The relentless change brought to us by the consistent doubling of computing power that Moore’s Law describes continues and is now likely to change at least some SaaS applications in the near term.  What do I mean? Consider – we now have a very competitive mobile application market and thanks to Google Chrome and now Apple Safari, it has crossed to the desktop on browsers.

Meet the New Paradigm

The event that brought this to mind was the announcements of the release of Safari 5.o.  Leaving out the typical “improved performance” claims – two things were apparent – it is now a platform and it is designed for use in a cross-platform, mobile environment. On the platform side, Safari has joined Chrome in providing an extension system that allows developers to in effect, build secure and stable, rich clients into the browser. We’ve seen this for a while in the form of the “app stores” that are proliferating for mobile devices like smart phones and the “iPad” category (however you define it).  On the mobile, cross-platform aspect, the browser is now tuned for mobile users.  It is very noticeable if you try the new Reader function of Safari. It is quite usable on a desktop or laptop, but it really shines in the limited real estate of mobile devices. Multiple page articles merge seamlessly into one. Space wasting banners, sidebars and menus disappear. The browser becomes a credible, focused article reader for all devices.

What does this mean for SaaS? Take this evolving “browser as a platform” trend together with the announcement of iOS 4 (the artist formally known as the iPhone OS) and the growth of the Google Android and Chrome OS and you have a quickly changing landscape of operating systems tuned for a rich mobile environment and a browser-centric application implementation system. These advancements mean the expansion and adoption of HTML 5.0 is moving even faster than many of us thought. They will make the often tricky environment of JavaScript and Ajax less of an issue and the user experience of properly-tuned SaaS applications much more fluid and “desktop like.”  It means that locally-installed, OS dependent applications are becoming ever less relevant and cross-platform, network-delivered services are becoming increasingly rich and useful.

Frankly, as interesting as this news is, it also points out that SaaS is a very fluid environment. Keeping ahead of it is increasingly difficult. Knowing how to manage a SaaS product and chart a plan to navigate development is critical. Knowing what you need to support scalable SaaS operations and what you should embed in the application is critical. Understanding your user environment and what is expected in your market is critical. The list goes on and there has to be a way to understand the landscape and to make the choices easier. And the point of this article is – there is – it is SaaS University.

As a company, Scio has stayed involved with SaaS University because it answers the need our clients and the SaaS community has to have current knowledge about our industry and important issues. Because Softletter produces regional events quarterly, you can plan to attend when and where it makes sense and take advantage of the evolving content as you need to. The tracks and workshops are well attended, but generally sized so the sessions can be interactive and remain relevant. If you’ve been to the larger, vendor-led conferences – SaaS University offers content that is focused on providing valuable insight to SaaS entrepenuers.

The next SaaS University event is in Washington DC, July 20-22, 2010. There is a full two-day agenda of sessions in two tracks covering a wide range of subjects and a third day that offers a choice of four in-depth workshops. On that point in particular, I want to highlight our own workshop, Charting Your Course to SaaS.

Charting Your Course to SaaS – SaaS University, Washington DC, May 22

This is the third time we’ve offered this comprehensive workshop on SaaS and it continues to evolve as we respond to the needs of our participants. Following our joint workshop with Jim Geisman of Software Pricing Partners, we’ve continued to tighten the content and for SaaS University, will offer a more interactive format for this workshop, especially during the afternoon. The aim is to keep it small enough to allow everyone a chance to move the discussion toward the issues that interest them most.  It remains however, the only workshop that covers the business, operational and development issues that are critical to success in SaaS.

Companies that can benefit by attending this workshop:

• A new venture or as an ISV with on-premise products considering developing a SaaS offering
• A service company with significant vertical expertise than could be delivered and monetized in a SaaS model.
• An existing SaaS provider who made choices opportunistically that now constrain growth and cash flow.
• A SaaS entrepreneur with limited funding that needs to achieve positive cash flow early with products that evolve with the market.

Company challenges this workshop can help overcome:

• Building out a suite of products but are unsure of the strategies, metrics, and operational models needed to grow.
• Developing a framework for sorting out technical and strategic choices required to move to the SaaS business model.
• Facing significant operational problems including efficiency while keeping churn under control in an existing SaaS product.
• Developing a product roadmap and unsure of what can be accomplished and timeframes

Topics to be Covered:

• How is a SaaS Product and Business Different?
• Reference Framework for Creating Your Roadmap
• Making Strategic Development Choices
• Operating A SaaS Business by the Metrics
• 10 Ways to Fail at SaaS
• Applying Lessons Learned to Your Issues

Who Should Attend?

This workshop and seminar is important for anyone considering a SaaS product, in the process of developing a product or offering a product that hasn’t reached its potential, including: Entrepreneurs, CXO’s, product managers and key executives in startups, vendors moving to SaaS or existing SaaS companies.

About Your “Professor”

Mike Dunham, Vice President, Service Engineering for Scio Consulting, has over 25 years background in the development and introduction of new technology working with startups, government and the largest enterprise software companies. He has worked with Scio for five years, regularly authors articles on SaaS and the software industry and hosts a series of podcasts on SaaS best practices. Mike leads Scio’s professional services helping companies develop and bring to market new SaaS offerings.

The workshop costs $695, but you can get an Early Bird Price of $495 when you combine it with your SaaS University registration - total package price of $1290. As a way to bring together a great amount of information in a short period of time, the combined package is a great opportunity. As we get closer to the event, I’ll expand on the agenda, but this is a great time to start planning and get your team together to attend SaaS University in Washington, DC!  I hope to see you there…

Our workshop with Software Pricing Partners following the SaaS Summit: All About the Cloud is now finalized! Seating is limited so please check the details below and sign up NOW:

SaaS Offerings: How to Develop, Price, Operate, and Succeed

• One Day SaaS Executive Workshop Covering Technical and Business Topics
• May 13, 2010 at the Donatello Hotel (near Union Square) San Francisco

Executives responsible for succeeding in the SaaS market need to make a series of critical choices in developing, packaging and selling their offerings. This one-day workshop provides the insights and tools needed to make the right choices.

Many of the challenges SaaS companies face can be met by balancing and integrating technical considerations with the business aspects of SaaS. Companies that can do this can bring their products to market rapidly and become cash-flow positive quickly.

This workshop is the first to integrate pricing and business models with development and deployment. The workshop will be held on May 13th, the day after the OpSource and SIIA event SaaS Summit: All About the Cloud at the Westin St Francis Hotel on Union Square in San Francisco. The workshop venue is conveniently located one half-block from the St Francis, at the Donatello Hotel on Post Street.

Which companies can benefit by attending this workshop:

• A new venture or as an ISV with on-premise products considering developing a SaaS offering
• A service company with significant vertical expertise than could be delivered and monetized in a SaaS model.
• An existing SaaS provider who made choices opportunistically that now constrain growth and cash flow.
• A SaaS entrepreneur with limited funding that needs to achieve positive cash flow early with products that evolve with the market.

Company challenges this workshop can help overcome:

• Building out a suite of products but are unsure of the pricing and operational models needed to grow.
• Developing a framework for sorting out technical and strategic choices required to move to the SaaS business model.
• Facing significant operational problems including efficiency while keeping churn under control in an existing SaaS product.
• Ensuring the pricing model, development framework and operational plan will work in complex, highly competitive markets.

Topics to be covered:

• What Makes the SaaS Model Different and Difficult?
• Making Development Choices Strategically
• How to Choose an Effective Pricing Metric
• Creating a Lean Product Development Roadmap
• Using Packaging and Licensing to Increase Success
• Finding the Right Price Levels and Discounts
• Operating a SaaS Business
• Auditing Your Plans with a SaaS Reference Framework

Because of the value of this workshop, the importance of the SIIA/OpSource conference for SaaS providers and the convenience of the venue, this is an excellent opportunity to “put it all together.” The workshop content makes it well suited to a mixed group of business and technical members of your team because it joins the issues of both sides into a single view.

Per Person Pricing

Group Promo Codes

Three or more members of the same team:

• On or before May 3rd – 57KA5G
• After May 3rd – 7GNGBH

All attendees will receive copies of the workshop materials. The workshop fee also includes a “working lunch” and refreshments during the day.

Secure Registration with Acteva.

Hotel

The Donatello Hotel has a limited number of rooms available for workshop attendees at $139 during the period of May 9-14. This is an excellent opportunity to save with a very convenient location if you are also attending SaaS Summit/All About the Cloud Event.

• To receive this discounted rate, you must the contact the hotel directly at 415-441-7100 – and ask for In-House Sales and  the “SCIO Pricing” discount.

About the Speakers

Michael Dunham, VP of Service Engineering – Scio Consulting
Mike Dunham has more than 20 years of hands-on experience helping major corporations and government agencies succeed in an increasingly technical environment. As Scio’s principal consultant, Dunham provides clients insight into trends that affect business and technology planning so the processes Scio uses can bring clients’ ideas to life. As the VP of Service Engineering, Michael defines Scio’s service products and operational processes. A native of Sacramento, CA, he holds a bachelor’s degree in business administration from the University of California at Davis.

Jim Geisman, Principal and Founder – Software Pricing Partners
Jim is an acknowledged expert in software pricing and, since founding the firm in 1982, has helped several hundred companies develop effective pricing models and strategies. His consulting spans established and emerging software companies delivering B2B solution via desktop, enterprise-class and, more recently Software-as-a-Service / on demand software. Jim has been a board member or advisor to several early stage technology companies. He holds degrees in Electrical Engineering from Tufts University and an MBA from Harvard Business School.

A quick introduction on our podcast:

At Scio, we’ve been working towards a goal of achieving a “standard” process and platform for developing SaaS products for a long time. Of course, when it comes to services, nothing is ever “done” – it just reaches a point where you know you are achieving goals, satisfying customers and can continue to improve over time.

We’re in the business of developing SaaS products. To develop custom products economically and reliably, you have to build or adopt tools, methodologies and repeatable processes that streamline the process, cut out unnecessary waste, and control risk. We, like many software development groups who have adopted Agile development processes, have realized that much of the business of “manufacturing software” aligns well with the concept of Lean manufacturing and product design.  In fact, the leading Agile consultancy, Poppendieck, has produced a book on the subject.

But what does this have to do with SaaS? Our move down the Lean and Agile road is not an accident. It is our core belief that customers will be more successful if they and their products and business processes are also Lean and Agile. We’re not alone in that thinking. Bessemer Venture Partners, in the latest release of their Top 10 Laws for Cloud Computing, covers the core concepts even if they don’t acknowledge them as Lean specifically. Steve Blank and Eric Ries recognize something they call a “lean startup.”

So – what is the core of Lean as it applies to SaaS?  The original concept of Lean was started in Japan and has been defined as:

• Build only what is needed
• Eliminate anything that does not add value
• Stop if something goes wrong

At Scio, we’ve translated this to:

1. Build only what is needed – Agile and Lean are customer-driven methodologies. Building what is needed assumes you have a customer and you can get feedback directly and honestly from users. This doesn’t mean focus groups however that are just about “improving the current status quo.” As has been said, “If you asked people in the early 1900′s what would improve their personal transportation – we’d all be riding better horses.”  SaaS products are also user driven, as we and others have said many times.  To know what is needed, a SaaS vendor needs to get their product in front of end-users as early as possible and go through a “verification of vision.” This means testing the hypotheses that the product provides value, users will use it productively and customers will pay for it. At Scio, we’ve acted on this idea  by standardizing on SaaS specific platforms, services and frameworks (like SaaSGrid) that eliminate the development of the operational aspects of SaaS and provide a consistent multi-tenant architecture that can be used across multiple products. This, coupled with Agile scrum principles allows our customers to get their core products in front of key customers in three to four months. Because these common aspects of SaaS products are available on a “pay as you go” model, they don’t contribute unnecessary costs to the needed capital to launch a product and they only contribute incrementally to overhead.
2. Eliminate anything that does not add value – Getting a product in front of actual paying customers as soon as possible means not developing features that do not directly add value for end users. This assumes you can field test the feature set early and is the next level of verification just below the first point. It assumes what is known in Lean as “pull-driven” features – features that users need and actively advocate. It also points to the “slow drip of new features” that users expect from online services rather than the “version-driven” approach of traditional software releases. It does not however mean the end-user “defines” the product vision. This is where the first point and the second separate. Innovative products rarely rise directly from customer requirements, but value-driven features can and do.  For us, translates to building on modern extensible architectures that don’t require extensive re-writes to implement new features over time and “post release.”  We also ask our clients to take their assumed feature sets and apply the “80-20 rule” – which simply says that 20% of all features of a product will deliver 80% of the value. In Lean, features that do not add value are considered waste, but there are two forms of waste recognized: Those that do not add value but are unavoidable with current technology and those that create no value and are avoidable with a better design.  This also leads to more concentration on “user-experience” and understanding of the user’s context and avoidance of risky, over-complex projects.
3. Stop if something goes wrong – SaaS products naturally reach different audiences based on marketing, vertical demand, market maturity and the delivery medium of the Internet itself. But, what happens if your development cycle for a complete product is the 12-18 months common projects in traditional software? Your initial cost and risk go up drastically and if your vision is off the mark, failure can be very costly. At Scio, we focus on developing a core product that can reach paid customer release in six months or less. This keeps risk low and insures new products have the potential to reach positive cash flow at the earliest possible point in the product lifecycle.  This also fits with the mantra, “fail early and often.” A product can be a complete failure of vision or there may be just certain aspects that miss the mark. Either way, you need tools to monitor product usage and user feedback and a roadmap that allows you to get market verification early and to avoid “big bang” releases that are costly and not led by “pull” from users.

Lean also leads into continuous improvement – which is part of the service-led concept of SaaS. There is no “perfection” – only continuous improvement over time lead by user pull and innovation. The steady drip of user-led improvement leads to better retention. lower churn and a longer customer lifecycle – key SaaS metrics.  Better understanding of the value stream, another principle in Lean, leads to better pricing and more value recognition by customers.

There is a lot more to cover in terms of the alignment between Lean, Agile and SaaS. Take this as your “introduction” and follow the references I have provided. I’ll be adding more articles about this important subject in the near term – so watch for the Lean tag in our cloud – but in the sprit of Lean – we’ll stop here for now.

In Part 1 of this list we covered the first five points – so if you haven’t read that already, I encourage you to go and read that first. For everyone else – here’s the remaining five points in my hit parade:

6. Plan a yearly release cycle in conjunction with industry trade shows.

For marketing, product managers and developers with any experience in the software industry – this is a natural tendency. For the past 30 years, release schedules have rode the waves of industry events like clockwork. Because of the close association with end-users, a subscription renewal cycle which is frequently 30 days, and the “standards” set by industry leaders like Salesforce, Amazon, and Google – SaaS users expect a steady drip of improvements that have no set schedule. Waiting for some arbitrary “release date” is unnecessary and counterproductive. If the application is properly maintained and architected, the update will take place without any disruption to service.

Unlike upgrades to locally maintained applications – where IT departments had to schedule and plan for application upgrades and possible failures – those issues are now considered to be the domain of the service vendor. It has been outsourced – this is a core part of the service clients are paying for. Frankly – end users don’t care how it is done as long as there is no significant business disruption. Instead they are delighted to find a new feature that solves one of their problems – assuming all parts of the SaaS operation are meshed and working properly. The steady drip of improvement builds user loyalty and increases application “stickiness.”

7. Provide customized versions and features for specific customers.

In software development, this is known as “forking” your development or branching to produce a different, but concurrent, version of an application. Developers try to avoid it like the plague because it greatly increases risk – later changes may not be compatible with the customization done for a specific instance. In traditional installed software, with long release cycles, it was often done by system integrators or vendor professional services. It is an expensive practice that necessarily limits the ability of the customer installation to take the next version. So – they “sandbox” new versions and thoroughly test them before deployment. This may put them several months behind the release schedule of new versions, but it has always been considered a necessary evil in enterprise software deployment.

In SaaS, the tactical reasons for allowing individual instances and customer specific customization become operational nightmares. Now the steady flow of upgrades (point 6) becomes a significant cost issue for service maintenance. It requires more resources, planning, and risk. With the narrow margin of most SaaS operations, it can quickly become an issue that impacts reliability and profitability.

Proper SaaS product management provides two ways to get around this potential bump in the road:

• SaaS applications are architected to be configurable (rather than one-off customizations) to meet the demands of their market. Available configurations are consistent across the application and limited (if at all) only by feature bundling and pricing. Configurations are tested as a part of the normal development cycle without any special conditions. If a new customer requires a new element in configuration, product development evaluates the market and development effort required and makes a decision at the strategic level as to when and if the new configuration might be available. When it is completed – it is available to all clients and part of the standard application.
• If the customization would be to enable integration with other applications in the client portfolio – this is handled at the API level and possibly by external services (like Boomi) that can transform data for specific purposes. This separates the client side needs from the application and allows them to be “loosely coupled” instead of tightly integrated. Product development has to insure that the API remains consistent or at least clients with API integration are notified before critical changes – but beyond that – the service is available to all users consistently – not a limited few who have special needs that have to be evaluated individually.

8. Start with a free version to test the market.

This has been a common mistake by SaaS vendors – led by the many general consumer services available from companies like Google. Few vendors have the income of a Google and advertising-led income is really only possible for the most successful consumer applications.

Let’s say it clearly - The initial assumption of worth is equal to what you charge. If you charge nothing, you will get a lot of drive-by users who have no interest beyond trying to see what the service is all about. Taking input from free “hanger-ons” that have no intention of becoming paid subscribers is very dangerous. Where they want to lead you has nothing to do with profit and user retention at the subscribed end of the market.

That doesn’t mean a 30 day free trial is not a great way to onboard users initially. But – there still has to be a limitation and a stated worth. Users may decide it isn’t worth the price after trying for a few days. They will allow their test subscription to lapse and they will drop off. The rate of conversion from trial to subscribed becomes a clear indicator of the effectiveness of marketing (funnel formation) and product development (trial conversion and subscriber retention). It also doesn’t mean that “Freemium” packages can’t work – where the basic application is free but key services have a cost.

Pricing is a delicate dance between value received and money paid. In service offerings, the best case is always to provide more perceived value than the service costs. At worst, they can be roughly equal – but if they are out of balance to the cost side, subscriber retention will suffer greatly.

9. Build the richest, most complex offering for day one.

This approach is symptomatic of technical marketing and traditional software sales. For years, applications have been sold as technology with comparisons of feature lists. So, the natural tendency is to say – “We do it all! We’ve got all the bases covered!”

This approach leads to several issues in SaaS:

• Long, costly development cycles that produce a large feature set with no user-driven demand. How do we know the features we’re building are critical? What tells us the money and time spent will be returned in subscriptions? Go back to point 2 in this article. 80% of value is derived from 20% of features. There are always features that are necessary regardless of value, but as they rise, they increase cost and complexity for end-users.
• Developing new features into a very complex application becomes increasingly difficult over time. A smart SaaS vendor will generally break out potentially complex new capabilities into additional but separate services as Salesforce has done with Force.com. This keeps the core application focused and allows the new offering to “stand on its” own and seek its own audience.
• Complex applications require more time for users to become productive, training, and support. These are all costs, whether they are borne by the vendor or the client. They reduce adoption and put retention at risk. If the complexity is truly necessary it needs to be compartmentalized so that users can either take it on gradually or upgrade to “professional” versions when they are comfortable with basic functionality. Time to initial productivity with a service needs to be as near zero as possible.
• Complexity doesn’t sell itself. In fact – it drives people away. Think “Evolution – Not Revolution.”

10. Ignore change and agility.

Taking the sum of all the previous points, you should be able to see one thing stand out – A SaaS business is not your father’s software business. It is driven by change and renewal. It responds organically to market and user demands. It grows based on successful market adaption. I call this an agile business and so do many others. It is nothing less than a complete rethinking of how a business organization “works” at every level. It is both cultural and process-led.

This is not the Agile Manifesto – while still acknowledging it comes out of the same guiding principles. Putting a homily up in reception will not make it happen. Ignoring the issue will not make it go away. You can let the issue grind you down over time or you can accept it, plan for it and execute strategically.

So – that’s my list. What’s yours? What’s tops on your agenda?

At the recent OpSource SaaS Summit 09, I had the opportunity to meet many entrepreneurs either operating a SaaS business or preparing to offer a product as SaaS. I was not surprised to see that the most popular sessions were based on marketing, sales compensation, sales channels and “Thriving Not Just Surviving.” In this economy it is critical to understand the practical issues around running a successful SaaS business model.

In this article, I’m going to cover some examples of using SaaS metrics to guide business operations. If you haven’t read our SaaSoNomics 101 article – I’d suggest you hop over and give it a look, before you start on this one. It will give you an overview of the “generally recognized” metrics – and I have made a couple of additions and updates since we published the article.

To expose how the gears of a SaaS business mesh, let’s start with one of the most difficult areas – Sales Compensation. It is fine to say that the majority of SaaS sales should be generated and completed on the Internet (and I do) but the simple fact is that especially in enterprise or high value Line of Business (LoB) applications there is a limit to how effective the reach of online marketing can be. In a traditional software sales model, sales commissions are based on “bookings” – the sales of application licenses. The license cost is based on an assumed “window” of time between new versions, costs and sales expectations – which is why software companies suffer so badly when they miss a scheduled release. A booking is usually a high value sale. By their nature, SaaS sales are comparatively small and recur over a much shorter time period.

The classic way to compensate SaaS sales is to use the Committed Monthly Recurring Revenue (CMRR or simply MRR) generated by the client as a guide. This is based on the conclusion that the monthly recurring revenue is 1/12 of the yearly revenue and if $1 of commission was paid for every $1 of CMRR the commission paid would be roughly equal to the typical 8% paid for licensed sales. To extend the model further, the actual percent received can be varied by the percent of quota achieved by the salesperson. So, in this way, a salesperson achieving 25% of quota might receive $0.25 for every $1 of CMRR which would scale up to as much as $1.5 per $1 of CMRR for those who achieved over 75% of quota. Using the CMRR is also important because it makes the sales team focus on subscription-based metrics.

That model is fine up to a point – but if your salesperson is not selling to the right market or completely disclosing the focus of the application, your up front churn (RR) may be higher than you expect. If your basic subscription period is short, this could eat up all your profits very quickly because in effect – your cost to acquire (CtA) has risen even though you may not recognize it immediately. Linking the achievement of a low initial churn or negative churn (negative churn occurs when the client buys more seats or services than originally committed over their lifetime value – CLV) to sales assumes your service is well-aligned with the target customer base so it is likely that can only be done on an “average RR” basis across the entire customer base. A salesperson with an average RR in the first six months of client subscription that is lower than product-wide average over the same period may need to be reviewed or “retrained.”

If your revenue model is based on usage or transactions at any level, there may have to be some recognition of the average usage or transaction rate per user in sales commissions. This becomes even more complex to compensate for – which in part accounts for the fact that even where transaction or usage fees are a large part of service revenue – a low base subscription is often charged. This base subscription should cover the overhead (broadly, overhead includes the Cost to Acquire (CtA) plus the Cost to Maintain (CtM)) and allow the transaction and usage fees to provide a separate income stream over the base.

Because typically customer retention is even more critical for LOB and enterprise SaaS than it is for “consumer” services – it may be necessary to consider a model more like those used in professional services. When licensed software is incorporated into a custom application by a professional services group, the salesperson is usually compensated for license renewal as well as the services contracted. In this model, the salesperson becomes an “account executive” who is responsible for the long term customer relationship and provides feedback to the product and services management on customer satisfaction. This model fits well into the concept of “Agile product management” that I truly believe needs to be incorporated into all SaaS business models. This may mean over time you will need to separate front end sales (hunters) from account executives (farmers) with different compensation models for each.

So – what does all this tell us about SaaS metrics? The sales team needs to understand the metrics they are being compensated on fully and have individual as well as average metrics against goals available to review on demand. Company management needs to have a “dashboard” approach to watching the metrics to assure their Cost to Acquire and Time to Acquire is not rising, early stage Churn is under control, and their Customer Lifetime Value ratio is not dropping. If the service is enterprise or LOB based, a component of sales or support compensation needs to be based on long-term customer relationships and retention. These types of controls have parallels in other types of business models, but because of the typical subscription period in SaaS – constant monitoring and well-considered goals are critical to success.

As the title of this article suggests – there are additional examples of metrics that can be applied to decision support in a SaaS business. We plan to cover more of them but I would like to hear from our readers: What “business intelligence” do you feel is missing from your existing or envisioned operations dashboard? What would you like to hear more about? Let me know – either in comments or by message on Twitter to @MichaelDunham. And yes – Stay Tuned for more!

Late last week there was a lot of buzz around the announcement that the president and chief executive at Salesforce, Steve Cakebread, and two of his top sales executives had left the company. The news has generated blog entries with provocative titles (Is the Bloom Off the SaaS Rose? by Jeff Kaplan) and several sober assessments about the general effect the down economy is having on IT spending.

It is interesting to me that what didn’t lead the articles was a clear assessment of the metrics of a Software as a Service business and how that might be impacting Salesforce and other SaaS-based companies going after the enterprise market in this economy. The metrics of any business model are arguably “entertaining reading” for only a very limited number of people to be sure. But it is a critical subject for companies with new SaaS products or ISVs moving to SaaS to understand and be ready to measure from day one of operations.

First, let’s talk a little about marketing SaaS products. Outside of the enterprise market, SaaS products are – and should be – sold across the Internet for the most part. If your users are going to access your product across the Internet, if they don’t have large investments in existing products and infrastructure – it makes sense to leverage the network “where they are” to make sales. Of course, just like any other software company, SaaS ISV’s demonstrate at trade shows, use targeted email, and ads in magazines tied to their verticals. But with the increase in social media outlets and related marketing, there are many new doors opening to reach prospective customers in the virtual world of the Internet.

Early in its growth pattern, Salesforce used these channels quite well as it matured its product. With increasing success, more investment came and along with it – the desire to “dominate” the market. To do this, a great deal more money was spent on marketing and on bringing in a sales team that could drive “enterprise sales.” In a licensed model, the “traditional” model for enterprise software, the license fee is a large capital expenditure the customer sees as providing “future benefits.” Enterprise software sales executives are used to dealing with the objections to the high price and use various strategies to bring down the initial “bite” and trade it against maintenance fees, services and add-ons that would otherwise raise the price.

When a company like Salesforce first approaches the enterprise market, the need to “horse trade” is low. The success they find is based on prospects that may be reaching the “sunset” for their current license investment, need to increase their license commitment because of deployment increases in seats or servers or to reach newly acquired offices in other locations. These prospects are facing capital outlays for new licenses, hardware and support, against which the flexible model of a SaaS product can be persuasive. When that “low hanging fruit” is exhausted however, the cost of customer acquisition begins to rise steeply. Prospects with two to three years left on their license, a relatively new infrastructure and stable staff have relatively little impetus to “drop” their investments for a new product and perhaps risky technology and in this economy even less interest in pushing a new initiative through finance. They take more time to make a decision (lengthening the sales cycle), require more “due diligence” (raising the sales, sales support and marketing costs), and will likely counter offer with a smaller commitment for seats or subscription term to “test the waters” (lowering committed revenue). If you are a sales team engaged in a strategy of market domination, waiting until the prospect’s pain becomes more pressing may not be an option.

Because of the way a SaaS company receives its income, an expensive market domination play can be a risky strategy. To understand that – we need to dive into SaaS metrics. There are several accepted operational measures that a SaaS ISV should be aware of:

• Committed Monthly Recurring Revenue (CMRR) – Also referred to as the Monthly Committed Recurring Revenue (MCRR). The total of committed subscriptions for the period.
• Retention Rate (RR) – Also known as Churn. The percent of customers that renew their subscription at the end of the term. This includes “automatic” renewals, even though they may be a separate class in some implementations because they can always “opt-out” – although the tendency is less than in manual renewal systems.
• In Trial - The number of prospects (not users in a company or organization subscription model) subscribed in a trial period. SaaS ISVs offering trial subscriptions should also track Average Users per Customer during trial (to answer: how large are the trial prospects? Do they cover a full Line of Business? Might they need a Sales Engineer to help them evaluate?). The Average Trial Period is also of interest and depending on the sales model can be different from Time to Close.
• Average Deal Size (ADS) or the Average Revenue Per Client (ARPC)- the average Committed Monthly Recurring Revenue (CMRR) from a customer.
• Average Revenue Per User (ARPU)- Like the ARPC but broken down per user instead of per client. When the size of client implementations vary broadly across your customer base, this helps to establish your average user load and revenue. The impact of this metric depends on the subscription or revenue model of the application.
• Time to Close – The time it takes for an identified prospect to become a subscribing customer. This can be easily monitored for trial customers but requires CRM to monitor for a sales team.
• Close Rate – The percentage of In Trial customers that convert to subscribers. This can be aggregated with sales team prospects from CRM but it wise to also follow it separately to gauge pure web-based marketing and sales.
• Cost to Maintain (CtM) – The cost of services required to maintain customer instances. This should include hosting charges, hardware and software renewal, support, staff operations and outside services required to maintain customer instances outside of sales, marketing, R&D, and product development. This is an important metric because it also provides a window into Contingency Costs.
• Cost to Acquire (CtA) – The average of the cost of sales and marketing activities in a period divided by the number of customers acquired in the following period. The period is usually adapted from the Time to Close so that costs and the customer acquisition relationships are realistic.
• Customer Acquisition Cost Ratio (CAC) – A key indicator of how long it will take a customer to “payback” their Cost to Acquire. The ratio is developed by dividing the Annualized Net Gross Margin added during a quarter by sales and marketing costs of the previous quarter. Example: CAC Ratio (Q408) = [GM(Q408)-GM(Q308)]*4 Sales & Marketing Costs (Q308).
• Customer Lifetime Value Ratio (CLV) – The net present value of Annual Recurring Revenue from a customer less the Cost to Maintain and Cost to Acquire. A lifetime “horizon” needs to be assumed – usually a 3-5 year window is used unless the company has been in business long enough to make assumptions based on Churn.
• Software to Services Ratio – In a subscription only model, professional services may supplement income. In a mixed model, subscriptions can be supplemented with “value-add” services that can be transaction or on-demand based and professional services. In either case, this is a ratio of subscription revenue to services and is important when there is a low margin remaining after Cost to Maintain and Cost to Acquire are taken out. A high services ratio can compensate for the low margin if the services are considered to be high value by your customers and in high demand.
• Largest Customer % – Knowing the percentage of gross income your largest customer provides helps to assess risk. In a new company or a vertically-based SaaS, it might be also wise to assess the percentage of gross income provided by your top ten (largest) customers. The point is to assess your risk if they drop their subscription and leave you in a position of supporting sales, marketing and operations with too low a margin.

If reviewing that list made you feel like your head is about to explode – don’t worry – the next article in this series will be SaaSoNomics 102 and I’ll cover some practical examples of these metrics.

But let’s go back to Salesforce – why is it I don’t feel like the departure of their top executives is a clear indication the sky is failing on the SaaS business model? Because they have been pursing enterprise sales. The easy sales have been made, the length of time to acquire new customers and the cost of sales is rising. This means that assessing their Customer Acquisition Cost (CAC) and Customer Lifetime Value Ratios (CLV) against their Retention Ratio is likely to show their new customers will not generate a profit in a reasonable timeframe. That means a change in strategy is required to maintain profitability. Knowing that, knowing how to assess your business metrics and change direction in response is key to running a SaaS business and something we will explore with some practical examples in our next article in this series. Stay Tuned!