Wednesday, January 24, 2007

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.

The Three Most Important Letters in Open Source: CYA

Anyone who follows politics knows that one man’s given is another man’s question. In the software VC world, the merits of open source are regarded as givens- a business model innovation that brilliantly aligns customer and vendor interests.

However, outside of the software VC market, open source remains an enigma wrapped in a mystery. How does free pay? Is open source a backdoor towards communism? Is it anti-capitalist? Despite RHT’s market cap and the success of JBoss, I continue to meet many who question the wisdom and financial merits of open source.

Open source is rife with acronyms – GPL, MPL, OSS, etc. In my experience, however, the three letters in open source that matter most are CYA ("cover your ass"), not GPL…in fact, CYA best explains the economic incentives of open source customers. Simply put, customers will not deploy software into production, independent of whether developers think that they need support, that is not supported.

No IT manager worth his salt will put mission critical software infrastructure into production without a throat to choke. Telling the head of equities that trades are failing due to a software crash and that you have an email into a community forum asking for a fix will result in termination faster than you can say “dumb ass.”

In analyzing open source, I have talked to many developers who tell me they do not need support for many open source projects and that forums, list serves, and documentation provide the material they need to solve their problems. However, IT managers are focused more than ever on service levels and subscribing to open source vendor’s support subscriptions allows them to cover their asses if and when infrastructure fails and transactions are at risk.

If CYA is the key to monetization – what does that mean about the categories of software that are likely to succeed via an open source model? Fundamentally, the closer a product is to a transaction the more important CYA becomes. Applications that are not mission critical –content management, for example - run a material risk of developers using the GPL license and sourcing support from the community rather than via subscription arrangements with the vendor in question.

What other variables characterize successful open source companies:

  • Established market- successful open source projects target established software markets where the incumbent vendors are over charging their customers for bloated, proprietary solutions. Famously, once RHT Linux met their enterprise expectations, Morgan Stanley’s purchases of Solaris servers fell off a cliff and the investment bank realized close to 10x cost reductions per CPU. Can you target a large market and deliver a standards-based product that allows IT organizations to grow their IT capacity at a greatly reduced cost basis?
  • Evidence of organic pull most appropriately characterized by downloads, forum usage, etc.
  • IP rights retained by C-corp established to commercialize project. Indemnities become challenging when it is difficult to provide documented attribution of source code ownership. Also, potential buyers will discount a company’s value if IP remains unclear.
  • Active community – an active community of developers led by a project leader who is employed by the company

Next time someone asks you how free leads to fee…remember that IT managers and risk taking are oxymorons and that having a throat to choke while saving large amounts of money feels good!

Monday, January 22, 2007

Internet Television History: 24 is on the Web!

In a moment of television and Internet history, Season Six of 24 is available online, via MySpace and

For many years and many CES keynotes, IPTV proved to be more hype than substance. Starting today, however, TV's hottest show is available on the web!

Major networks are putting their premium content assets on the web, and the high quality, full-episode streams suggest that the promise of IPTV is finally being realized.

The company behind 24 on-line, Move Networks, (see previous post on company).

Move, based in Utah, provides major content owners and network operators enabling infrastructure for the delivery of both live and archived long-form, high quality Internet video.

Please click on the links above to enjoy 24, Prison Break, and Fox's other prime time programming.

If you are into the CW, click here to watch Everybody Hates Chris, Beauty and the Geek, and other favorites.

The future of Internet Video - long-form, high quality content that combines prime time broadcast CPMs with Internet per click, per stream analytics and tracking - has arrived!

Thursday, January 18, 2007

Widgetbox in New York Times

Widgetbox, the leading widget web marketplace and syndication platform, is featured in today's NYTimes article on widgets.

Ed and his team deserve credit for recognizing the value of syndicated content, commerce, and application functionality. Widgetbox seamlessly allows web service providers, developers, and end users to deploy and manage widgets. If you have yet to put a widget on your blog, please try one today!

Thursday, January 04, 2007

Red Herring Article on VC Bloggers

Sean Wolfe of Red Herring published an article today on the mushrooming number of VC bloggers - VC Bloggers Aplenty?

Brad's newly launched Ask the VC blog prompted Sean to explore why VC's blog and what value exists in the practice.

Sean kindly interviewed me as well for the story. As I mention in the story, the value for me in blogging lies in 1) greater fluency of current trends and technology, 2) a forum for reaching a broad audience on a daily basis and finding new deals, and 3) a medium for demystifying the VC process and sharing best practices and didactic experiences.

Check it out.

Wednesday, January 03, 2007

2006 Redux

In the 1990s, Queen Elizabeth famously declared that she had suffered through an annus horribilis. In 2006, the valley, in contrast, enjoyed an annus mirabilis.

The massive shift of off-line to on-line ad spending (with newspapers still getting 4.5x on-line!!), the power of SaaS and open source models to align vendor and customer interests, the standards and tools that empower users to define how and where they consume content, and the early signals that media companies finally realize the power, not threat, of the web all combine to create powerful tailwinds for start-ups and their venture backers.

The conditions remain ripe for innovation and the “mirabilis” looks set to continue well through 2007. Investors often contrast secular trends (ex. off-line to on-line) with seasonal trends (ex. XMAS buying), and I am confident that powerful secular trends are at the heart of the renewed vigor of the start-up economy.

It comes as no surprise then that my first full year at Hummer Winblad proved to be a very eventful and productive one.

Over the course of 2006, I have been lucky enough to work with a series of great entrepreneurs, work on six new investments, and see four liquidity events.

In 2006, I worked on investments in:

  • Infopia – a SaaS multi-channel e-commerce company
  • Widgetbox – a web widget marketplace and syndication platform
  • Hubpages – a platform for creating and monetizing web content
  • Mulesource – an open source integration platform
  • Move Networks - a video streaming infrastructure provider
  • Replay Solutions -a very cool development tools company

With respect to liquidity, we were fortunate to see:

The opportunity to work with such a large number of innovative companies/founders in an era blessed with powerful tailwinds is truly exciting.

This year we hope to add to our roster of great companies, and I encourage start-ups that share that same vision and passion to get in touch with me as we kick off our very busy Q1 season.

I look forward to hearing from you.

CES 2007

Happy New Year!

I plan to attend CES next week and welcome the opportunity to meet with promising start-ups who also are scheduled to be in Vegas.

Feel free to ping me to set up a time to meet.