The challenge for B2B Software Solution providers is that the growth rate of on- premise software is somewhere between single digits and negative while the growth rate for SaaS Solutions is 40% and higher.
The question is: “Should you change or die? The answer is obvious. The issue is how do you accomplish a transition? The devil is in the details.
On-Premise software solution providers license their products on a perpetual basis. Revenues are driven largely by new customer order bookings. This places primary emphasis on new account acquisition. Resources were slanted heavily toward sales & marketing with significantly less for customer support. The result was that few of these companies did a great job of insuring high customer satisfaction. Stories of long implementation projects with high costs and abandonment rates are legendary.
Cloud application (SaaS) providers (using subscription models) are driven to maximize renewals. It is generally accepted that these businesses need to achieve a renewal rate of 90% or better for decent financial performance. This leads to a focus on Customer Delight with appropriate resource allocation to that function. Customer Delight & Support is now elevated on a par with Sales, Marketing, Finance & Engineering.
Let’s take a look at how these two models lead to cultural differences that make the transition from On-Premise to SaaS provider difficult.
Key metrics for running the business:
On-Premise-the metrics are sales-oriented with new account bookings as the most important. We regularly heard the end-of-quarter announcements when a large deal did not come in on time and revenue suffered, along with stock prices for public companies.
The primary Saas metrics are Annual Recurring Revenue (ARR), Customer Acquisition Cost (CAC), and Customer Life Time Value (CLTV) and Churn. Ron Gill, CFO of Netsuite said it well: “With SaaS, companies are more model-driven than they are driven by new account sales”. Successful SaaS companies eat, breathe and sleep Customer Delight at every level in every department.
The Culture Differences
Sales-The SaaS sales department has to set reasonable expectations with prospects. Promising the moon leads to disaster. Perpetual model reps are used to doing a couple of huge deals a quarter whereas cloud app sales are more of a high velocity model in which reps have to be good at managing many more sales cycles. Attempts to use the same sales team for both models usually fail, due to the difficulty in designing compensation plans that motivate reps to behave in alignment with corporate goals. On-Premise sales structure tends to be field-centric while SaaS sales structures are more apt to emphasize Inside Sales.
Marketing- Product Marketing in On-Premise moves toward community management in SaaS. Real-time User Analytics guide Feature Set enhancement for cloud app providers who implement many updates per month or week. On-Premise software vendors do periodic customer interviews with long delays to new features. A key challenge for SaaS providers is how to hold events that are not focused on new releases.
Engineering-In the On-Premise game, engineering could work on cool features that were favored by management. Different customers often have their own unique source trees with the attendant support headaches. In a cloud model, there is a single source tree and user analytics drives the allocation of engineering resources. In On-Premise, there may be one or two product releases per year. In SaaS, we see many releases per month, per week and in some cases per day.
Operations-With SaaS, cost of goods sold (CoGS) is significant whereas it typically runs less than 5% in the old model. Security becomes the obligation of the vendor where it was managed by the customer in the old model.
Services-in the On-Premise model, the services often were 2X to 5X the license price while SaaS provider services tend to run around 30% of ARR. Interestingly, the services are very different. In SaaS, there is an emphasis on Business Process Re-engineering (BPR) more so than lower level data integration. This places a need for providers to hire different skills.
Finance-In the on-prem game, an order has a huge impact on revenue for the current period (assuming that implementation does not delay revenue recognition). This leads to the high volatility in earnings of these companies. In SaaS, revenue is recognized ratably over the life of each contract. The result is that an order booked in the current period has a very small impact on revenue for the period. The unearned revenue that builds as orders are booked leads to dramatically more accurate revenue forecasts and low earnings volatility. Chris Cabrera, CEO of Xactly said it well (paraphrased):”If you have a mixed model (SaaS and On-Premise), perpetual license revenue becomes a drug that enables you to mask an otherwise bad quarter by booking a big (On-Premise) deal”
The Culture Clash!
As you consider making the transition to SaaS, you need to recognize that it is likely to be disruptive. Not all your existing players can or will make the change. Some of your On-Premise team may try to protect the existing (On-Premise) ways of doing business as you bring out your cloud application. This can be counter-productive to achieving a high level of customer delight.
The way of the future is SaaS. This is driven by the tremendous new capabilities, value and TCO advantages that SaaS Solutions provide customers. Large software providers like Oracle have the resources to create separate divisions where the cloud application providers have an appropriate culture. For small (<$100M) companies, we believe the smart approach is a complete, rapid transition accomplished in a year or less. Note that such a fast transition is not easy, but stretching It out over a long period increases the risk that you will not accomplish the change. We have only identified one company that is successfully providing solutions as both On-Premise/perpetual and SaaS/subscription from the same business unit. If you know of any, please identify them, as we want to learn more about this important issue. If you face these challenges and want to learn more, contact me at Growth Process Group on how best to make the transition.