Brutal reality of SaaS...

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Chris Marino

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Jul 18, 2008, 10:16:57 AM7/18/08
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Sarah Lacy describes the brutal reality of building a SaaS business.

http://www.businessweek.com/technology/content/jul2008/tc20080717_362776
.htm

To me, the problem can be addressed by SaaS companies that can leverage
the economics of the open source distribution model. Some more thought
on my blog (http://blog.snaplogic.org/?p=208), include below as well.

CM

......................

Sarah Lacy's article in Business Week is a sobering reminder of the
challenges software companies face building on-demand businesses. The
point made vividly clear here:

"SAP thought customers would go to a Web site, configure it
themselves, and found the first hundred or so implementations required a
lot of time and a lot of tremendous costs," Richardson says. "Small
businesses are calling for support, calling SAP because they don't have
IT departments. SAP is spending a lot of resources to configure and
troubleshoot the problem."

Nick Carr chimes in here with the point:

Anyone who thinks the software-as-a-service business is a gold mine
is wrong. The economics are fundamentally different from those of the
traditional software business - and not in a good way

I spoke yesterday to a SaaS platform provider who's business is to help
ISVs deliver their solutions as a service. They described some of the
challenges their customers face being multi-tenancy, scalability,
security, APIs, not to mention simply cramming the features into a
browser.

I've watched other companies launch on-demand offerings with great fan
fare only to find later that the offering languished among their
traditionally delivered alternative. Then, after facing the brutal
reality of the SaaS model purge all references to the SaaS offering
(don't they know there's a Wayback Machine?).

As Sarah notes, there' s no putting the genie back in the bottle. So
what's a company to do?

One point that Sara mentions but doesn't fully explore is the role of
open source in SaaS. There are many dimensions to this including how
SaaS companies have leveraged open source to more quickly deliver their
services, or how some open source companies are trying to reign in the
free riders with the AGPL.

However, I believe the real impact of open source on SaaS will be
because of it's distribution model, not its development model. JBOSS's
sales machines is well known among open source businesses. They were
tremendously successful monetizing their community which dramatically
reduced the costs of sales and marketing. In fact, most professional
open source companies benefit more from more efficient distribution than
development.

So what's this mean for SaaS companies? The successful ones are going to
not only leverage the development model of open source, but perhaps more
importantly, the distribution model as well. There are already examples
of this. SugarCRM is perhaps the most prominent open source company that
has extended their model to include SaaS. That's the fastest growing
part of their business and already represents about 30% of their total
subscribers.

I believe this is an exciting evolution of both SaaS and open source
businesses.

bcinque

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Jul 18, 2008, 10:41:02 AM7/18/08
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Chris,

I have to scratch my head when companies think they can ride the Buzzword Train put there name out there, put a solution together and then think life will be good. What I mean by this is Cloud Computing or variants of (from extensive threads on this group) is at a point where people are trying to wrap their heads around the concepts, risks/benefits, practicalities, use cases, etc of Cloud Computing. Its a dynamic world right now and after that post you sent (btw thank you for that) I am left with thinking:

Darwin at its best -  where the most adaptable will win

My general question with this vendor example is - is it fair for the media to judge the ever changing environment of Cloud Computing by poor planning for entry into that offering? The example companies given have been discussed in previous threads, I think it was subj: Larry doesn't see ROI in Cloud (or something like that). The article seems to compare the larger vendors but isn't the grass roots of the Cloud Computing model tied to the dynamic and nimble smaller companies? Maybe/Maybe not.. Like you said  "....this is an exciting evolution of both SaaS and open source businesses."

Brian

(my views are my views not my employers)

Chris Marino

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Jul 18, 2008, 11:19:59 AM7/18/08
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Brian,
 
I think most companies, large and small, are attracted to the cloud because the economics are so compelling (lots of discussion on this topic in this group).  The successful ones, IMHO, will be the ones that fully embrace it and not use it as a hedge against their legacy businesses.  That's true of software companies trying to stem the tide of open source by offering cripple-ware as well as those simply SaaS-enabling software what wasn't designed within the constraints of the on-demand model. 
 
CM

Lynne VanArsdale

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Jul 18, 2008, 3:29:07 PM7/18/08
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Seems to me that software companies are finally going to have to realize what "ease of use" means in order to get value out of the SaaS equation.

Jim Peters

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Jul 18, 2008, 3:50:27 PM7/18/08
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That is the single most astute one-liner I've seen in a long time ...
--
Jim Peters
+415-608-0851

Stuart Charlton

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Jul 19, 2008, 1:14:53 AM7/19/08
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On 18-Jul-08, at 10:16 AM, Chris Marino wrote:
>
> To me, the problem can be addressed by SaaS companies that can
> leverage
> the economics of the open source distribution model. Some more
> thought
> on my blog (http://blog.snaplogic.org/?p=208), include below as well.

I am curious why you feel this way. There are very few examples of
open source companies having a major ($100m+) revenue success story.
Not saying it won't happen, but it's still the exception.

> However, I believe the real impact of open source on SaaS will be
> because of it's distribution model, not its development model. JBOSS's
> sales machines is well known among open source businesses. They were
> tremendously successful monetizing their community which dramatically
> reduced the costs of sales and marketing. In fact, most professional
> open source companies benefit more from more efficient distribution
> than
> development.

To play devil's advocate: JBOSS made in revenues in one year what BEA
made in 2 weeks (prior to its Oracle acquisition). Success is in
the eye of the beholder, I guess. ;-)

Having said this, you have hit on a trend that Simon Phipps calls the
"adoption-led market"
http://blogs.sun.com/webmink/entry/the_adoption_led_market

The problem is that this is a 4 to 12 year transition (a timeframe
Phipps used during his talk at Jazoon 2008), and at best it will be a
partial transition. The Acquisition-led market is the current
dominant force. I don't see companies moving away from RFP's easily,
especially considering that they use them in areas beyond just
software and IT!

> So what's this mean for SaaS companies? The successful ones are
> going to
> not only leverage the development model of open source, but perhaps
> more
> importantly, the distribution model as well.

Why would a small/medium business care? Why would they choose
Sugar over Salesforce.com except for features directly related to
their business need?

The argument I've heard here is "insurance", i.e. freedom towards
interoperability and extensibility. But if the business has no IT
staff, or no capability to manage a systems integrator (who are
notorious for putting 90 people on a 9 person project), is this really
freedom?

IMO, one fallacy of open source is that it automatically implies
economical interoperability and extensibility. But, arguably, the
system's architecture and supported open data standards matter much
more than whether the source code is available.

Cheers
Stu

Chris Marino

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Jul 19, 2008, 12:10:28 PM7/19/08
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Stu,

>
>On 18-Jul-08, at 10:16 AM, Chris Marino wrote:
>>
>> To me, the problem can be addressed by SaaS companies that can
>> leverage
>> the economics of the open source distribution model. Some more
>> thought
>> on my blog (http://blog.snaplogic.org/?p=208), include below as well.
>
>I am curious why you feel this way. There are very few examples of
>open source companies having a major ($100m+) revenue success
>story.
>Not saying it won't happen, but it's still the exception.

Agreed. Even mySQL, the ultimate model for open source success, was
only modestly successful monetizing their installed base. It's well
known that their $1B exit was not based on any traditional valuation
metric (i.e. multiple of sales, income, book value etc.).

There are interesting things happening inside open source companies
these days that are trying to address this. I'll spare you all the gory
details, but many are wrestling with the difficulty of building their
business based solely on support offerings, while others seem to be more
receptive to proprietary features as part of their paid-for offerings.

>
>> However, I believe the real impact of open source on SaaS will be
>> because of it's distribution model, not its development
>model. JBOSS's
>> sales machines is well known among open source businesses. They were
>> tremendously successful monetizing their community which
>dramatically
>> reduced the costs of sales and marketing. In fact, most professional
>> open source companies benefit more from more efficient distribution
>> than
>> development.
>
>To play devil's advocate: JBOSS made in revenues in one year
>what BEA
>made in 2 weeks (prior to its Oracle acquisition). Success is in
>the eye of the beholder, I guess. ;-)

Are you arguing that BEA had a successful, sustainable model? I could
sell a lot of $5 bills for a buck too. Not to pick too much on BEA (I
have friends there), but a quick scan of their income statement for year
'06, '07 and '08 they spent (way) more in Sales and Marketing than their
net license revenue (license rev - cost of license rev).

'08 '07 '06
Lic. 35.9% 40.9% 42.6%
Cost 11.0% 11.2% 7.6%
S&M 35.3% 37.4% 36.5%
Tot (10.4%) (7.7%) (1.5%)

http://sec.gov/Archives/edgar/data/1031798/000119312508069043/d10k.htm#t
x29246_8

How are you going to fund R&D out of that? The distribution economics
of proprietary software are broken. I know this is a Cloud Computing
list, so won't veer too far into the land of open source, but Larry
Augstin (VA Research, etc., etc. etc.) often speaks about this. Here
are some slides from one of his presentations from OSBC a while back...

http://osbc.com/live/images/13/presentation_dwn/A_New_Breed_of_P_and_L.p
df

For anyone interested in the economics of open source, these are
*really* worth drilling into.


>
>Having said this, you have hit on a trend that Simon Phipps calls the
>"adoption-led market"
>http://blogs.sun.com/webmink/entry/the_adoption_led_market
>
>The problem is that this is a 4 to 12 year transition (a timeframe
>Phipps used during his talk at Jazoon 2008), and at best it will be a
>partial transition. The Acquisition-led market is the current
>dominant force. I don't see companies moving away from RFP's
>easily,
>especially considering that they use them in areas beyond just
>software and IT!

Not so sure about the timing of this. I think it depends on the segment
of the market. For larger enterprises, RFPs aren't going away. As for
the smaller one, they don't use them. They just sign up.

>
>> So what's this mean for SaaS companies? The successful ones are
>> going to
>> not only leverage the development model of open source, but perhaps
>> more
>> importantly, the distribution model as well.
>
>Why would a small/medium business care? Why would they choose
>Sugar over Salesforce.com except for features directly related to
>their business need?

Price is another factor. Don't know the head to head comparison of
these too, but I would guess that Sugar costs less.

>
>The argument I've heard here is "insurance", i.e. freedom towards
>interoperability and extensibility. But if the business has no IT
>staff, or no capability to manage a systems integrator (who are
>notorious for putting 90 people on a 9 person project), is
>this really
>freedom?
>
>IMO, one fallacy of open source is that it automatically implies
>economical interoperability and extensibility. But, arguably, the
>system's architecture and supported open data standards matter much
>more than whether the source code is available.

Not sure I agree that there is implicit interoperability, but the
extensibility benefit (by most end users) is indeed over stated (any one
on this list hack Firefox, or ever write an Extension??). Also agree
that standards/API matter to most users more than access to source (see
Juergen's post on why APIs are more important that source when trying to
build community http://blog.snaplogic.org/?p=88)

Bringing this back to SaaS, my point is that if you look at the income
statements of SaaS companies, customer acquisition costs are
astronomical. SaaS companies spend until they reach the lifetime value
of a customer (LVC). That's the break-even point.

Open source changes the distribution economics of on premises software,
and I believe can do the same for SaaS. Unfortunately, there are not
lots of examples of this and the models is evolving rapidly. Sugar and
Wordpress are two examples that I can think of. What it amounts to is a
more leveraged channel that you might otherwise get for SaaS. Sure you
can re-sell SaaS. Salesforce.com has resellers, but they don't have
OEMs. The only place you can get Salesforce is from Salesforce.

That's not true with Sugar on demand. You can get it from a bunch
service providers that offer it on their infrastructure. What I find
most interesting about this is that a while back there was a big dust up
over a company (vTiger) offering a forked version of Sugar as a service.
Now, a year or so later, after some licensing issues got figured out,
Sugar actually encourages these kinds of offerings.

CM

Cameron

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Jul 20, 2008, 5:05:28 PM7/20/08
to Cloud Computing
> > To me, the problem can be addressed by SaaS companies that can
> > leverage the economics of the open source distribution model.

> I am curious why you feel this way. There are very few examples of

It's certainly true that you could leverage open source as a way to
get into SaaS .. it would almost certainly lower the cost of entry and
could (if properly used) lower the cost of scale.

As far as using it as the distribution model for your goods .. I
wouldn't personally bet on that one ..

Peace,

Cameron Purdy | Oracle
http://www.oracle.com/technology/products/coherence/index.html

Cameron

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Jul 20, 2008, 5:08:14 PM7/20/08
to Cloud Computing
> >To play devil's advocate: JBOSS made in revenues in one year
> >what BEA made in 2 weeks (prior to its Oracle acquisition).

> Are you arguing that BEA had a successful, sustainable model?

I'm curious: Do you believe that JBoss had a sustainable model?
> build communityhttp://blog.snaplogic.org/?p=88)

Chris Marino

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Jul 20, 2008, 10:58:11 PM7/20/08
to cloud-c...@googlegroups.com
>> >To play devil's advocate: JBOSS made in revenues in one year what
>> >BEA made in 2 weeks (prior to its Oracle acquisition).
>
>> Are you arguing that BEA had a successful, sustainable model?
>
>I'm curious: Do you believe that JBoss had a sustainable model?

Didn't follow them too carefully, but I know some people that thought
they were hitting the wall just as they got acquired. So, perhaps as
they existed then, not sustainable. However, there's a lot going on
with open source business models and JBOSS had a better chance than most
to perfect it...

Robert Stinnett

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Jul 20, 2008, 11:38:34 PM7/20/08
to Cloud Computing
Chris -

This one line of your response stood out to me because I think it is
so appropriate. Cloud Computing is a radical change in some ways that
is changing how we look at IT. I often like to ask two questions,
"What could happen if we tried it?" and "What do we have to lose by
trying it?"

Cloud Computing, in my opinion, is going to reshape many IT
functions. Economics will be the driver behind it. Let's think about
a few realities any business faces today when dealing with IT
functions.

* Energy cost. This is a major factor that is becoming even more
important by the month it seems. Powering and cooling all that
equipment. If a company is seeing its energy rates rise by 10-20%
annually, that cost has to be absorbed or passed along. You can only
do either option for so long. Furthermore, in many companies we see
massive over-allocation of IT resources. We have huge amounts of
excess capacities at times that are being powered and cooled without
regard to if we actually need them.

* Agility. It takes time to provision servers, allocate storage or
upgrade computing power. This may take weeks or months in some
organizations. Companies find they are becoming enslaved to the IT
department waiting for these allocations. They lose their ability to
be agile and react to global business conditions.

* Staffing. In most companies, the business is not about IT. IT is
there to support the business. Unfortunately, it often seems that is
not the case.

Cloud computing can help solve all three of these (and so much more).
With the cloud, you use what you need when you need it. There is no
such thing as excess or idle capacity. If you need 10 servers online
for a project you simply "reach into the cloud". If you need 500GB of
space, you simply request it from the cloud. You focus on your
business and not on IT.

The workplace is changing and so many people do not realize it. We
are in a global economy -- and it is so funny to find that companies
just don't understand this. Oh, sure, they know it but they operate
their business like it was still 1950 and people only worked from 8AM
- 5PM. The companies that are agile and adapt to change will thrive,
and no doubt the cloud will be a part of it. Those that resist will
see increasing IT costs, increasing IT burdens and competitors passing
them up left and right. This change won't happen overnight, but will
take place over time -- and it's already happening.

Sure, there will always be a need for some internal IT systems. But
for a lot of data processing and computer needs, the cloud offers the
most affordable, scalable and agile method available.

It's going to be a fun ride....

Robert Stinnett



On Jul 18, 9:41 am, bcinque <brian.cin...@gmail.com> wrote:
> Chris,

Stuart Charlton

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Jul 21, 2008, 1:57:40 PM7/21/08
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On 19-Jul-08, at 9:10 AM, Chris Marino wrote:

Chris,

There are interesting things happening inside open source companies
these days that are trying to address this.  I'll spare you all the gory
details, but many are wrestling with the difficulty of building their
business based solely on support offerings, while others seem to be more
receptive to proprietary features as part of their paid-for offerings.

Sure, having worked at a BEA, I can understand the problems (though from the perspective of moving to a "blended" open source model from proprietary).

To play devil's advocate:  JBOSS made in revenues in one year 
what BEA  
made in 2 weeks (prior to its Oracle acquisition).    Success is in  
the eye of the beholder, I guess. ;-)

Are you arguing that BEA had a successful, sustainable model? I could
sell a lot of $5 bills for a buck too.  Not to pick too much on BEA (I
have friends there), but a quick scan of their income statement for year
'06, '07 and '08 they spent (way) more in Sales and Marketing than their
net license revenue (license rev - cost of license rev).

'08 '07 '06
Lic. 35.9% 40.9% 42.6%
Cost 11.0% 11.2% 7.6%
S&M 35.3% 37.4% 36.5%
Tot (10.4%) (7.7%) (1.5%)

BEA's cost of sales has been out of whack with its peers for some time; I don't think it was a fundamental flaw in the model so much as an inability (or unwillingness) to make drastic changes to the field organization (for a variety of reasons).

For example, let's look at Oracle's 10-K (instead of 'cost of licenses'  I am using Oracle's amortization of intangibles, which isn't entirely accurate, but is reasonable enough for our purposes here, I think):

                      '08         '07
Lic                 33.5%      32.8%
Intangibles  5.3%          5%
S&M       20.5%      21.7%
Tot                 7.7%        6.1%

This also does not account for recurring maintenance & upgrade revenues, which accounts for 50% of Oracle's revenue and accounted for 64% of BEA's revenue in 2008.   Certainly a major portion of sales & marketing is about customer retention & satisfaction ;-)

How are you going to fund R&D out of that?  The distribution economics
of proprietary software are broken.

Clearly, given the success of Oracle, IBM, Microsoft, Amdocs, etc., that remains to be seen.   And the BusinessWeek article you quoted basically quotes NetSuite as suggesting that S&M costs aren't budging in the On Demand world!

I'll re-iterate my position:  claiming that an open source model changes the economics of distribution and will somehow drastically reduce S&M expenses is basically not reality yet.    I think it may be reality some day.    Open source certainly has not hurt valuations:  Zimbra convinced Yahoo! it was worth $350 million on bookings of $20 million, and MySQL convinced Sun it was worth $1B on bookings of $60 million.  (source http://news.cnet.com/8301-13505_3-9853461-16.html)

But it assumes that enterprises en masse will shift to an "adoption-led" market.    The economics of distribution can only change when the demand-side changes its behaviour.    I do think this will happen, but it will be only a partial shift, and it will take a decade to develop.  At which point the revenue opportunity is.... what?  Something smaller than the big vendors have now, but, how much smaller?  The entire commercial open source market will likely take another 18-24 months to crack $1B, and over half of that will come from RedHat.   (Source:   just Google around revenues of the leading players)   

Over 10 years, we might see it hit $10 to 20 billion if we see 30%+ annual growth.    Meanwhile, Oracle _alone_ is tracking to reap well over $200 billion in revenues over that time period.    There's also IBM, Microsoft, CA, Amdocs, BMC, Symantec, TIBCO, Informatica, etc.....

Now, look, I want the industry to change, and I'm as flabbergasted as anyone as to why customers put up with upwards of 21%-of-license annual maintenance fees, with no opt-out.    It just hasn't been worth the hassle to rip out (though I'm hearing rumors of it happening slowly now at some large shops).  By and large, many large enterprises prefer to do periodic bulk enterprise deals with a small number of vendors where they get their demand for a period on the table and get bulk discounts for it.    There has to be a huge incentive of cost reduction or innovation to move outside of that model, and that has to take into account switching costs.

Of course, I agree that the SMB market will be the growth area for On Demand and FLOSS vendors today, of course, but that's not necessarily where the money is.  

Cheers
Stu

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