When I started writing this blog I put together a list of topics, and one of them was making bold predictions about a new, capital-efficient software model taking over the world. But as often happens when I write these posts, the story took a different turn and I found myself writing about two different software business models. There is no industry jargon for the business models I am mentioning below, and I am not attempting to coin new catchphrases, so I am using SAAS 1 and SAAS 2 for lack of a better term. For the uninitiated, SAAS = software as a service, which is a fancy way of saying that the software is not installed on a customer’s computer but rather delivered through a web browser. It is all the rage in software investing for a lot of reasons I can’t fit here.
So what is SAAS 1? In a nutshell, it is a software company with the following features: large applications with deep complexity, direct sales teams that either cold call (inside sales) or directly sell customers, large account management teams, real integration requirements, 6+ month sales cycle, and customers “locked in” to annual contracts at $100K/yr price points. Most of these companies have customers that pay about 45 days after receipt of invoice, so at scale they have real working capital constraints. The distinction I am making is more about business model and product than underlying technology, and you can build this sort of business on any technology stack you want.
The thing I have noticed about SAAS 1 companies is that they take an incredible amount of capital to get to scale. Most of them don’t generate free cash flow until they get over $20mm-$30mm in revenue, and at that point the investors have likely put in $50mm in cash. Funds like Greycroft have a hard time with companies that burn cash like Joker in Arkham Asylum. So I am spending my time looking into other types of SAAS companies.
They companies I am most excited about today have the following features:
1.) Customers pay via credit card
Over time having zero days A/R saves companies a tremendous amount of capital.
2.) Zero integration/implementation expense
The time and cost required for implementation is the silent killer for start-ups. This is a blog post in itself. Salesforce.com really nailed this with their AppExchange, and I am starting to see other companies use APIs creatively to drive efficiency here.
3.) Zero sales cost
B2B software marketing is starting to look a lot like consumer marketing. This means that prospective customers see an ad, go to a website, and sign up without ever talking to a sales person. As you can imagine this works particularly well for products that are a.) very simple, and b.) affordably priced. I have also seen an increasing number of software companies using viral marketing, just like consumer applications.
Think back to when you signed up for Facebook – did someone from Facebook call you and offer a four day training session to on board you? I don’t think so. It is so easy to use that anyone from a 13 year-old to a 90 year-old can figure it out. Good software products are built the same way, including self-service tutorials to walk customers them through the product. Product complexity not only increases the costs of support and training, but it also increases churn, which is the biggest killer of subscription businesses.
If you are setting out to build a software company today, and you have the option to choose a path, I would encourage you to choose SAAS 2. It will make your life easier, and given the low capital requirements chances are good that you will be able to keep a larger ownership percentage and make more money over time.