This is part 2 of my interview with Xactly CEO Chris Cabrera who tells us what it takes to start a new SaaS company and why you’d even want to try.  If you missed Part 1, be sure to go back and check it out!As always in these interviews, my remarks are parenthetical, any good ideas are those of Chris Cabrera, and any foolishness is my responsibility alone.

Challenges of Being a SaaS Company Today

What are your thoughts about Salesforce’s Force? 

Chris:  Force is great, especially for an up and coming company that wants to build a SaaS offering that ties into SFDC.  For us, we were early adopters of the App Exchange.  We’ve created deep integration and mashups using Apex.  We absolutely will stay with the Force to broaden and deepen our relationship.  They’re a customer of ours so we learn a lot from working with their sales force. 

Having said that, only about half our customers are Salesforce customers.  We won’t rewrite our product in Force as that wouldn’t make sense.

Bob:  (I hear this a lot from various folks.  They like to use AppExchange/Force as a “connector” to the Saleforce ecosystem, but they’re loath to build their flagship app on the platform.  There are a lot of reasons for it–the platform doesn’t do that much for you other than make it easy to connect to Salesforce, the economics are not great for a company in terms of cost they have to pass on to their customers, or most commonly people just don’t think it makes sense if their app has no close affinity to Salesforce.  I think Chris is absolutely right though that if it makes sense to partner with Salesforce and create some component on Force that ties back to your world, there are lots of benefits in doing so.)

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?

Chris:  As you pointed out in your blog, I think its great for one of the biggest software companies pointing out that SaaS is for real.  It remains to be seen if they can sell it without having a problem serving both masters.   It’s very difficult.  If they succeed with both, they’ll be the first I know of.

Bob:  (Figuring out how to take advantage of the SaaS market without crashing a big conventional software business is one of the hardest business strategy problems of our time.  Check out my latest back and forth on this one with Phil Wainewright:  SAP has a clever and sneaky strategy!)

What are your thoughts on partnering in the SaaS world, especially for startups?

Chris:  One of the most powerful things about the SaaS world is the ecosystem.  With mashups and internet technologies, the ultimate customers can buy from multiple vendors and have it appear as one to their end users.  With our product, salespeople see their commissions right alongside salesforce.

Partner with companies whose offerings are complementary.  We’ve done that with Salesforce, RightNow, Concur, SuccessFactors, BigMachines.  It’s critically important not to do it all yourself.

Bob:  (Xactly has one of the smartest partnering strategies I’ve seen in a SaaS vendor (more on his SI partnering strategy shortly).  Where many SaaS vendors are trying to do nearly everything themselves, Chris is carefully creating a win-win ecosystem with selected partners.  There are no “Barney” partnerships for Xactly, each one has real value for both partners and commitment that goes both ways.  Perhaps this accounts in part for how Xactly has been able to grow so quickly in just 2 1/2 years.)

What advice would you have for VARS and Sis?  How can SaaS ISV’s help their partners best?

Chris:  We partner with Astadia, BlueWolf, Iconixx, and CompTech.  These VARs have implemented 4,000 salesforce installs.  They’re looking for how to go back to their customers and get more value for them from SaaS.  What better way than to bring another solution?

Our strategy around VARs and SIs is to look for firms in adjacent solutions.  We then do mutual referrals and they do the implementation services on deals they bring us.  Our average implementation is 6-7 weeks.  These VARs/SIs have built their companies on making money on that size implementation.  It’s challenging for big SI’s like Accenture at the moment because their model needs a much bigger engagement to get excited.

BlueWolf and Astadia work with a select few—sole selected Xactly.  Complementary verticals.  They’re not playing the agnostic game.  They picked the tool they liked.  Partners are not agnostic to one another.  That’s what makes it really work.  The vendor can afford to invest in a partner that’s committed.

Bob:  (Chris touches on a whole bunch of key points here, both for partnering and for SaaS.  First, note the very short services engagement needed to install his software: 6-7 weeks.  The one or two orders of magnitude less than conventional enterprise software, and it’s a key ingredient for SaaS.  Much more than that and you’re better off to start taking out customization features so you can keep it simple.  Remember what Chris said in Part 1: he needs no try before you buy program because buying is so easy it just doesn’t make sense.  The second thing is that many conventional VAR/SI partners are too oriented to big bang engagements.  Steve Singh talked about the misalignment that happens when SaaS companies try to deliver fast ROI and big services partners want to drag out their hourly billings.  As a result, Singh says it doesn’t work to hang out with SI’s.  But Cabrera has found a middle ground.  Some of the smaller firms have adapted to shorter cycles where a partnership can make sense.  Additionally, he touched on another key element.  Often, VAR/SI partners want to be completely solution agnostic.  They’ll sell whatever the customer is buying because they don’t want to limit their market.  What they’re overlooking is two things.  First, they are in a position to accelerate the deal cycle for all concerned if they have one recommended solution they sell.  Second, their ISV partner will be prepared to invest more in them if they’re working from a better commitment position.)

Xactly has grown extremely quickly.  What’s your formula for success?

Chris:  It’s true, we’ve grown so quickly.  We’ve tracked every deal and our average sales cycle is 92 days.  Because we’re selling a lower ticket item, it is almost risk free.  The ability to get the customer to agree can happen so much faster.  There isn’t a big hardware investment.  There’s no 9-12 month install. They aren’t stuck on the dessert island of an old version.  The old Enterprise fears are gone.  Customers realize we have to earn their trust every month, so it’s easier.

Bob:  (These are the classic arguments for success that SaaS CEO’s have on the tip of their tongue.  I find the sales cycle number extremely interesting.  92 days is very short for most enterprise sales cycles, yet Xactly is closing customers at very large companies like John Hancock and Akamai.)

How do you get customers to trust a relatively new and small company with their data and critical business process?  What do they do if you don’t make it?

Chris:  Great question.  There’s a lot of moving parts to the answer. 

First, when customers look at where their data is today, it’s often on the laptop of one or two people.  It’s hardly secure.  In most cases they agree that in our carrier grade facility its more secure.  Second, companies look to compliance with standards like SAS-70 type 1 and 2.  We have all kinds of redundancy and backup, offsite replicated storage, and a lot the customers aren’t doing themselves.  SafeHarbor is another standard that makes the difference.  Most customers can’t afford to do all of that on-premise, but we leverage economies of scale across our installed base because of our multitenant architecture.  When they see we have a better solution than they could afford to build, that ends the conversation.

The likelihood we disappear is low given our financial backing.  But, we do have arrangements through escrow where customers can get their data and the code.

Bob: (Like security, this is another of the great boogeymen that SaaS detractors wave.  But customers are getting wise to the idea that SaaS can be a safer place for their data after all.  Emerging standards are also making it easier to judge whether vendors have all the right safeguards in place.  It’s just one more sign that the SaaS model is growing up when huge corporations can trust a small company like Xactly with sensitive sales compensation data–the equivalent of a payroll system. )

Next Installment

In our next installment we’ll be talking with Chris about Sales and Marketing for SaaS companies, as well as seeing some interesting perspectives on SaaS Technology and Infrastructure.  Be sure to subscribe to the blog so you won’t miss the next installment.  Just click here to subscribe with your favorite reader.  You can also get the blog via email by clicking here.

The economics of SaaS are magical.  SaaS combines two powerhouse ideas for generating revenue and growth: radically reducing friction in the sales process and recurring revenues.  The first means SaaS companies can close deals with a fraction of the effort needed for a normal transaction.  As SaaS CEO Chris Cabrera said when I interviewed him, there is no need for a try before you buy because buying is so cheap and easy customers just want to get started after the first demo.  I’ve talked about recurring revenues as well.  Recurring revenue gives SaaS companies the power of compound interest.  This recurring revenue cushions the down times and compounds the good times so long as they keep customers happy to minimize churn.

The people I talk to in SaaS companies are loving life and are convinced the world is going SaaS quickly.  There are many signs that the old barriers and objections are steadily coming down.  Cabrera commented that security, that big nasty totem SaaS detractors love to wave, was a factor in 2 out of 10 sales calls 3 years ago, and now he only hears about it in 2 out of 100 calls!  Cabrera goes on to suggest that in 10 years, SaaS will have completely taken over.  I don’t think he means there will be no other businesses, just that SaaS will dominate the marketplace.  Singh, for his part, also feels that the SaaS players will move rapidly upwards in scale, and his own company is efficiently pursuing an acquisition strategy to compound that growth further.  SaaS companies have proven they can sell up-market too–Sing has customers with 180,000 seats and Cabrera is selling 200-300 seats per customer which is a far cry from the low teens of seats that Salesforce sold to each customer when it started.

The other magic of SaaS is that it’s a completely disruptive business model.  It forces companies with an established business to take their usual model where license revenues are recognized in their entirety in the quarter they were sold and start spreading that revenue out on a monthly basis.  Many of these companies are barely making their numbers as it stands, and any move to SaaS is going to create a short term apparent slow down in business that they can ill afford.  Because both men have lived the non-SaaS life as well as SaaS and know full well what’s on both sides of the curtain, both Steve Singh of Concur and Chris Cabrera predict it will be very hard to impossible for companies to switch.

Let’s assume all of this is true:  the economics of SaaS are magical, SaaS will inherit the world within 10 years, big software can’t move up market because the big companies will buy SaaS too, and the business model change almost requires living through self-immolation.

What are the established players going to do?

They’re going to try to eat the elephant in bites.  They’re establishing what I’ve called “protected game preserves“.  Phil Wainewright calls it the “See No Evil”, “Hear No Evil”, and “Speak No Evil” strategy for SAP, Adobe, and Microsoft.  Oracle is apparently going to ignore SaaS for as long as it can.  Their strategy is based on capturing recurring revenue too, but they do it buy buying the companies that succumb along the way and milking their maintenance and professional services recurring streams.  Perhaps they assume there will be big enough SaaS companies in a few years that they can acquire those too.

Here’s how the protected game preserves work for these companies:

• Adobe is entering the new market of word processors with their BuzzWord acquisition.  It doesn’t compete with anything they sell today, so it’s a safe bet and a protected game preserve.
• SAP is trying to confine their ByDesign product to the mid-market, where they don’t sell much anyway.  Peter Zencke is already talking about how this product is a lot slower than their regular product because of its layered architecture.  Probably true, but its a nice way to tell a big customer “no” that pushes them for SaaS.  It’s interesting that the “factor of 4” slowdown is almost exactly what they need to keep it away from their large customers.  This is the pat answer to Phil Wainewright’s concern that if the product is great it will cannibalize.  SAP will tell you it’s great, but doesn’t yet scale outside the market they want to restrict it to.
• Microsoft is featuring add-on services to their existing perpetual license products.   Same old markets, but you have to buy their regular product for the services to be of any use.

How well are these strategies likely to work?  I like SAP’s the best and Adobe’s the least. 

Adobe is venturing very little, and has minimal risk, but they have a lot of ground to cover to shake loose an interesting audience.  They’re building a market there, which is potentially time consuming even helped along by SaaS compounding.  It’s also a market that offers them no leverage to speak of for transitioning the rest of the business.

SAP, on the other hand, seems pretty clever.  They built their entire span of products into ByDesign, so they have a ton of leverage to achieve a great product/market fit.  At the same time, the 4x poorer performance is a poison pill that starts to keep it from being too threatening with the big customers.  They can go into that middle market and butt heads with other SaaS players hard.

Microsoft, as usual, is in the middle, scratching their heads about the web.  They know they need to do something, they’re just not sure what.

The real issue all of these players have is that SaaS is a hobby for them.  SAP has made a pretty big development commitment, but it remains to be seen how much effort they can afford to invest.  Remember, even if SaaS isn’t cannibalizing, these companies all have to invest in growing their SaaS businesses while still keeping enough investment on the core that they don’t tank their numbers.  Even a protected game preserve strategy can’t help with that because the budgets are a zero sum game. 

Here are my predictions on how this plays out:

None of these companies will take huge pain, Steve Singh is right about that.  Of the three, the Germans at SAP have historically had a greater pain tolerance when they’re doing what they think is right, and I also feel they have a pretty clever strategy to make a really big game preserve.  I give them the best chance of keeping head above water as the SaaS transition unfolds, but I don’t look to them to build a commanding presence because they can’t invest enough without maiming their core.  The rest of these companies are going to have to look for acquisitions in the SaaS world.  It’s the only way to seize SaaS market share quickly.  By acquiring, they don’t pay the advance cost of the compounding, they get compounding handed to them as a going concern that is hopefully growing rapidly and profitable. 

The difficulty with a SaaS M&A strategy is that if the SaaS pundits are right, the fundamentals for these companies can deteriorate while SaaS valuations go up.  That’s a nasty M&A whipsaw if your acquisition currency is devalued while your targets increase in value.  Adobe has something of a hedge because their business is highly correlated with activity on the Web.  SaaS and Web 2.0 are both web-based, so Adobe can benefit.  Microsoft I wonder about.