Pattern Recognition, by Ian Sigalow

SaaS Models, Redux

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Ian Sigalow

Ian is a co-founder and partner at Greycroft Partners in New York City. He has been a venture capitalist since 2001.


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SaaS Models, Redux

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A few weeks ago I wrote about the different models behind software-as-a-service (saas) companies.   That post covered the basic features of software models, but it didn’t include the economics behind the different businesses.   If you are an entrepreneur looking to launch a software company, or sell any subscription product into the enterprise, I have a few suggestions:

1.) All great enterprise companies are built around a repeatable sales model.   I know this sounds daunting for a start-up that doesn’t have a product yet, but take meetings with prospects and make your best guess about the model.   The reason to focus on this first is that a sales model determines minimum pricing, which in turn determines how much product (and what type of product) you need to build.

2.) There are only three sales models when it comes to enterprise software: “direct sales”, “telesales”, and “marketing-originated sales”.   The first group requires in-person meetings to close a deal.   The second group is done over the phone.   The third group doesn’t require sales people at all – you just run marketing campaigns that drive people to landing pages where they buy with a credit card, similar to consumer marketing. [note: “Freemium” for the purposes of this blog post is lumped into marketing-originated sales.] If your product can sometimes be closed on the phone but sometimes requires an in-person meeting, then you should default to “direct sales” in your pricing.

3.) In addition to the above there are a few caveats on sales models: A.) If your product requires support or onsite training than, independent of what I previously mentioned, you should price your product like a direct sales business, and B.) If your product requires integration, beyond giving someone an API key, you should also price like a direct sales business.

4.) If you have a direct sales model, in my experience you need to price your software subscription at $3,500/month or greater.   When you do the math around average sales salaries, the number of meetings a sales person can take in a week, the number of prospects they can close, the cost of supporting customers, etc – you will figure out that this is the bare minimum price point that delivers a positive return on investment.   If you can get more than this amount that is great.   If you cannot get at least $3,500/month from your customers, then you need to figure out a way to sell a stripped down version of your product with telesales or an even more stripped down version of your product as marketing-originated sales.

5.) I alluded to this above, but telesales supports a lower price point than direct sales.  I have seen companies successful at $1,500/month using a sell-by-phone model.   Those businesses are generally run very lean (i.e. sales people are not highly compensated) but it can work. The product generally has to be a SAAS 2.0 product with a simplified user-interface, no integration, and no services.

6.) Marketing-originated sales can accomodate the lowest price point.   The only hassle is that you need to pick a price that people can put on their credit card, so that generally restricts the pricing on the upside (almost all of the companies in this segment are under $100/month).   In order for your company to work as a venture capital investment with this sales model you will need to have a broadly applicable product, such as GoToMyPC, Logmein, Constant Contact, etc, otherwise the company will bump into a glass ceiling on growth.   I have seen a lot of cool products that are sold this way but unfortunately they cap out at $10mm a year in revenue.   These can be wonderful businesses for a sole owner but are bad venture investments.

As a last point, I started writing this blog post because I was surprised by the number of enterprise companies coming through with a similar formula: products priced at $1,500-$2,500/month, a requirement of occassional direct sales, and some amount of integration, training, and services involved in each deal.   These companies get early traction because they have undercut the competition or perhaps they have been willing to do more customization than another vendor in the market.  I have been tracking a number of these companies over time and not one of them has been successful.   At the end of the day offering a lower price is not a competitive advantage in itself, and it is critically important that your customers are willing to pay you for the value you deliver.

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Ian Sigalow

http://sigalow.com

Ian is a co-founder and partner at Greycroft Partners in New York City. He has been a venture capitalist since 2001.

Comments
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    AUTHOR matthew putman

    Posted on 11:43 am June 1, 2011.
    Reply

    Thanks for the post. It is very helpful, as I try to build a service element into my business,that includes a type of enterprise software. I certainly agree with your pricing suggestions, as any service model that requires a lot of time takes a huge amount of resources, and is not as profitable as one would hope.

  • user

    AUTHOR jgannon

    Posted on 12:40 pm June 6, 2011.
    Reply

    Re: enterprise software sales models, channel sales (specifically, value added resellers) is a critical one to mention (maybe one puts this into the “marketing” bucket). Once you have built a strong channel, the leverage you get in terms of being able to generate revenue without touching the customer is pretty compelling. The catch is that most potential channel partners are going to need to see a company succeeding (e.g. strong pipeline, deals closing, reference customers) prior to adding that vendor to their portfolio of products. And, the vendor will need to invest a great deal in sales enablement to make the partner network successful. Not surprisingly, early stage enterprise software companies can waste alot of time chasing channel partners because they haven’t yet proven to those partners there will be a strong pipeline of demand for their products.

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