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SaaS and the Cloud Ten Years In


    I recently had to give a talk on trends in SaaS and the cloud. Attached is the full Powerpoint. Some of it is plain vanilla, but doing it helped crystallize in my mind what drove the last ten years and what are the key trends that will matter over the next ten years.

    First, SaaS is a business model, and a computing architecture, it is not a market. CRM is a market, web analytics is a market, ERP software is a market. A great software business model like SaaS, in a mediocre or slow growth software market, like manufacturing software, will probably result in a slow growth company. SaaS is not pixie dust.

    Second, the markets that work best for SaaS are ones that actually leverage the SaaS architecture which is based on having all the computation in the cloud and leveraging the browser as the free client. Applications like CRM (Salesforce) or Expense Reporting (Concur), serviced large numbers of clients, many of whom were dispersed outside the four walls of the enterprise. Here SaaS had a clear competitive advantage. Accounting software has small numbers of users, most of whom are deskbound. Here the SaaS advantage is much less. This explains, I think, why Salesforce and Concur are huge companies and Netledger struggled until it became Netsuite and offered an integrated product.

    Third, GAAP is not flattering for SaaS companies. The sales expenses come up front, the revenues are recognized over time and the result is that high growth SaaS companies have horrible looking GAAP income statements. Three or four years ago this was a real cause for concern amongst investors. Now the markets have figured out that provided that the sales efficiency is high and the combination of gross margin and churn makes the math work, up front losses are acceptable (for example, Cornerstone IPO).

    Fourth, these deals are compounders not rocket ships. Beyond say $10M in revenue it is extremely hard to grow greater than 100% per annum and almost no companies have done so. The kind of exponential growth seen in internet companies is not possible in enterprise software. Fortunately the kind of exponential growth decay (see sticky growth factor post) that happens to unsuccessful consumer internet companies is less likely here also. These companies simply keep on compounding which is why the Street has grown to love them. They rarely blow up and miss badly.

    Finally, the key in these investments is to play to win, even at the expense of short term losses. The winner gets almost all the returns. In each market here the number one is 2x to 10x the size of the number two player.

    This slide shows the dollar value created in SaaS since 2000. The data supports the conclusions above. The behemoth is Salesforce, that has compounded steadily and played to win since being founded in 1999. There have been at least eight outcomes in the one billion to five billion dollar bucket with more to come. The majority of these companies fall in the “leverage the architecture” bucket focusing on inherently cloud-centric and large number of user-centric applications. All of them had steady early losses before bursting into profitability at scale.

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