Software as a Service - Part II, Revenue & Expenses

The following discussion studies the value proposition of the Software as a Service (SaaS) business and licensing model. Additionally we’ll look at the sales, marketing and cultural and operational challenges it presents for corporations looking to deploy such a model.

Part I in this series evaluated the Value Proposition, or “what makes this business model interesting to the customer”

This section, considers the Revenue Model and Operating Expenses. We’ll look at the inherent implications of this model and it’s specific financials as contrasted with the ISV licensing model.

As before, this article is not an endorsement of SaaS, but a (hopefully) thoughtful examination; as such many comments express “less” or “more” - the specific quantities will of course depend on your circumstances.

Business Model Implications

For the sake of considering the implications of the SaaS model, it is counter-pointed against the traditional software(ISV) licensing model.

Revenue Model

The software as a service model is quite different from the traditional software (ISV) licensing model in that the large, upfront licensing fee and the resulting professional service fees and maintenance costs are replaced by periodic ‘all-in-one’ subscription payments - typically on a monthly or installed basis. The tradeoff being that software as a service firms have significantly smaller upfront revenue and cash flows in exchange for longer-term and more predictable cash flows that are the result of a service-based relationship.

Consequently, the true measure of success or value for a software as a service firm is not necessarily tied to revenue growth or the P&L, but is measured by metrics for new customer acquisition, rate of customer retention, predictability & visibility of cash flows, and the growth of deferred revenue on the balance sheet.

Cost of Revenues

Significantly different from the ISV model, software as a service firms require less investment in upfront professional services due to the rapid time to deployment and Web-based delivery. Many ISVs partner with top-tier systems integrators to provide upfront professional services and implementation, but also maintain internal resources to support these functions initially and going forward.

Instead, software as a service firms invest in customer service & training, account management, and application support and management, which includes network operations, to ensure successful application delivery, virtually 100% uptime & performance, and high user adoption.

Operating Expenses

An area of key distinction between ISVs and software as a service firms lies in the approach for product development and sales & marketing.

The ISV typically supports multiple code bases across different technical environments (client/server, mainframe, Web-based, etc.) and delivered in a single-tenant model that is maintained on the client’s premises. Conversely, software as a service firms base their technology on a single Web-native code base that is capable of supporting numerous end-users in a multi-tenant, shared application environment. The end result is that software as a service firms are able to lower the incremental product development costs with each new customer acquisition.

Additionally, while ISVs charge for software upgrades, maintenance, and generally have new software release cycles every two to three years, software as a service firms provide free software upgrades, include maintenance & support in the service relationship, and support more frequent and seamless software releases & upgrades.

In terms of the sales and marketing approaches, there are also noticeable differences. Since the ISV supports a model that is based on large upfront professional services and implementation that are often more than two times the software license fee, major consulting and IT services firms have been natural allies and partners in developing sales alliances and indirect channels.

Conversely, software as a service firms have needed to be much more creative in their sales & marketing approach, since traditional alliances & channels pose unique challenges due to the changed economic relationship for the systems integrator. Consequently, many software as a service firms have invested in multiple indirect channels to the market (vertical industry partners, infrastructure alliances, OEM, VAR, private branding relationships) as well as building direct sales channels.

In the end, software as a service firms manage the tradeoff and conflict posed by growth that require investment in multiple sales and marketing channels, by stable cash flows that require more patient growth expectations as the model and customer acquisition grows over a longer period of time.

That’s the end of Part II. In our final look at SaaS, In Part III we’ll examine the specific challenges inherent in the model. Careful consideration of these will be reasons for organizational success.

Gotta a comment?

2 Responses to “Software as a Service - Part II, Revenue & Expenses”

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