I stirred up considerable discussion by dropping a chance remark in the middle of my Steve Singh interview:

I wonder sometimes whether the conventional software model has ever really flourished except during bubbles of one kind or another.  Look at Big ERP.  They had the benefit of several major bubble waves:  the rush to switch to client server architectures, the Y2K debacle, and then right on the heels of Y2K was the Internet Bubble.  Would these businesses have grown nearly so large without any of those bubbles?  Maybe SaaS would’ve gotten here sooner.  The choice between the two is a Tortoise (SaaS) versus the Hare (Old School ISV) race.

Phil Wainewright was taken aback by it, and in retrospect, it was unfair to drop that out there without giving it a blog post of its own to explain.  Before I do that, let me summarize some remarks others have made that are pertinent. 

Phil runs with the premise for a bit, likening the purchase of conventional software to subprime mortgages, suggesting companies must then rue the purchase when normal times return, and further suggesting that in a recession, conventional revenues will collapse while SaaS revenues will “power ahead”.  While Phil juxtaposes Larry Ellison’s denouncement of SaaS (where’s the money in SaaS?) briefly against my comments, he finishes with a great Talkback post where the poster says the only reason Larry doesn’t pursue SaaS at Oracle is because its too hard to reinvent the company, which is exactly what Steve Singh says (one of the few guys who has successfully reinvented a good sized company).  To all of this, I do say that conventional revenues are much harder hit than SaaS revenues, but not all conventional software companies are hit the same in recession.  I will explain in a moment, but it all boils down to recurring revenues.  Before leaving Mr. Wainewright, I suspect after reading his piece that on balance he sees there is some truth to the idea that conventional ISV’s are built on bubbles.

SaaSWeek picks up on the theme.  Their penultimate question and conclusion:

“Is SaaS an inherently stronger model that is destined for eternal greatness by inherent design? Nope.”

Their thining behind this conclusion is that they feel that dealing with the scale issues of very large businesses as well as their flexibility requirements are too hard for SaaS companies. 

They put scale as, “Anyone want to run GE’s global payroll using SaaS?”.  I think they’re dead wrong on that one.  ADP handles companies that large all the time for payroll and they’re one of the biggest SaaS companies out there.  I’m familiar with the scale requirements of these kinds of organizations–Callidus Software pays sales compensation for some of the largest sales forces in the world for companies like Allstate, Sprint-Nextel, and many others.  SaaS has no problem there. 

Flexibility is a much harder issue, and one that I will have to wait for future postings to address more fully (flexibility is also related to the SaaS+Open Source discussion I need to address separately too).  For now, let me just say that it is an area where many SaaS vendors have dodged the bullet by simply refusing to offer much flexibility.  That works for applications where flexibility doesn’t add much business value, but even Salesforce is investing heavily in making their solution customizable.  However, there is no reason why SaaS vendors can’t strive to deliver flexibility, it’s just harder to do because you need sophisticated meta-programming capabilities on top of your multitenant architecture.  Trust me, we’ll drill down on that later.

SaaSWeek goes on to say:

A manufacturer of canned corn can be fairly certain their business won’t fluctuate much in terms of workforce, product innovation, economic cycles and so forth. Why would they spring for a SaaS solution when they can call a local ERP vendor, eat the initial cost but then run on the same system for 15-20 years with bare-minimum, in-house maintenance?

Here I think we have an apples to oranges comparison that SaaS vendors deal with frequently.  You can’t compare the cost of maintenance of On-Premises software against the (apparently) higher cost of SaaS.  The SaaS cost much more closely reflects Total Cost of Ownership.  Maintenance only entitles you to upgrades, which our canned corn friends have no interest in, and the ability to call Tech Support with questions.  TCO for the canned corn gang is going to include keeping the data center running, doing backups, replacing hardware that fails during that 15-20 years (any of you run a 15-20 year old computer), installing patches when problems come up, paying the salaries of the IT people that do that stuff, and so on.  When you look at the IT salaries in particular, SaaS comes out way ahead in nearly any sober calculation.  Look at Steve Singh’s numbers he gave in the interview for how much he saves folks with his software.  Touching back on scale for a moment, Steve Singh’s Concur sells to very very large organizations just as well as small ones and its all SaaS.  I would argue the closer your organization is to needing something that has the best possible economics and doesn’t need uber flexibility, the closer you are to wanting to insist on SaaS. 

BTW, in a recession, aren’t those the qualities you look for: best economics and skip the bells and whistles?  Don’t you want to live with what you can get by on until there are better times?  Are you really going to invest in a boil-the-ocean IT rework of major infrastructure when everyone is hunkered down in the nuclear winter?  And doesn’t SaaS let you get by paying for just what you need as you need it, and leave you with the option to easily change your mind later when times are good and you do decide to boil the ocean?  Do you change paradigms like ripping out your mainframe stuff to install shiny new client/server ERP during a recession?  Those are some gut arguments in favor of SaaS during lean times.

Now let’s get back to recurring revenue.  The lower TCO argument tells why customers want to buy SaaS in bad times instead of conventional software.  Recurring revenue is what you need as an ISV in bad times.  Every software company faces a potential downturn in new customer bookings during bad times.  That includes SaaS companies.  But here is the difference.  With perptetual software, every quarter is a new ball game.  What you sold last quarter is recognized revenue and no longer matters in the current quarter.  If the bottom falls out and you sell very few new customers, the perpetual software company is busted.  The SaaS company looks a little different.  The reduced new customer sales are riding on top of recurring revenue.  So the percentage change looks less.  Let’s see it graphically:

This compares a conventional new sales model versus a SaaS recurring revenue model through good times and bad.  We assume that SaaS recognizes 1/4 of each new sale each period, but that it gets to keep recognizing 1/4 a period forever (e.g. no churn).  We assume conventional recognizes the entire new sale in the same period.  We start out selling $2M a period (perhaps a quarter), and we three quarters of 30% growth followed by a period of decline, and then a period where growth comes back.  The SaaS company has the same problem–it can’t sell as many new customers during bad times either, but it falls back on the cushion of recurring revenue.

Now I ask you, which company would you rather have invested in?  Which one would you rather be working for?  Do you see why I wonder about whether the success of big conventional software isn’t built during bubbles when abnormal growth rates fuel a meteoric rise?  Clever readers will surmise the next shoe I want to drop.  It’s an old shoe too:  big conventional ISV’s have a huge advantage over small conventional ISV’s.  Yes, it’s all the old stuff about brand and yada, yada.  But, to make it worse, they have a lot more recurring revenue!  In fairness, all conventional ISVs have some recurring revenue so the graph doesn’t look as bleak as I’ve drawn it.

Conventional ISV’s can gain recurring revenue from at least 2 sources:  maintenance revenues and professional services.  Even if you have a downturn in new license sales, you still have some recurring revenue cushion.  But the biggest conventional ISV’s like Oracle and SAP have been building up their maintenance base for many years until it is substantial.  And yes, Virginia, the bubbles I mentioned around client/server adoption, Y2K, and the Internet Bubble, all tremendously fueled that build up.  For those not familiar, it is customary on Big Enterprise Software to charge an annual 10-20% maintenance fee.  All big responsible companies pay their maintenance if they’re using the software (and some pay even if they aren’t using it, but that’s another story)

Professional Services is another source, albeit a less efficient one (because it is of shorter duration and lower profitability), of recurring revenue.  If you’re engaged in a long term installation or if you’re called back into the installed base to install an upgrade or do further customization, you get to charge for services over a period of time.  It’s likely not as long as a SaaS or maintenance contract, but it is significant.  That’s why it should be no surprise that when times are tough selling new licenses, companies hunker down around their services organizations. 

Which brings us back to SaaS, where Software is the Service.  It’s all Services.  It’s all recurring all the time.  This is a beautiful thing!

So there you have it.  The economics of recurring revenue streams and why they mean SaaS companies have yet another long-term structural advantage over conventional software.  They can continue to show growth even when things are quite difficult, so long as they can sell more than their churn (i.e. customers who leave and don’t come back) in new recurring revenue contracts.  In a future post we will consider churn at SaaS companies and some of the factors that lead to churn as well as strategies for minimizing churn.

This continues my interview with Steve Singh, CEO of Concur.  In this installment, Steve gives his view on Salesforce, their Force platform, SAP’s ByDesign and acquisition strategy for SaaS companies,

As before, my parenthetical remarks (meaning my reaction but not something Steve and I talked about) are in parenthesis.  Any mistakes are mine, and any great insights are Steve’s!

What’s your view of Salesforce.com?

Steve:  I have tremendous respect for Marc, he’s the best.

If I compare Salesforce to Concur, we took a vertical business process and owned it across all horizontal customers.  We took a stagnant industry and turned it on its head.
Salesforce is more on the outside “we’re a big tech company.”  They want a broad technology platform.

What are your thoughts about Salesforce’s Force?  Could you see using the platform at Concur? 

Steve:  Concur wouldn’t use it.  The cost structure requires a higher price to customer, so it only works for small companies who can’t take on the cost.  If you already have a big SaaS presence, why do it?  No economic  reason.

Bob:  (Steve focuses a lot on economics.  He’s made the comment before that scale drives the economics of profitability for SaaS.)

Would your customers use it?

There is tremendous value to IT customers.  Mostly those related to CRM.  Marc has nailed it.  On-demand platforms should focus on a vertical niche.  We’ve launched  a supplier platform.

Bob:  (I would echo Steve’s sentiments on Force.  I’ve yet to meet someone building a major app on it.  There are many who want to leverage it for connectivity to the Salesforce CRM world.  I’d like very much to talk to anyone that wants to educate me in the error of my ways on this platform.)

I’ve said that SAP’s ByDesign brings competition to the SaaS world for the first time, but that it’s a good thing for all concerned.  What are your thought’s on SAP’s By Design?

Steve:  They announced something that was already public for quite some time.  You can’t fault them for trying.  They’re trying to start in the middle market where they have no presence.  Their challenge is whether they can deliver a whole different experience.  Meanwhile the rest of us aren’t standing still.  The leaders of SaaS are in an incredible position.

Bob:  (Steve’s remark that SAP has targeted the middle ground where they have no presence sounds like a classic example of my “protected game preserve” strategy for companies attempting a SaaS transition)

Concur has been pursuing an acquisition strategy.  How does SaaS change the rules of that game?  What do you look for and what do you try to avoid?

Steve:  You could view acquisitions more successfully in a SaaS company because you can integrate the technologies in the back room while maintaining a different UI for a period.  Captura, Outcast, Joco.  They were SaaS apps to start.  Data layers, business layers, UI layers.  You can integrate in steps.  You can leave out integration when it doesn’t help.

There will be more SaaS M&A.  Look at payroll.  Adding employment verification.  What does it have to do with payroll?  Leverage business and service delivery models to address related spaces that are part of the business process.  Adds a lot of depth.

Can you acquire a non-SaaS company and SaaSify it, or do you only want SaaS?

Steve:  It’s not worth it.  Too hard.  I would rather build the functionality or buy a younger already SaaS company.  It’s too hard to make the change.  Once is enough  for a lifetime.

Bob:  (I had another conversation today about the software M&A game.  The person I was talking to was concerned that there are fewer and fewer buyers as things roll up.  SaaS may change that dynamic in a lot of ways.  If you are starting a company, SaaS even makes better sense as an exit strategy.  First, because Steve is right, companies should prefer to acquire SaaS.  Second, it positions you for the opportunity that the up and comer SaaS companies offer.  The game at the top of being bought by Oracle and SAP may be less lucrative (or even unavailable if they don’t want what you offer) than hooking up with the middle tier of healthy acquirers, which may just be the biggest pure-play SaaS companies.  This also makes me wonder what the private equity world is thinking about SaaS.  Are they frantically converting their properties to SaaS without the pain of public scrutiny, or are they pursuing business as usual?  One person I talked to said the great thing about SaaS is you’re acquiring a recurring revenue stream.  In a traditional acquisition, license sales all too often crater right after the acquisition.  Salespeople will totally drain the pipeline to get every last bit before the change.)

Next?

Our third installment will air next week and will have Steve Singh’s thoughts on Sales and Marketing for SaaS companies.  Stay tuned!

I had an opportunity to talk with Steve Singh, CEO of Concur Software about SaaS.  Steve’s company Concur is in the business of automating corporate travel and expenses through SaaS (or On-demand as Steve prefers) offerings his company provides.  Concur is also one of the few that’s successfully undergone a transition from being a conventional vendor selling On-premises to being a pure SaaS vendor.  Did I say succeessful?  Concur is now one of the powerhouse SaaS plays, second perhaps only to Salesforce.com.  Steve’s a real gentleman to talk to, extremely smart, and as you’ll see, he is passionate about what Concur does and about SaaS in general.  He provides a number of key insights that companies thinking about entering the SaaS world should consider.

Below is my transcript on the interview, with my parenthetical remarks (meaning my reaction but not something Steve and I talked about) in parenthesis.  Any mistakes are mine, and any great insights are Steve’s!

What’s your elevator pitch to customers about what Concur does?

Steve:  It’s an amazing opportunity, so good I have to pinch myself sometimes.  We bring innovation to a stagnant market by automating business processes around booking travel and getting expenses reimbursed.  This creates a more efficient supply chain around these areas.  This kind of processing is amazingly expensive.  It costs companies anywhere from $45 to $50 per trip to book travel without automation.  We bring that down to $5.  It costs $40 to $60 (let’s call it $48 on average) to get an expense report reimbursed and we can automate it to do that typically for under $8 a transaction.

In addition to the savings, we eliminate a ton of paper.  We pull data together for mining.  We help companies address governance and SOX issues.  Think about how big a portion of budget travel and expenses can be.  CEO and management have to sign of on the integrity of these transactions.  Concur spends something like 2 1/2% of expenses on Travel and Expense reimbursement.  That’s a big piece of our budget.  And, it’s very hard to govern a process without automating it.

How is your product sold?

Steve:  Our metric is transactions.  Think about it like a cell phone plan.  You get volume discounts with lots of minutes, and incremental minutes cost more.  A volume discount can be thought of as your free minutes.

Concur has 5,000 customers and we’ve sold about 28 million transactions.

Bob:  (This differs from companies like Salesforce.com that charge by the seat month.  It’s an interesting model to consider where the transactions are what the customer is thinking about.   This makes perfect sense for Concur, who want to align their charges with the customer’s perception of savings based on Steve’s economic figures on costs per transaction.)

What crystallized your decision to go SaaS?

Steve:  I would love to tell you there was an epiphany, but we just paid attention to our customers.  Our business and stock were doing well, but, there was a realization that our business served large customers well but nobody else.  This is true for all conventional software companies.  This limited our market and growth.  We wondered how best to solve that problem?

The only real example serving customers of any size and with an accountable 2-way relationship was On-demand.  Licensed software has no accountability.  Our examples were companies like ADP or Paychex.  Technologists think they invented everything, but On-demand has been around for decades.

Bob:  (It’s great that the proximity of ADP to the space helped give Concur an example to learn from.  Others have to stretch further, but now that SaaS is out there, everyone should “get it.”  Steve Singh is not the first SaaS executive I’ve talked to that brought up ADP.  Dave Thompson, former VP of Marketing for WebEx, told me their sales model was formalized around many small transactions because they hired their VP of Sales from ADP and he kept asking how to make WebEx more like ADP.)

Steve:  To make the transition involves a lot of pain.  Only some technology is common, everything else has to be reinvented.  The best example of what can happen if you get it right is to look at Concur vs Extensity.  In March of 2000, both were the same size.  During the downturn, Concur went On-demand and Extensity stayed On-premise.  Extensity was betting the downturn was the source of their problem, that it was just the economy and their growth would resume as soon as the economy turned around.  Fast forward to today and our guidance is almost $35M, Extensity is at $3M.

Bob:  (I wonder sometimes whether the conventional software model has ever really flourished except during bubbles of one kind or another.  Look at Big ERP.  They had the benefit of several major bubble waves:  the rush to switch to client server architectures, the Y2K debacle, and then right on the heels of Y2K was the Internet Bubble.  Would these businesses have grown nearly so large without any of those bubbles?  Maybe SaaS would’ve gotten here sooner.  The choice between the two is a Tortoise (SaaS) versus the Hare (Old School ISV) race.)

Steve:  It’s about driving a long term business, not short term success.  We knew we faced a lot of pain going SaaS, but we wanted to focus on the long-term.

Our first quarter of transition expanded new customers sales faster than ever before.  This was like getting instant feedback that our decision had been a good one, so I’ve never looked back.

What Were Your Biggest Fears About the Transition, And How Did They Turn Out?

Steve:  Our stock cratered and we wondered in the first 6 months.  We replaced all but 2 executives over 9 months.  The only 2 that stayed were the founder and myself.  Nobody else wanted the job.  We had massive changes in sales, support, prod development.  We created a new hosting organization.  We needed a new consulting organization that changed from traditional SI-style consulting to smaller deployments.  Essentially, we started a brand new business.

Our biggest fears:

• We didn’t know if people would buy SaaS.  Even though customers bought payroll that way from ADP, they weren’t buying anything like what we had.  There was no proof they’d buy software as on-demand.  We did do customer research, but it was a bet.  Our first quarter told it all.  We couldn’t have asked for a better response.  This is why SaaS is doing so well.  It’s cost effective.  The vendor is accountable to the customer.  The customer’s life is easier.  And there is a much lower cost structure.
• We also had a fear of whether our people could transition.  They had a lot of choices outside Concur.  It was the height of dot com.  Many wouldn’t take the pain.  We lost a lot of folks who wouldn’t do it.  Some were fine to lose and some it was very painful.

Bob:  (You can hear the pain in Steve’s voice when he talks about how hard it was during the early transition.   It’s awesome that they got instant positive feedback from the market, but you wonder what happens to companies that try a SaaS experiment without really committing and don’t get enough instant feedback?)

What surprised you as you moved into the SaaS market that you didn’t expect?

Steve:  We knew we’d do well in the middle market bringing enterprise class services that were unavailable to that market before.  But we didn’t think global accounts would embrace as quickly as they did.  American Express.  BofA.  Alcoa.  They came early.  They thought we had a much better solution than any other choice, including our own on-premises software. 

The other surprise was how things went with sales.  On-demand delivers reduced cash flow versus perpetual.  Initially, we tried to incent our sales orgs to tackle big accounts perpetually to offset the cash flow issue.  Eventually we made comp completely neutral.  Same commission no matter what the customer buys.  We let the customers decide whether to go SaaS or On-premises.  When the sales comp favored On-premises, it was a 50/50 split.  When we made it neutral it went to 99% On-demand versus 1% after comp change.

Bob: (Having been in the incentive compensation software business, I can’t tell you how powerful compensation is as a tool for aligning sales behaviour.  Steve Singh’s example points this out.  His salespeople where swaying almost half the customers to do something they didn’t really want to do because of the comp plan the sales people were on.  CEO’s take note: the next time you want to turn your supertanker company on a dime, think about using compensation to push that turn through faster!)

Do you think SaaS is an inevitable bridge that every ISV has to cross in some form or fashion?

Steve:  Absolutely.  Look at what’s happened in the last 30 years.  We went from mainframes and sky high transaction costs with few users.  Then we went minis.  Lower costs, more users.  Micro/PC.  Web-based On-demand  is the lowest cost structure and most users yet.  It’s inevitable continuation.

Bob:  (It’s a fascinating way of looking at it.  If Singh is right, there’s a lot more action in store for the SaaS world as we go forward!)

Any other advice for those who want to convert?

Steve:  This is just one guy’s prediction.  I don’t believe large companies can make the conversion.  Forget their genetic code.  How many will take the pain?  Companies won’t reinvent themselves. 

Think of taking a $40B company to On-demand.  The value of the business will go through huge negative change.  It will get crushed.  Cash flow will get crushed.  You have to layoff.  The transition is really hard and its very sudden.

If you’re north of $100M its hard.  Over $1B its impossible.

I’d like to compare businesses that have gone through fundamental shifts in the business model.  Very few have done it.  Intel is one.  But for every Intel there are 100 DECs.

You will see a next generation of leaders that don’t look anything like the last generation.  Keep your eye on the SaaS leaders.  Lots will happen there.

Bob:  (I think Steve is probably right, but we’ll see whether a few don’t decide to walk over the hot coals to SaaS anyway.  The amazing thing about SaaS is that it is better for customers and much worse for the incumbent non-SaaS ISV’s.  This is what makes it such a disruptive new business model.  It literally has the potential to completely change the landscape.)

Next?

Check out Part 2, where Steve gives his view on Salesforce, their Force platform, SAP’s ByDesign and acquisition strategy for SaaS companies,.  Part 3 discusses Sales and Marketing for SaaS companies as well as some observations Singh makes on future trends in the SaaS world.  Be sure to click the “subscribe” link at the top left of the blog page so  you don’t miss out on these future posts!

And special thanks to Steve Singh for taking so much time to talk with me for this interview.

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To Seth Godin’s point, Steve Singh is the guy that said “follow me” at Concur and converted the company from Seth’s green curve to the blue curve.

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