The Economics of SaaS: We Need a Platform

Recently, I wrote a post titled “When it Goes Right, What Does It Cost to Build a Great Software Company?"

Based on a universe of 1990s client/server companies, my analysis found that:

• Median Capital Raised: $10.1m
• Median 1st-4th Year Revenue Ramp: $.1m $.8m $6.9m $21.6m
• Median revenue at profitability: $48m
  
• Median Years to Exit: 4
• Software model supports the creation of great companies on <$15m of capital

The post begged the question regarding the metrics associated with SaaS. This post, based on a review of the current public SaaS comps, is the SaaS analog. The analysis includes: WSSI, CRM, OMTR, RNOW, TLEO, and VOCS.

While the SaaS companies grew up in a different IPO market, the results suggest that SaaS companies take:

• 1.6x longer to get liquid
• 3.65x more capital
• 1.75x more revenue to hit profitability
• Salesforce, for example, raised $64.52m in equity, to Peoplesoft's $10. Websidestory raised $43m to BOBJ's $5m.

Click HERE to see data behind analysis

SaaS is here to stay – the advantages to customers and vendors are well established.

The remaining challenge, however, is how to build viable SaaS companies more cost effectively. Will the rise of AMZN S3 and EC2, Apex and AppExchange, etc eliminate the need for bespoke infrastructure investment. We will stop stop asking about MSDN subscriptions and ask instead about AMZN subscriptions?

One can only hope some form of platform infrastructure emerges to accelerate SaaS companies development. If not, the merits of SaaS will be challenged by the time, capital intensity, and delayed profitability of the model. Platform companies – Powersoft/Sybase, ORCL, MSFT – drove down the costs of building client/server application companies. The industry needs the SaaS analogs to unleash the power of the model at the cost optimal level.

A simple analysis holds that Fixed Costs/Gross Margin = breakeven revenue. While for SaaS this is a somewhat circular calculation (as in SaaS fixed costs are amortized into COGS), the rise of platforms will drive down fixed and allow SaaS companies to reduce capital required to get to scale. Fixed costs must be reduced in order to unleash the full power of the model and the rise of platforms will reduce the bespoke investments historically required to build SaaS companies.

Now, the data above is for public companies who came to prominence in very challenging times. We are active SaaS investors and are already seeing the fruits of leveraging commodity platforms and partners to build companies more cost effectively. However, the public record to date suggests that the SaaS industry remains relatively immature without the obvious parallels to the client server tools and server companies that drove the success of huge numbers of application companies in the 1990s.