Evaluating SaaS Vendors – Understanding Business Models and Profitability

For those of you who don’t know, I was CTO of a SaaS vendor a number of years ago. In addition to building a SaaS platform (back then in 1996 when we started we were an ASP – application service provider), we acquired and merged with a number of other SaaS companies. Part of my job was to evaluate the viability of the SaaS company's technology platform and operations. So I have a few things to say and tips for those of you in a SaaS company or evaluating one.

Mind you that I am, in general, pro SaaS. As I said last week Don't be afraid of SaaS but Diligence is Required.

First and foremost, you need to find ways to evaluate their business model . Some vendors like Google (apps...) Salesforce and Quickbase have achieved operational scale or are profitable. But many SaaS vendors that we look at are startups or growing companies. If you can’t get their profitability, there are some quick questions that can help you evaluate their profitability. Consider the VERY simple model:

(Num Customers) * (Average Price Normalized By Year) – (# employees) * (fully loaded cost/employee)

Again, obviously a huge hand wave, but many SaaS vendors will feed you information on customers and employees – if not – beware! Show them that you can do this calculation during their sales call and they may be more willing to disclose more details on their profitability.

Why is this important? Because, quite frankly, many SaaS vendors underestimate how far they are away from both financial and operational profitability. For example, many SaaS vendors still believe that their core business will be the foundation for other, more profitable businesses. Now that SaaS vendor’s Board and investors may buy into those future businesses, but you as the customer are taking on the risk. These future businesses may never materialize and that their core business (for the product you are buying) may never reach profitability.

If it appears that the vendor needs a large number of new customers to achieve profitability, better dive deeper to learn how they will close the gap.

4 comments:

  1. An interesting read, thanks for writing it.

    One thing that back-of-the-envelope calculation doesn't factor in is how much debt the company has.

    One of the things I hear mentioned a lot when it comes to SaaS is the supposed huge up-front cost in getting the application developed in the first place. And then the struggle to re-coup that expense from relatively small monthly subs.

    That hasn't been my experience in building KashFlow (leading UK SaaS accounting software), but that's because I've been fortunate in being the founder *and* developer. I guess if the development time was paid for in cash instead of sweat then it would have racked up a big bill.

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  2. Interesting and informative information. Good to know.

    I just wanted to share some piece of information which I came across while I was looking to expand and scale up my business. There is this business profitability and scalability calculator which is there on this site Seo Traffic Spider and its really cool. When you enter the data in it in terms of the amount and time you are spending on promoting your website, it calculates the total resources in terms of cost you are accruing for your website promotion.

    The best I like about it is that after calculating the result, it gives you a customized less expensive solution based on your data and its really interesting. You can try out this tool and see the results for yourself.

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  3. Good points here, Isaac. Each SaaS provider offers various features and services, with advantages and disadvantages. Like most big purchases, it's important to compare and shop. Finding the right SaaS vendor that perfectly fits your needs and wants can be a difficult, if not stressful, task.

    HyperOffice.com recently released some free resources, including a white paper and SlideShare presentation, on selecting a SaaS vendor and what to look for. The bigger deal is there's a free live webinar hosted by Rusty Weston, former head of Global Services and InformationWeek.

    All this information can be found at http://hyperoffice.com/saas-reviews-for-smbs

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  4. Every company should evaluate any SaaS vendors. What is their products, and the quality of the product.

    ReplyDelete

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