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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
During this period of time most SaaS companies sold their products based solely on their Total Cost of Ownership or TCO benefits. It was possible to make a strong case around shifting the software buyer’s costs from their capital budgets to their operating budgets, and this was attractive since most businesses were focused on conserving their cash. This is why leading SaaS firms like Salesforce.com and SuccessFactors enjoyed very strong Compound Annual Growth Rates, usually in excess of 40%, even during the depths of the Great Recession.
A subtle benefit that buyers started realizing was that purchasing a software service was that all of the required software support and management costs like facilities, hardware, power and even staff, were no longer needed. So companies could take fixed costs associated with facilities, infrastructure and staff and make them a variable expense by purchasing SaaS. This is a powerful benefit because if the economy is bad then it is easy to dial down the costs and use less of the service and if things get better, then it is easy to add more capacity or functionality. This shifting of fixed expenses to variable expenses continues to be popular among software buyers even now, given the instability in the economy.
As more businesses continue to look for ways to streamline their costs and improve overall agility, SaaS products are a nature enabler but buyers are starting to become more skeptical of blanket TCO savings claims. Smart SaaS firms classify their product’s cost savings and business benefits in more of a tiered business justification framework that allow the software buyers to more easily build their own internal business cases. By structuring costs and benefits in this way they have been able to retain their credibility during the sales cycle.
Here is an example of a simplified tiered cost/benefit structure for a SaaS product purchase that we have used with several of our software clients. Costs are classified into hard costs, or as CFO’s refer to them as ‘real costs’ and then there are soft costs which are more productivity-based benefits. Then there are strategic benefits that are not necessarily cost-based but provide additional benefits at a higher level. Some of these may actually be revenue opportunities or ROI-based benefits.
Hard Cost Savings
- Headcount
- Facilities
- Hardware
- Power
Soft Cost Savings
- Improved user productivity
- Faster cycle times
- Better reporting
- Transactional accuracy
Strategic Benefits
- Move fixed costs to variable costs
- User adoption and engagement
- Improved collaboration
CFO’s at companies that are buying software often follow a similar type of internal justification framework for purchases even of SaaS products. The key is not to lead with an ROI-focused sales approach but more with a lower cost of operations and some additional benefits approach.
Remember that most companies are also looking for ways to free up capital that can be re-purposed towards innovation. In fact, the larger the buyer, they probably have a lot of fixed IT costs and they are looking for creative ways to move some of these frozen capital investments over into new revenue producing projects. As growth flattens out across the economy, all companies will need to come up with new products and services that will create a new demand stream that will increase growth rates. [Think iPad] Leveraging SaaS solutions is not only a great way of reduce existing operational costs, but this type of investment can also act as a catalyst for new innovation and growth opportunities. Is an attractive theme for C-Level buyers in today’s market.
In summary, most organizations buying software today are not very focused on the ROI-types of benefits that were commonly sold during the last ten years. Keep in mind that even a pure-TCO sales approach will be attractive to most buyers who continue to look for ways to lower or control operational costs. The real winning formula to position your SaaS solution in a way that combines the TCO-saving theme with the ability to free up new funds for innovation. This approach is even more potent when the SaaS product can actually be an innovation catalyst for creating new products and services. The good news is that SaaS solutions can be positioned just for cost control (TCO), improvements in operational efficiencies, even increasing revenues (ROI) as well as a catalyst for innovation.
Company: Merced Systems
Started: 2001
Located: Redwood Shores, California
Geography: North America
Market: Sales and Service Performance Management solutions
Products: Merced Performance Suite, Merced ICM, Merced Intelligence and Merced Express Products
Key Customers: Sprint, T-Mobile, Dell, Delta Airlines, Discover Financial Services, Dish Networks, ING Direct, Kaiser Permanente and OnStar.
Website: Merced Systems
Blog: Performance Matters
Twitter: @mercedsystems
Recent News:
Merced Systems Awarded Patent for Temporal Specificity
Merced Systems to Host Sixth Annual Customer Summit for Sales and Service Industry Leaders
Merced Systems Achieves Eight Consecutive Years of Growth and Profitability
I asked Harold Goldberg Merced Systems’ Chief Marketing Officer about his business and his view of the SaaS market for 2011.
Why did Merced launch a Software-as-a-Service business?
We started in 2002 and launched our first private cloud offering. At that time we typically sold to the business user, who in turn had to work with IT to get their approval. Our customers liked our SaaS-based approach, since they could have an expert manage their software on-line, and that expert is Merced.
This service started with just a single company and it has just grown organically over time by just listening to our customers about what they needed.
A few years ago we started to expand this offering and launched our SaaS service with subscription payment plans with users paying a fixed fee per month for access to our products. Most of our initial customers signed up for a 2-year subscription and then they could add more years and users to the contract when they were ready. We know that most of our large customers tend to move a lot of people around inside their organization and like to have a fixed price for our services because it provides them with a predictable way to plan for their costs in the future.
We have seen the use of our SaaS model in a variety of different ways including one customer, who wanted to do a pilot using the SaaS product because they wanted to get into production quickly, then they bought out the subscription and converted to a license and had us managed their solution in our data center.
Merced will usually lead with our SaaS offering but will also offer managed services or perpetual options when that meets our customer’s needs. We find that it all depends on the organization and their resources and capacity to manage another enterprise application.
Customers like our flexibility because they can have it their way and today we are definitely seeing more customers who are interested in SaaS and Private Cloud solutions.
Why is moving to SaaS important for Merced?
Because we sell to large enterprise customers, it has been important to be able to start with an initial sale to a department then spread out across the customer’s organization over time. This is an important part of the SaaS business model. We can get our customers a product to get started with easily and then demonstrate a real ROI, and rapid time-to-value because our products can be turned on relatively quickly compared to their on-premise alternatives.
Most sales and services organizations are looking for ways to the costs associated with internal operations. Our customers look at our ROI as an important driver over the long term. In the near term they are looking for improved performance around sales and services effectiveness, which usually translates into increased revenue production. Our products help by delivering better compensation plans, process visibility, coaching and the result is that reps and agents become more effective, and our customers usually see between a 20-40% productivity increase with the use of our products. Our SaaS products just help us to get our products into the customer’s hands much faster than a traditional on-premise deployment model.
Another value of SaaS is that it provides transparency for our customers as well as their partners. Our customers want to see real business value and since our products are specifically designed for front-line workers, and everyone is focused on making these employees more productive, a monthly investment in Merced translates into visible performance improvements and higher revenues. The SaaS solution allows them to pay monthly and renew and expand their footprint based on real business results.
I think the last reason is around our financial model. Our SaaS and managed services solutions provide a predictable revenue stream that is valued by our management and investors. Because SaaS revenues are recurring it allows us to more accurately forecast revenues and tie them back our expenses in development, support, sales and marketing. Over time this has become a real win-win for the company.
What lessons have you learned in building your SaaS business?
Actually our SaaS model looks a lot like some of the insurance companies I have worked with in the past. Company revenues are based on building a book of business and compensation plans are built on top of customer retention, cross-selling and up-selling new products, so the model is familiar to me.
A couple of the lessons we have learned over time are that we can deliver value much faster to our customers using the SaaS model. Since we are managing their technical environment, it is possible for us to take lessons learned and apply best practices and how we manage our software much faster than our customers could. This also applies to the entire service delivery process including support, because they can see the customer’s entire environment.In fact we can get in front of issues before they happen. This helps build high customer satisfaction with our customers, which is why we have a 98%+ renewal rate.
Because we manage our customer’s technical environment, it also makes it more efficient to migrate customers from an on-premise version to our SaaS version and even makes our regular SaaS implementations go faster and smoother.
As I mentioned earlier, our customers like the flexibility of our product delivery options. Many customers will start with a departmental pilot using our SaaS offering. Another division might want their version of Merced in their own data center and we can then link those versions to create a hybrid solution to meet our customer’s needs. We think this is the real promise of the Cloud, to be able to integrate our SaaS products with our customers existing and new on-premise systems, which makes us unique.
As we enter 2009, I am hoping that the economic environment will begin to improve for technology firms. I realize that very few analysts feel positive about the economy but one thing I agree with them is that companies will have dramatically less capital to spend on technology in 2009. Forrester states that IT spending growth will only be a pathetic 1.6% and Gartner’s Peter Sondergaard, Senior VP of research, thinks that 2009 IT spend could be 2.3% to no growth at all.
What is interesting is that what growth there is, Software-as-a-Service will be one of the top spending market segments according to reports by Verizon and Gartner. The reason for the optimism is primarily because these types of types of technology investments can lower a company’s total cost of running their business. This relates to my last blog post that TCO is going to be the major driver for technology buyers in 2009.
My prediction for 2009 is that this will be the Year of the Subscription. Not that subscription-based business models are anything new, just think about the next time you pay a bridge toll, your mobile phone bill or your mortgage. The reason for my prediction is that companies are now faced with a once in a generation restriction on capital and companies are thinking more about reducing costs and how to make these technology purchases using their operating budgets. With this focus on operating expense purchasing by buyers, this will place tremendous pressure on technology firms that only sell their products through a traditional capital expense model.
Here are some simple tips to get your technology business leverage a Subscription business model:
If you are an Existing Technology company with little or no recurring revenues:
- Evaluate your business for ways to provide new subscription products, services or content to your existing customers.
- Offer a subscription pricing option to new customers that have a capital budget constraint.
- Add a premium support option that can be priced as a subscription upgrade to a customer’s existing maintenance or support offering.
If you are a SaaS company then you should consider:
- Re-evaluate your pricing and packaging strategies to maximize your competitive advantage against traditional competitors. Now is a great time to grab markeshare.
- Focus on customer satisfaction because the only weakness in a subscription model is when your customers don’t renew their contracts. Keep your renewal rates up and look to up-sell at renewal time.
- Be very clear on your company’s recurring revenue metrics; customer acquisition costs, lifetime value of you customers, and customer profitability, to name a few. You should then develop specific plans to improve and monitor these metrics on a monthly or quarterly basis.
Keep in mind that even though this will be a difficult year, but there is always opportunity in a chaotic market for innovative companies. Remember 2009 is the Year of the Subscription.
Remember the good ol’ days of selling software, when you could talk to customers about the virtues of ROI, or Return on Investment? ‘Our new software can cut your costs by 90%, make you more strategic and you will get that raise you were looking for!’
Funny thing, that was only about 6 months ago. Even Software-as-a-Service sales professionals were skilled at ROI selling but now ROI is out and TCO, or Total Cost of Ownership is back in.
The reason for the change is that buyers don’t care about investments or benefits, they are only concerned with reducing and managing costs. So this should be really good news for SaaS providers because their solutions not only provide ROI but clear TCO advantages. Some of these advantages include:
- No hardware required: web servers, application servers or firewalls
- No software required: database, infrastructure or security software
- No IT team required: DBA’s, IT managers, security guys, etc.
It seems like most companies have already thinned their workforces, frozen their budgets and trimmed unnecessary spending in an effort to reduce costs. What you are going to see next is IT Cost Swapping. This is when you start doing a line item review of all of your IT and business costs and realize that your customer is probably paying a huge amount annually for ERP maintenance to your friends at Oracle and SAP and not getting much in return. In a recent CIO magazine article about the upcoming SAP maintenance fee increase from 17% to 22%, a Forrester survey of over 200 SAP customers found that over 85% saw little or no value in these annual fees. So it is a stroke of genius to raise the costs as the economy goes into the toilet, right? Well SAP isn’t alone, Oracle is also planning on a large price increase in 2009 which could be as large as 10%. In fact Oracle said that their maintenance revenue was the most profitable component of their business, that’s because it’s pure profit!
A smart Cost Swap Strategy could involved a portfolio analysis of all of your customer’s ERP software and building a plan to replace older on-premise ERP products with up-to-date SaaS products. The advantage with this approach is that your customer can get the benefits of modern software, while actually reducing their overall IT cost structure. For more Cost Swapping ideas, drop me an email at: kevin@montclairadvisors.com.
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