self-service environment.   This is quite a different approach than what was done with on-premise software, which was done in person and using a highly scripted demo.

Trials:  In the past, if a customer wanted to get their hands on the software and really use it, the only way that can be accomplished was with a Professional Services team and a conference room pilot.  Most SaaS companies allow prospective customers to play with their products by offering them a 30-day trial, after a simple self-service sign up and a quick tutorial.  This automated approach is cost effective and allows a SaaS firm to manage potentially hundreds of product trials with very little support personnel required, and this is a great source of qualified leads.

Renewals & Customer Relationships: This is another contrast between the two models. In a traditional software company the customer relationship is usually dispersed among various functions including Sales, Support and possibly Professional Services.  In SaaS firms the customer relationship and the renewal process are both very important, and usually have clear ownership, usually with the Account Management organization.

When you consider all of the differences in these two approaches to selling traditional software and software as a service, it is not reasonable to have the same reps trying to master selling both options.  The best sales reps are always focused on selling, hitting quota, and earning commissions.  Sales reps will sell what they are comfortable with and when considering a SaaS transition, it is best to create separate teams, with one that can specialize in the SaaS value proposition, solution, sales methodology and can make money on the SaaS-specific comp plan.

When firms make it simple for their reps to sell, you will get the sales momentum you are looking for in all of your lines of business.  You don’t want your sales reps to be the ‘jacks of all trades and masters of none‘, because that isn’t the formula for SaaS sales success.

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!

When most companies think about moving towards a Software-as-a-Service business model they often just change their pricing model.  You know the drill, instead of charging a big perpetual license fee upfront with some services and then an annual maintenance fee, you switch over to a SaaS agreement that is structured quite differently; with the subscription being spread over the term of the agreement and some upfront services to get started.

Don’t get me wrong, changing your pricing is a big deal if you are a traditional software company.  By changing your pricing dynamic you are moving from a Capital Expense (CapEx)  to an Operating Expense (OpEx) orientation, this is a dramatic change!  It’s even a bigger deal if you are a publicly traded software company.  But the overall SaaS business model is really all about monitoring and measuring metrics, ratios and statistics.

I ran into a very interesting company recently, OpEx Engine,  that has done extensive benchmarking of SaaS and technology companies, and has complied a library of operational metrics for over 50 public and privately held software firms. Lauren Kelley, OpEx’s CEO is an ex- Art Technology Group (ARTG) executive who realized that smart technology  people were looking for these types of real-world benchmarks and operating metrics. Lauren’s team has spent the last two years accumulating a lot of really value information.  I can’t tell you how many times I have looked for good comparative metrics on how much companies typically invested in sales and marketing, research and development and G&A when building out a business model.  For instance, did you know that of all of the publicly-traded SaaS companies that DealerTracker (TRAK) has the lowest R&D investment as a percentage of their revenue? (4.9%)  Did you also know that Salesforce.com (CRM), Omniture (OMTR), NetSuite (N), and SuccessFactors (SFSF) all spend more than 50% of their revenues on sales and marketing? That’s an easy one but you should definately check out the free information that Lauren provides on her site.

There are many other metrics that are needed to successfully run a SaaS company but one of the most important is your overall cost of sales and marketing.  Understanding what your true Customer Acquisition Costs is a critical SaaS business performance indicator.  I was recently at the SIIA On Demand Conference in San Jose where I heard Josh James, the CEO at Omniture present his sales and marketing modeling methodology, that he has dubbed the ‘Magic Number’ for SaaS companies.   Since it would probably justify a completely separate post, all I can say that this is a really innovative way to determine if your % of sales and marketing spend is either too much or too little.  Phil Wainewright wrote a great piece on the Magic Number - When to spend cash in a SaaS business - which is definitely worth reading.  What Omniture has done really well is to figure out the overall profitability of their clients, market saturation, marketing effectiveness and the number of Quota Bearing Sales Reps (QBSR’s) that are required to grab market share. It’s cool.

Other sources of good SaaS market information and metrics are:

TripleTree, a boutique investment bank which conducts some solid SaaS research, Cutter Consortium, Saugatuck Technologies, and Jeff Kaplan’s firm Think Strategies.

If you hear of any other good ones, let me know.