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Business Case: SaaS Rules of Thumb

The transition to Software as a Service (SaaS) has appeared imminent for a few years, but the shift has flowed more like a glacier than a flood. The current economic environment seems to be changing that -- suddenly the model looks much more attractive to customers. Concerns about trusting infrastructure to outsiders are becoming less important than the need to find fast ways to cut costs and improve productivity.

Even so, solution providers aren't in on the action yet. A recent Redmond Channel Partner survey found most solution providers aren't selling SaaS. Only 16 percent reported reselling Microsoft's Software plus Services products, while only 20 percent had firm plans to expand their SaaS offerings in the coming year (see "Here's What You Think," March 2009).
For the moment, the place where the rubber is meeting the road with SaaS is with major software publishers and ISVs, who are deciding which products to SaaS-ify, and how.

Microsoft is using its Microsoft Hosting Days series of events this year to address that ISV audience, though there are also tracks for hosters and solution providers. At a recent event in suburban Washington, D.C., the focus was on ISVs and how they can successfully make the transition to SaaS. Based on the experiences of some of its ISVs who've already made the leap, Microsoft is providing other ISVs very specific guidance and rules of thumb for the transition.

Where SaaS Stands
Microsoft provided Hosting Days attendees with some baseline figures on how ISVs were handling SaaS in 2008. According to a Microsoft slide deck:

  • On the multi-tenant versus single-tenant architecture technical question, it's a 50-50 toss up.
  • Another 50-50 split involves whether ISVs create their own data center for hosting or use an existing hosting company.
  • About two-thirds prefer to own all their intellectual property, versus building upon a third-party business platform -- like, say, Microsoft's.
  • Half are doing pure-play SaaS, while half are mixing business models.
  • About half sell "human" services that complement the SaaS offering.
  • When it comes to target market, the enterprise is first, and the midmarket second. Only a few SaaS ISVs are targeting small to midsize business customers so far.
  • On channel strategies, about two-thirds sell primarily direct. About half have at least some resellers.
  • The average initial sale is fewer than 10 seats.

Setting Sights on Seats
Microsoft representatives told attendees on several occasions that 25,000 seats was the key figure for ISVs and solution providers when deciding whether to build their own data centers for hosting or to approach a hosting provider to handle the back-end.

Business models that anticipate getting to 25,000 seats in three years or less will probably make more money by hosting themselves. Businesses with fewer seats than that can see higher margins by outsourcing the hosting.

The figure stems from the relatively mature outsourced-messaging market, and the question of private-label sales of Exchange messaging. Nonetheless, it gives a good back-of-the-envelope starting point for calculations in other scenarios.

The Rule of 78s
ISV companies making the transition to a SaaS model need to change the incentives for their sales forces. One big change is considering the impact of monthly billing in the development of monthly sales quotas. A sale made in January brings 12 months of billing for the year, while a sale made in December is good for only one month of billing.

Adding up all the months that way -- 12 for December, 11 for November, 10 for October and so on -- comes to a total of 78. So, to calculate monthly sales quotas, Microsoft recommends using this formula:

(Annual revenue goal)/78 * (# of months left in the fiscal year)

In short, deals closed sooner are worth more on an annual income statement, a Microsoft slide noted.

Search-Engine Marketing
Microsoft is recommending that ISVs making the transition to SaaS recognize that different sales and marketing approaches are necessary for Web sales.

Comparing Sources of Capital.The reality for early-adopter Software as a Service (SaaS) ISVs has been a little uglier than the envisioned result, with deeper up-front investments, longer waits to the break-even point and lower net margins, according to Microsoft. Microsoft laid out different ways for ISVs to finance early-stage SaaS efforts.
Source Pros Cons
Operating Profit (such as organic growth) Safe Slow
Customer Prepayments One to three years of cash up-front on subset of customers Discounted price; higher customer expectations; uneven cash flow
Outside Equity No repayment schedule; large profits available; VC connections/expertise Loss of control; dilution of ownership; push to profit too soon?
Bank Loans Proven; straightforward; inexpensive (relative to venture equity) Banks are risk-averse; collateral required; repayment required
"Subscription Credit" Borrow against anticipated subscription revenue; no dilution; no collateralization More expensive than bank loans; payments go through lock-box

The traditional ISV approach calls for sales through independent representatives, distributors and resellers, and marketing through PR, events and trade advertising. To make SaaS sales, a Microsoft Hosting Days slide suggests, ISVs need to ramp up their direct inside-sales teams and focus on upselling customers acquired through free signups, trial offers and low-priced basic offerings.

The most important marketing element, according to the Microsoft materials, is Search-Engine Marketing (SEM). That's followed by e-mail marketing and viral marketing, achieved through blogs and rating engines. "Consider a strategy of SEM demand gen to a telesales close," Microsoft suggested in the slide deck.

In another slide, presenting data from Forrester Research Inc., Microsoft showed that SEM is currently the largest component of interactive-marketing spending, narrowly edging out online display ads. By 2012, Forrester predicts, spending on SEM will be nearly double spending on online display ads. "Search-Engine Marketing is and will be king," the slide claimed.

Taking Part
Microsoft has one more Hosting Days presentation scheduled for the United States on April 16 in Chicago. The company is also holding the events in several locations worldwide in April and May, including Argentina, Belgium, Italy, Romania, Spain, Switzerland and the United Kingdom.