In every technology market, the number one player gets disproportionately rewarded.
In every technology market, the number one player gets disproportionately rewarded. The winner obviously has the most revenue, but in addition, that revenue, and the associated profits, are more highly valued by the public markets. Salesforce.com trades at 6x 2010 revenues, while SaaS companies on average trade at 4x revenues. The same is true across the entire technology industry. In the consumer internet space you tend to see businesses where a network effect generates the winner. Once you have the network effect it is yours to lose. In the enterprise software space, a strong network effect is often lacking. So how can make sure you win ?
As a new enterprise software market starts to emerge, you frequently have two to four viable contenders, all slugging it out to be the market leader. Couple this with the SaaS business model, where the sales and marketing investment model is very capital intensive upfront, and what it takes to win, is a combination of a profitable units sales model and a willingness to spend what it takes, to get to the number one position. I have been in that position twice, in the last ten years, where I have been on the board of a company with a direct head to head to competitor, in a great high growth SaaS market, and the decision we had to take was, how aggressively to invest and when.
In the period 1999-2003 I was on the board of Placeware which was a company in the web conferencing market, competing with Webex. The market was exploding and Placeware grew from $ 4M in 1999 to $ 51 M in 2002, 12x growth in three years. In the same period Webex grew from $ 3M to $ 81M, 27x growth in the same period, and went on to grow to $ 300M in revenues. Placeware was acquired by Microsoft for $ 200M in 2003, a good outcome for the investors. Webex was ultimately acquired by Cisco for $ 3.6B, a far better outcome. The key difference, Webex raised and spent capital more aggressively on sales and marketing, than Placeware, and as a result was able to grow more effectively and establish market leadership. Note I said effectively and not efficiently. Webex may have sacrificed efficiency, but it made up for it in effectiveness. A key part of the Webex win, was getting public in that last open window in August of 2000 before the final implosion of the tech bubble.
|Exit Value||Exit Year|
|Webex as % Placeware||59%||130%||227%||273%|
In the period 2006-2009 I was on the board of Omniture, competing head to head with WebSideStory, in the web analytics market. Same situation. Here WebSideStory in 2002 was almost 4x bigger than Omiture but went public earlier and committed to Wall Street that it would maintain and increase profits. Omniture stayed private, raised money from Hummer Wimblad and my firm Scale and instead opted for growth at the expense of profits. WebSideStory grew 4x in four years, Omniture grew 22x in the same period. While WebSide roughly broke even after 2003, Omniture's losses accelerated in 2004 to 2005 before transitioning to strong profits in 2007 as the advantages of scale were realized. Omniture ultimately acquired WebSide in 2007 for 14% of the combined entity plus a $ 50 M cash payment. Again the value was created by the aggressive winner, fortunately for me, this time, I was on the winning team. The numbers below tell the story.
|Exit Value||Exit Year|
|Omniture as % WebSideStory||27%||53%||91%||109%||145%|
|Operating Income||2002||2003||2004||2006||2006||Total Loss|
I have become convinced that winning in SaaS is not complex, just hard. There are only two steps. First of all you need to be absolutely sure the sales model works. Note that forgetting this step is like hitting the accelerator on a sports car, without learning first of all how to steer. Someone will get hurt. However assuming you can steer, then you need to get the capital, and the mandate to invest aggressively, and "damn the torpedos, full speed ahead".
A recent investment we made at Scale, is in a company called ExactTarget which opted for this approach. The company had grown extremely well and was already the largest company in its market when we invested. The company was considering going public and had an S-1 on file, before opting instead to raise a round from Battery Venture and ourselves to continue to stay private and invest more aggressively. The company plans to maintain and increase its leadership position, and go public later on, not just as the largest company in the market, but the largest by a significant margin.
For Webex, going public early was a savior, for Omniture and hopefully for ExactTarget, waiting to go public was by far the better move. This illustrates the reality of "life on the Street". Being public provides capital, and often cheap capital which is good. In return, like a relative who lends you money, Wall Street wants to interfere in your life and thinks it knows best. At times the Street will push you to focus on short term profits over growth, even though growth will mean more profits in the long term. At other times, it will tell you to spend, perhaps to excess.
The only way to deal with this is to remember that Wall Street, does not know your business nearly as well as you do, and may not have your long term interests at heart. You are building a ten year business but some hedge funds trade shares in ten milliseconds. You are not aligned. If you can get the cheap capital without letting Wall Street dominate your agenda, it is well worth while. However if the cost of getting that capital, is having to run your business for the ten second trader guys, you will end up in a modestly profitable second place position to a competitor with more patient capital and a long term focus.