It’s ironic when you look at the typical SaaS player’s view of conventional Enterprise vendors who they think of as Luddites, but I have to say, I don’t think many SaaS players fully “get it” either.  Let me explain.

SaaS represents not one but two major areas of innovation.  It innovates in the area of Business Model by switching from perpetual license to “on-demand” subscriptions.  Many make the mistake of stopping there, perhaps adding that part of the business model innovation involves switching from selling a phyical software “good” to selling a service.  Stopping there is a huge mistake.  The transition from goods to sevices is not purely a business model change.  Treating it as such leads to the old hosted/ASP model.  That’s because the second major area of innovation revolves around technology.  Specifically, technology that is needed to transform a good into a service without undue cost of service delivery and technology needed to deliver that service from the clouds.  There are SaaS players that “don’t get” both sides of this equation.  Some are very surprising. 

I don’t think Salesforce.com, of all players, “gets” some aspects of the Business Model.  If they did, they would radically alter the pricing on the Platform-as-a-Service offering, because the current pricing, even the radically revised pricing, is completely off target for a SaaS vendor.  Why?  Because the value proposition just isn’t there compared to the Sales Force Automation offering from Salesforce.  The service is priced at $50 a month in its normal configuration.  Let me explain why that’s crazy.  If you take an average of public SaaS companies, it typically costs them an average of about 25 cents to deliver each dollar of SaaS service.  Salesforce themselves get by for a lot loss.  Now suppose you want to create a new SaaS business on the Force platform.  To be competitive, you need to be able to deliver it for that same 25 cents on the dollar.  But, SFDC wants you to pay them $50 a month.  So, that means you’d have to charge $200 a month to be competitive with SaaS players that didn’t use Force.  Most SaaS players charge $50 or less each month for their service, so this math will almost never work. 

What does this mean for Salesforce?  Two things if left unchanged.  It means the consumers must largerly be IT, who aren’t trying to sell a Service, and who might view that as a more reasonable price.  Second, it means a lot of ISV’s will use Force not to develop meaningful products, but simply to connect to the Salesforce ecosystem.  They can’t afford to deliver their flagships on Force because its too expensive.  Basically, it becomes a platform for generating sales leads, not software.  Compare and contrast it with something like Amazon’s web services.  I was just going over pricing on that with a friend and he couldn’t believe it.  He kept asking whether there was a $50,000 minimum purchase or some such.

It may be that Salesforce understands this problem at some level.  They have just introduced “on-demand” pricing.  In this model, customers are billed by logon.  Each logon costs $5, and up to 5 logons a month per seat are supported.  Interestingly, logons will cost $0.99 through the end of 2008.  The Smart Money says that $0.99 is not “promotional pricing” as they say, but rather a way to test the elasticity of the market.  It’s more in line with what the service should cost in the first place.  Projecting, it would put the mainstream service at $10 a month instead of $50, and would mean you could build a $40/month app and pay Force 25% of your revenue.

Another group that doesn’t seem to get the business side is Cowen.  According to Larry Dignan, Cowen rates it as highly likely that software as a services (SaaS) will hit the demand wall.  It’s tempting to point out that there is always a last Luddite to realize change is upon us.  You can almost always find one of these predictions just as a major movement causes the chasm because at that point in time it feels like an edgy contrarian prediction, and often these can be right.  Just not when you’re bucking a major trend.  I can see how the thinking went.  Cowen are Wall Streeters.  Wall Streeters are keen on getting an “edge”.  To have an edge, you have to do something different than the masses.  This is why contrarian strategies get so much attention.  In fairness to Cowen, they were attempting to come up with the most likely technology suprises for 2008.  By definition, they had to find things that buck the conventional wisdom, or they wouldn’t be talking about a suprise.  That’s about the limit of the slack I can cut them because they rated SaaS hitting the demand was as their #2 most likely surprise.  Only “The Telco Threat to Cable Becomes Glaring” was rated more likely. 

Why does Cowen think SaaS is so likely to hit a demand wall in 2008?  Their logic is convuluted.   They admit:

Saas vendors are unlikely to post a financial shortfall even in a difficult IT spending environment because the subscription nature of their business models affords a high level of predictability. Even if IT budgets contract, software delivered as a service can be deployed for such a minimal up-front investment that new customer signings and net subscriber additions will continue to grow at a rapid clip. On-demand vendors will continue to gain share vs. legacy providers of on premises software at an inexorable pace in both good and bad environments for corporate IT spending.

Yep, heard that, knew that, believe that.  So how come there’s a likelihood of a negative surprise?  Cowen goes on to say:

None of the above claims has been tested in a slowing economy. Enterprise software company activity levels are always volatile and back-end loaded. This challenge is a constant in the software industry — and applies as much to on-demand software companies as to traditional on-premises software companies. The exposure of SaaS vendors is heightened by the fact that nearly all are “one product companies” that are fighting the increasing inclination of corporate IT buyers to consolidate spending with a few large vendors like Oracle SaaS vendors all provide applications for which new deployments are likely to be tightly tied to the willingness to fund discretionary new projects (which is more economically sensitive than spending on IT infrastructure). Moreover, new deployments and seat growth for the on-demand vendors is likely to be highly exposed to fluctuations in both HR and marketing budgets – departments that traditionally bear the brunt of corporate belt tightening early in a business downturn.

“Aha!”, says I.  We’ve heard that before.  Now we see where they’re coming from.  They’re playing the “SaaS is a new project from a new one-off vendor and IT won’t start new projects with new vendors in bad times” card.  Dignan excuses them without too much comment after this explanation.  I’m not so easy.  This argument is riddled with problems.  First, they’re describing the well-known behaviour of BIG IT.  Big  IT will definitely retrench by killing or blocking new projects and reducing number of vendors in times of stress.  But here are the problems.  Business users, not IT, are much more likely to be in control of the sales cycle for SaaS.  SaaS is largely sold to SMB, not the Global 2000 where Big IT lives.  That is not to say it is never sold to the Global 2000, but that market is not (yet) driving most of the growth in SaaS.  Last I checked the average number of seats for Salesforce.com was about 20 per customer or so.  Not 100, not 1000, not 10,000, but 20.  Big IT has absolutely nothing to say about 20 seat deals.

The other point I want to make here is that this scenario, where Big IT retrenches to fewer bigger vendors and kills new projects and new ideas is a description of commoditization.  Big IT gets away with it because the big players are “good enough” and the new projects are “not important enough.”  SaaS is the ultimate commoditizer.  It is much cheaper to go with SaaS than the bigger conventional perpetual license vendor.  SaaS requires far fewer IT resources and causes them far less pain than the typical big enterprise software boil-the-ocean project.  That’s why it has been so successful.  In short, SaaS does what IT wants better than the big vendors can.  Savvy Big IT people are starting to understand this and employ it to their advantage to cut costs and bail out troubled projects.  If I was a CIO and had an on-premise project in deep trouble, the first thing I’d do is look for an opportunity to replace it with SaaS.

In our next installment, we’ll take a look at some of the technology issues that I think a lot of SaaS vendors don’t get.  You might want to subscribe to my RSS feed or get on the emailing list to make sure you don’t miss it!