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 I was learning to drive many, many years ago, I remember my dad telling me to pay attention to not only where the other driver’s eyes were looking but also to where their wheels were pointed. So it was with my search for SaaS at the recent Oracle OpenWorld event in San Francisco. Amid the hundreds of exhibitors and sessions, Cloud Computing in the form of SaaS based applications was being called out, acknowledged and exhibited. There were “campgrounds” of SaaS based applications exhibiting and the normal spread of CRM On Demand sessions. Clearly, Oracle senses the need to position itself as a supporter of Cloud Computing which requires them to encompass and embrace the growing proliferation of SaaS-based services and vendors. Like Levi Straus during the Gold Rush, who made his fortune supplying the miners with clothes and supplies, Oracle has the opportunity to provide the platform and infrastructure that can be a significant enabler in the Cloud Computing story.

But this blog is not about Cloud Computing, it’s about where Oracle is with SaaS-based applications. Certainly, they are continuing their efforts to build out their primary SaaS offering, CRM On Demand with new features and social networking capabilities. There were large banners in the exhibit areas for CRM On Demand and a section of the exhibit hall was dedicated to a few dozen SaaS add-on applications like Helpstream, Adaptive Planning and Eloqua. Oracle’s decision to allow a huge presence for one of their primary SaaS competitors, Salesforce.com, in the west convention hall was interesting. Even more interesting was the opportunity that was provided to Salesforce.com’s CEO, Marc Benioff, to present at an SRO executive session. Marc eloquently thanked Oracle for the opportunity to participate in OracleWorld, talked about the growth of Cloud Computing, their newest offering, Service Cloud 2 and gave away copies of his insightful new book “Behind the Cloud.” In comparison to the exhibits of SaaS vendors and the mega-exhibit of salesforce.com, Oracle’s SaaS offerings had a relatively small presence. No new SaaS offerings for key markets like Human Capital Management or Enterprise Performance Management.

So back to my original point, where is Oracle looking regarding SaaS but also, where are their wheels pointing? Gauging by my OracleWorld observations, Oracle definitely feels the need to acknowledge the proliferation of SaaS-based applications. In my opinion, allowing Salesforce.com to present and exhibit is a huge change in course regarding SaaS. Salesforce.com is Oracle’s biggest competitor in the Customer Relationship Management marketplace but they also are built on top of Oracle database technology. This is not a unique situation in the Oracle world of co-opetition. SAP, their biggest competitor in the enterprise resource management marketplace, is also built on top of Oracle database technology. SaaS is here to stay and though Oracle is not showing any signs of interest in building out its SaaS offerings, it is very interested in ensuring that its database, middleware technologies and possibly its expansive infrastructure are used in the SaaS gold rush. The question of why Oracle is not looking at SaaS as an application delivery vehicle but has its wheels pointed to supporting SaaS vendors and gets into a discussion of Oracle’s business priorities and culture.

Oracle’s business model is heavily dependent on maintenance and support revenue. At 22% of license revenue, this represents a significant portion of Oracle’s revenue and margin. Any significant move away from license sales and to SaaS will disrupt this model and the business culture that has been built upon it. A second factor to Oracle’s delay to move to SaaS-based applications can be found in their sales model. The SaaS sales model is significantly different than the license sales model. SaaS sales typically involve a higher volume of transactions at a lower total contract value. Because SaaS based applications are pay-as-you-go and require limited configuration to be production ready, not only is the software component of the total sale reduced, the consulting component of the total sale is reduced as well. Getting a massive sales organization like the one at Oracle to embrace a SaaS applications focus will be a time consuming, culturally altering and expensive proposition. This is not likely to happen soon.

A more likely strategy for Oracle to pursue if they want to become a leader in SaaS based services would be to focus on the small or medium size business market with a dedicated and independent sales team selling SaaS based applications and not try to convert their existing base of global 2000 enterprise customers. Given the investment by Oracle’s CEO, Larry Ellison, in Netsuite, I am tempted to think of them as an experiment to test a new SMB sales model for Oracle. I suspect that part of the reason that Oracle allowed such a significant presence for Salesforce.com at Oracle OpenWorld is that they do not see them as a significant competitive threat to their installed base and need for them to continue their success to help drive the growing need for platform as a service and infrastructure as a service technology, a market that Oracle is definitely interested in. Of course, Oracle could use their merger and acquisition machine to quickly become the leading provider of SaaS based applications. There are definitely candidates out there other than salesforce.com that could help Oracle accomplish that.

Oracle OpenWorld as usual was an interesting window into the thinking and direction of Oracle. Regardless of the rhetoric that we have heard from Oracle about SaaS, as evidenced by the presence of SaaS on the exhibit floor and Marc Benioff’s presentation, Oracle is positioning to be a player in this market … someway, somehow.

This week’s Smart SaaS blogger is Gary Damiano.
He can be reached on LinkedIn or at gedamiano@gmail.com.

Monday October 12th

It has been several years since I went to my last Oracle User Group meeting, prior to them buying PeopleSoft, Siebel and BEA.  Here are my thoughts around the first day:

The Keynote

Charles Phillips and Safra Catz kicked things off and were helpful in shaping how Oracle is planning on not only rolling out Fusion but also how Sun will fit into their strategy.  Unlike other firms like CA or Infor who just purchase software firms and milk them for the maintenance dollars, Oracle is spending $3B a year on research and development.  They are trying to fit all of these acquired pieces together for their customers, to making them easier to install and purchase.  The analogy of buying a car piece by piece is one that is often used by firms that are looking to provide a tightly integrated ecosystem.  I am not sure if this is really what customers are interested in buying because it really creates a classic vendor ‘lock-in’ scenario.

Larry’s vision is to tightly assemble all the technology components a customer might need; horizontal and industry applications, middleware, databases, infrastructure and, after the Sun deal is approved, they can offer hardware too.  This type of vertically integrated strategy seems to work beautifully for Apple and their consumer-oriented iPhone but will this approach be as widely adopted by Global 2000 organizations with very complex requirements?

The other surprise to me was that there was no announcement of any ‘native’ Oracle Fusion applications. Many of us were hoping that there will be more news about Oracle Fusion application delivery dates, but maybe something will be announced over the next few days.  I believe that when the very smart development people at Oracle started working through the plan to rewrite JD Edwards, Siebel, PeopleSoft, Hyperion, Retek, etc…. Maybe taking a phased approach over 5-10 years might be more realistic than rewriting all the products into a new suite all at once.  That is probably why we saw all of the application ‘mash-up’ demonstrations using Fusion this morning.   This Fusion middleware mashup approach is the near term future for Oracle application customers.

This was only Day One, so stay tuned.

Here are some other general observations from Day One.

Open World Positives

• I was really impressed with the size of the event with more than 35,000 attendees, even in a recession.  The show appeared to be well organized and all of the keynote sessions that I saw were well executed and informative.  So Judy Sim, Oracle’s CMO, should be given a lot credit for her team’s efforts.

• Most of the customers that I interacted with appeared to be interested and engaged.

• The partner pavilion (trade-show) was completely filled out and appeared to be well attended.

• The Oracle Fusion middleware and Oracle Business Intelligence solutions were full featured and had  many new enhancements.  The little 5-minute demos were helpful and gave the audience a quick look at each product.

• I was pleasantly surprised to see the number of global customers and many provided public testimonials.

• I liked the tables (with power-strips) that were set up for analysts and bloggers for all of the Keynote sessions.

After working at Oracle for almost five years in the early 90’s, I can tell you that when Larry sets his mind to something he usually gets it.

Let’s take a trip down memory lane…

It started by just plain beating your competition at sales and marketing.  Remember, crush Ingres, destroy Informix, smash Sybase … they were close to dead and Larry let them slip away.  He would have obliterated DB2 and SQLServer but IBM and Microsoft were too big.  Still he ended up owning the database market.

With the database market securely in his grasp, he started looking to other places where data resided… Ah, applications.   Larry had always said that Oracle didn’t care about applications and that they were focused only on the database market.  Then starting in 2005, he started his assault on the applications market first with Retek, then PeopleSoft, J.D. Edwards, Portal, Siebel and then Hyperion.  SAP is too big to take out and you still need an aspirational competitor anyway.

Humm… if you combine middleware into databases, you probably would sell more databases… then he acquired BEA and Agile.

In September 2008, Larry ranted about “What the Hell is Cloud Computing?”  Then just a few months ago Oracle buys Sun Microsystems and is arguably now one of the leading Cloud Computing providers.  I guess the ‘Network really is the Computer‘.  Now with his new toy Exadata, he is going after Teradata but when he gets his new toys from Sun - Java, MySQL, storage, grid computing, virtualization - he will have a lot of Cloud Computing fun.   It will be interesting to see if Oracle keeps the hardware part of Sun or spins it out to his friends at HP.

So now we come to SaaS.

The battle between mentor and protege.  Marc Benioff, with the help of Larry Ellison, has done a phenomenal job launching the leading Software-as-a-Service firm, Salesforce.com and creating the entire SaaS industry.  At Oracle’s earnings call last week Larry claimed that although Salesforce.com is the largest SaaS firm at $1 billion annual run rate, and Oracle is now the second largest SaaS provider at an $750 million annual run rate.  This included some high profile wins for their CRM on-demand offering last quarter including NetApps, McAfee, Land O’Lakes and Conoco.   But I can imagine that Salesforce.com won their unfair share of the on-demand CRM deals last quarter.

Oracle Fusion finally arrives.

What I found interesting is that the new Oracle Fusion suite of applications is now code complete and in beta.  This means it will be available from an Oracle sales rep near you in the fall. Oracle Fusion is on-demand ready and will offer three delivery models; traditional On-Premise, SaaS and then there is On-Premise SaaS.   On-premise SaaS, is that like military intelligence? This is usually and incredibly bad idea unless you are a $23 billion dollar company that generates more than $5 billion in profits.  The new Oracle SaaS suite will all ERP modules including CRM and HCM applications focused mainly on F1000 sized organizations.

Even though Fusion might be a positive development for the Oracle On-Demand sales team, it is doubtful this will be enough to enable Oracle to control the SaaS market organically.   So look for Oracle do what they have always done when they want to control a market, buy their way to the top.  That would mean that some Oracle alumni’s like Marc Benioff or NetSuite’s (Larry and his family own a majority of Netsuite) Zack Nelson will probably be on Uncle Larry’s radar screen.  This is just like other Oracle alumni’s Craig Conway from Peoplesoft - who is also on the board of directors of Salesforce.com and Tom Siebel were pursued.

I guess in the end if you can’t beat’em, join’em.

Looks like someone is assuming an attack formation … the end of 2009 should be very interesting for the ever-evolving SaaS market landscape.