Business Decision: Why Software as a Service

In The Business of Software, author and MIT professor Michael A. Cusumano identifies four main questions that a software company should answer when developing a target market product strategy. Asked from the perspective of the software company:

1. Do you want to be mainly a products company or a services company?
2. Do you want to sell to individuals or enterprises?
3. How horizontal (broad) or vertical (specialized) is your product or service?
4. Can you generate a recurring revenue stream to endure in good times and bad?

Cusumano’s was one of several frameworks we used in planning Synap Software. In the next few Business Decisions blog entries I’ll share my thought process behind these decisions. Some worked out fine, some not so fine, and some are an ongoing story. Today’s entry is my answer to the first main question: Do you want to be mainly a products company or a services company?

Products or Services?

Services Provide More Chances for Recurring Revenue

Cusumano states that he used to believe it was better to be a products company but as of the writing of the book (2004 – which I know is an eon ago in tech years) he says he “no longer think(s) this is true”. Why?

The key is in recurring revenues. Services companies can sell support and consulting services even during times when customers are not buying software.

Services companies excel at showing that they can provide value (by saving costs, by finding hidden money, etc) even during times when their customers are having a hard time. Professor Cusumano posits that when customers feel that their IT partners understand their needs better than any other service provider, customers will be more likely to continue to do business with them – even in times of downturns.

Service providers seem to be in demand even when on the product side customers decide not to purchase an upgrade during tight times. A customer may no longer be growing so needs no additional seats, or a product may simply become commoditized or fully matured, offering customers no real motivation to make additional purchases.

… yet …

Products Provide Dramatically Improved Profit Margins

The kicker though is the “striking” difference between software companies and service companies: gross profit margin. He cites examples of large software companies that report 99% gross profit margins on their software product business, yet only 61% gross profit margins on services business! Wow! Who wouldn’t want 99% gross profit margins!?

This makes sense and is a basic reason that many of us have the big dream of riches from our software creations: for each additional piece of software that is sold, the incremental gross costs are very little.

The goal for a strictly product company is to create a product or products and then to not perform customizations, consulting, or support services for individual customers. All customers get the same product. When one customer looks and interacts with the company just like every other, Product companies have no incremental costs with each new customer. Steve Pavlina refers to this as ensuring that your income is not tied to your time.

But – before you head all cylinders down the product road seeking those giant profit margins, remember the issues with a product strategy are that 1: product sales can quickly fall short of expectations in down times and 2: just like with authors and artists, it can be difficult to produce that hit single.

How about a hybrid?

Professor Cusumano’s study is, of course, much more detailed and well-spoken than my comments here – but hopefully you get the point up to now and can follow along to the finale. I introduce it here in order to lead up to where Software as a Service fits in. Software as a Service sits right between product and services.

Software as a Service Provides the Software Company with High Margins and Recurring Revenue, and Provides Customers with Assurances of Top-Notch Customer Service

Like a pure product company, Software as a Service vendors have little incremental cost with each new customer (read: high profit margins). Like a pure services company, SaaS companies enjoy recurring revenue.

Sounds good for the software company, but what’s in it for the customer? SaaS provides customers with a constantly updated software product, reduced in-house IT costs, and immediate usability. The SaaS model also provides assurance to customers of a product they will want to keep using because the software company wants to ensure the customer returns month after month. The prospect of recurring revenue from a customer should encourage the software vendor to put out quality products and treat customers well. With the SaaS model, customers are not locked-in and have not invested much up-front, so can leave any time the product does not meet expectations.

Decision: SaaS

To me, Software as a Service is the best of both worlds for vendors and customers.

Result: So Far, So Good

As a final note, here are some additional aspects of the business SaaS customers and vendors need not worry about:

• activation keys, liscensing keys, version management, and installation support

Concerns: the most common concerns with SaaS delivery are support and data protection. We’ve addressed these by, for example, keeping our apps simple and easy to use so that each additional users does not require linearly additional support.

For these and other reasons SaaS is not right for everyone and not right for a lot of apps. For some markets and products it would not work to try to shoehorn into the SaaS model.

We went into this though, having picked the SaaS model first, and then determining what type of applications to offer that would fit.

Notes: This is republished content: I published this content burried in another blog entry back in November. With all Business Decision posts, I am simply sharing what we decided and somewhat of a framework that others could use when faced with similar decisions. I’m not making a recommendation that you should decide the same because I don’t know your situation.

Business Decisions: How We Chose What Product to Build

This is the first in a new series about business strategy choices we’ve made at Synap Software and how they work out. Most of these decisions are applicable to any company or startup, not only software vendors. In an old blog post I wrote a long list of what I called at the time “Best Practices” for software companies. (The post is here but is not required reading for this entry.) I promised to come back to it and explain the thought process behind each decision from the perspective of our company, so here we go.

Decision of Product Choice: Lead Management Software

There are several reasons I choose to build a small business marketing and lead management product. I’ll cover one reason here.

Reason #1: It’s What I Know

Though I promised to write this series some time ago, I was motivated to write this today after reading Phil’s Lessons Learned series. His blog is recommended reading. There is a thread running through his lessons learned series of the value of sticking with what you know and I agree with him. Whether it be the technological aspects, customer behavior, or industry metrics; sticking with what you know gives you a head start, helps you build the right thing, and keeps you interested throughout the long process.

1. Knowing lead management helps us build the right thing

   All designers and developers should read Robert Hoekman’s Designing the Obvious. The first step in his “common sense approach to web application design”, which he admits is “pretty darn obvious”, is to Know What to Build. And what better way to know what to build than to be your own subject matter expert?

   I know marketing, lead management, and workflow systems from 17 years of IT experience supporting Customer Care, Sales, and Marketing organizations. I’ve seen what works and what does not work through the eyes of users. I’ve seen users frustrated with large, long IT efforts and complex, expensive marketing and lead management software products.

   I believe that the major reason for the high rate of IT project failure is the disconnect between the builders and users of software. By “sticking with what you know”, to use Phil’s phrase, that gap between builder and user is substantially narrowed. I didn’t need to go to users and take an order only to find out that what they ordered is not what they really wanted or needed.

2. Knowledge indicates experience which indicates interest

   Another reason to pick a product area in which you have expertise is that your level of expertise probably indicates your level of interest. You built expertise from years of experience and those years devoted to the subject probably indicate some level of interest. Interest in a subject will help keep you trucking through the long hours, seemingly endless work, and sometimes lonely efforts it takes to get started.

   If I had not found small business marketing interesting I probably would never have gotten LeadsOnRails.com to a point of launch. My time and energy would have quickly been distracted into things I did find interesting.

3. I can talk about small business marketing and lead management software with others

   Step 2 of the 7 Steps to Improve Small Business Marketing is to participate in, listen to, and learn from your customers’ community. This is a lot easier and more enjoyable to do when you have your own experience and knowledge in the area.

Is small business marketing and lead management the right decision for us?

Building in a field I know is definitely the right decision. I couldn’t imagine trying to learn something new while also building a product around it. LeadsOnRails is satisfying users’ needs and expectations. I’ve been able to maintain a personal interest in the product through thick and thin.

The one area where I would like to do more is in regular and active participation in the small business marketing and lead management community. I have a plan and will share the results in a few weeks.

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The easiest way follow along as I cover more details behind each major decision we’ve made to this point, as well as my assessment of if it was a good decision, is to subscribe to the blog feed.

CREDIT

Two recommended reads prompted today’s post. One is Phil’s Lessons Learned #1 – Stick with what you know. After reading this I realized I haven’t really explained why lead management software is something I know. I recommend you read Phil’s ongoing series on some of his recent decisions. And yes, I realize Phil’s mention to stick with what you know is in reference to technology choices (e.g. desktop vs. web), yet it is applicable across the board.

The other is Ken’s Restarting the MicroISV Challenge where he points out that he never really explained his project idea which, again, made me realize I never really explained much about our company beyond the “about us” and short biographies on our company pages.