SaaS offerings should be priced the same as On-Prem offerings

Why should SaaS offerings from traditional ISV's be priced differently to traditional perpetual licenses? At the very least, I think SaaS offerings should be priced via subscription and traditional "licensed" models. Let the customer decide what they'd rather do. To support my theory let me try and get in front of the objections I'd expect to hear.

• Subscription models are superior revenue models due to their recurring revenues

How many times have we heard this? Yet as Larry Ellison pointed out, “If you look at the leader, Salesforce.com, they don’t make very much money and they’ve been at it for almost 10 years” While many will want to object to anything Larry says he has got a point. NetSuite and others are just passing $100 million. Impressive, but hardly earth shattering.

• SaaS revenue models are more "recession proof"

Well I guess we're about to see now how true this is. The common thought process is "Licensed software is a big up front cost while SaaS is a smaller recurring cost" Let me ask you one question on that. If you think the economy is not great today but you're sure it's going to be worse tomorrow how excited are you to sign up for a recurring cost? A CFO is going to think (in this order) i) Don't spend any money right now, ii) Spend it now if it makes sense for us today, iii) create an ongoing recurring cost that might be 3% or revenues today but could balloon to 5% etc if revenues fall in a recession. You can go for a year without maintenance and support on licensed software in a pinch if you have to. Short of cutting back seats, and thus value, you can't do too much with SaaS revenue (and that's assuming the pricing model is something easy like seats vs say "site traffic")

Thus I'm not anywhere near as confident as most are on the recession proof element to the pricing model.

• With their steady predictable revenue streams SaaS companies are better positioned in the long run to grow and prosper

There's a general rule of thumb when procuring CFO's look at SaaS vs licensed offerings. It's called 3 years. Generally, Licensed fees + Support over 36 months will equal 3 years of the SaaS equivalent offering. Ie $1 million licensing fee + 2 years of 20% maintenance vs $500K per year for the SaaS equivalent. That's great, but that software company with the license fee has $1 million in the next 45 days while the SaaS vendor has (quarterly advance) $125K. It's hard to underestimate the power of having that much more (8x) money in your hands today vs 3 years to catch up and surpass. If we both did 10 deals at the end of the quarter I'd have $10 million in cash and you'd have $1 million. I can show up on your doorstep and offer you 6x revenues for your SaaS company and still have $250 000. You on the other hand are going to have a very difficult time acquiring me. 

To those that argue against my 3 year model along the lines of "Well, you're wrong. SaaS allows a customer to start at a much lower price point and scale over a greater period of time" I say "See Larry's point above"

• SaaS companies need to have subscription fees due to the ongoing costs associated with providing an OnDemand offering

Companies like Amazon and Google are driving cloud computing costs towards zero and thus undermining whatever truth there once was to this argument.The 20% maintenance fees that traditional licensed sales charge are probably fine to cover SaaS support and upgrade costs. (perhaps you could extract as much as 30% to reflect the increased business value of not managing these apps internally and thus earn solid margins on these revenues)

Lastly, what's one of the most commonly documented rationale's for "Old World ISV's reticence to adopt the SaaS model more aggressively? Concern with managing Wall Street's revenue expectations as well as managing sales compensation conflicts. Price them both the same way and *poof* no more problem.

My conclusion? For certain products it's more effective from a technology perspective to offer a SaaS model. However, if there is dogma in the financial model discussions it's not the traditional ISV's. It's the SaaS companies. Offer companies both and if you only offer one offer the traditional perpetual licensing model until you're well established.

Comments

[Darren]

All of these are solid points.

I learned something new with the 3 year rule!

And I agree with your point about having money in your pocket today rather than morsel each month. It's all about the time-value of money. You're exactly right. You'd be better off if I gave you $1000 bucks today. Rather than paying you back $500 each year for 2 years.

Another thing most people don't understand is that the SaaS model is not pay-as-you-go in the purest sense. Yes you pay monthly but you contractually agree to be a customer over a period of time. So there's another point of hesitation for the CIO.

[Justin Benson]

Thanks Darren!. It's probably another post but I think there is a lack of understanding around the 3 year rule. The outcome is that places a "ceiling" sometimes for SaaS players getting to the biggest table that may not be understood enough.

[chris]

I believe your 3-year rule defines the floor of SaaS pricing, rather than the norm. I good salesperson should be able to get the procuring CFO to consider a payback of 4 years or perhaps longer. Also, he should be able to illustrate the other costs of on-premise software - server, database, networking and IT staff. There is also the procuring company's cost of capital to consider. So the pricing probably ranges from your 3 year unloaded cost rule to a 4.5 year loaded cost payback.

[Todd Gardner]

Darren,

I think you did an OK job describing the major drawback of the SaaS model for the ISV, and that is cash flow during its growth years. It's not just the time value of money; it means more and more expensive VC dollars to grow the business.

That said, the SaaS model as "recession-proof" has two components: new sales, and internal revenue.

I believe, contrary to you, that SaaS will fair better in a recession. No one is looking at next year or the year after and firms are actually focused on their one balance sheet. SaaS gives them a solution faster and with a smaller cash outlay.

On the revenue and cash flow front, there is no-contest between a SaaS company and a traditional ISV when new sales slow. Hopefully the traditional ISV took all thier up-front payments and put them in the bank becasue they will need them as their revenue and ongoing cash-flow plummets over the next 4 quarters.

Finally, the simple answer to pricing SaaS like perpetual is that it simply won't work. It's an ongoing service performed every day for the customer. No one pays for that up front: forever.

Would you pay the cable company $20,000 for a life-time supply of cable? Or worse yet, $15,000 for the right to watch cable and 1,000 per year for new programs (maintaniance fees). How about paying the lawn service $45,000 for mowing your yard forever.

You might consider paying a year in advance like many SaaS users, but that is about as far as anyone will go.

BTW, like the post. The debate should be had. SaaS is not a panacea for anyone.

[Justin Benson]

Todd,

Thanks for the feedback and the examples.

Let's take your example on the lawn mowing. You have a new guy in the neighborhood whose trying to build up his business by getting more equipment NOW which allows him to do all his jobs faster with less labor costs.

So, they give you two offers. First one is to charge you $100 per month and they require a one year contract. The second offer is they offer you $3000 up front and just $60 a year in maintenance. IF you have the money and know you'll be in the house 5 years (hopefully a business will assume it is) you're going to think hard about the cash up front option. Let's say in addition you're a sales person who makes lumpy income (commission based) Now you really don't want to have high monthly recurring fees because your salary is lumpy. If you have that money now put it down and keep your recurring costs low.

Or maybe you trial them for 12 months before pulling the trigger. ;-)

Don't forget, unlike even 5 years ago, the cost of computing power and delivery etc is going down dramatically. A licensed fee model of up front + 20% maintenance would be fine for many SaaS providers - especially if they end up with a blended revenue stream by offering both models.

Thanks a lot Todd for your input.

Justin

[Justin Benson]

Chris,

Good comments. The 3 year rule though is partly driven by CapEx vs OpEx considerations which are well defined in a CFO's mind.

Justin