Many articles are written every week about how to succeed in Software as a Service, SaaS. The focus of this article will be what makes SaaS unique and appealing. It is a business model that has been applied to a product type that has become a massive focus area. VC has not seen a startup focus area like this before, ecommerce is the closest comparison. Why is the category so special? It really comes down to 3 things
1. Proximity to clients
2. Measurable Metrics
3. Accounting treatment
4. Value Generation
Proximity to clients
Part of the brilliance of SaaS is that usinesses develop a relationship with end users. They often sell directly to them and have an ongoing feedback loop. This provides feedback and versatility. The biggest advantage is in what this eliminates — proximity to clients disintermediates traditional channel partners — wholesalers, retailers, distributors etc. The intermediaries increase price for the value consumers and decrease economics for value producers. They do have the benefit of generating sales when they otherwise may not have been there, however.
By removing layers of intermediaries, the value resides with parties directly.
The set of standardised metrics in SaaS makes the segment much easier to assess. The problems are more easily uncovered. Best practices are readily transferrable. This gives both the founder and the investor a template or playbook to work off. It helps to identify the root cause of problems and take actions against them. The forecast may be inaccurate, but it drives the right discussion and focus and allows the company to get back on the right track.
Accounting Capex vs Opex
Traditionally and enterprise would have to invest Capex which gets amortised over time in addition to dealing with upfront R&D costs to build out a product. It benefits companies by them not having to invest and also by allowing to treat software subscription as operating expense. It is an expense that generates value/utility and also acts as a tax shield by lowering gross profit. One of the benefits of the OpEx model is that there is no long-term commitment. The lack of commitment is valuable financially, in that it frees the enterprise from having to make a significant, long-term investment
SaaS businesses earn revenue by charging on an upfront and ongoing basis. Strong value must exist for clients to pay for the product. This value must sustain in order for a customer to continue subscribing. For many traditional businesses, the value transacted ends after the initial sale. With SaaS it is opposite — the first transaction should mark the beginning of an annuity income stream. This puts pressure on the company to provide real and increasing value. The startup can share in this value increase as they grow over time.