As the software industry evolves, there are constantly new terms and phrases created to describe and categorize each new model. And, when one of those emerging models has success and the financial valuations for being connected to that model skyrocket, impostors appear and quickly contort their firms to be part of that hot, emerging category. That’s why today, if you ask almost any software company to classify themselves, whether they’ve been in business for 2 years or 10 years, you’ll hear all the hottest valuation terms: mobile, social, cloud, big data, SaaS, PaaS. This isn’t new. Who can blame us, we want higher valuations.
One of the biggest categories where impostors lurk today is SaaS or Software-as-a-Service. The 7-10x revenue multiples that the best known SaaS business, Salesforce.com, has sustained are too powerful an incentive to resist. That leaves investors and analysts with the task of sorting through the distortions to determine the truth. Here are five ways to sort out the true SaaS companies from the fakes.
1. IS THERE A SINGLE INSTANCE OF CODE? True SaaS is not customized, it is configured. All customers are using the same instance of code. Some modules may only be used by a certain subset of customers, but the code is never branched for multiple customers. This allows for streamlined development and release cycles that lower cost and speed innovation.
2. DOES THE APPLICATION RUN IN THE CLOUD? If the software is running in Amazon’s cloud or one of its competitors, then you can be confident it is ready to scale. While SaaS applications can still be found in other hosted environments, this acts as a general way to quickly determine if the roots of the application really are SaaS based.
3. WAS THE APPLICATION BUILT AFTER 2006? Although there clearly are SaaS applications written before 2006, there aren’t many and most have had to be significantly enhanced to run in the cloud. The frameworks and tools for SaaS have matured dramatically in the last 3-5 years.
4. DOES IT TAKE MORE THAN A WEEK TO IMPLEMENT? This question reveals a lot, not only about the software, but also about the basic philosophy of the company. While creation of some of the content and information that is used in the system takes longer than a week, a new customer’s instance is usually generated in minutes and then with some basic configuration is ready to go within hours or days.
5. ARE THE GROSS MARGINS FOR THE BUSINESS GREATER THAN 70%? Usually this number is 80 to 90% but, I’m being generous here because some enterprise focused SaaS businesses charge higher setup fees, provide content creation services and business consulting along with their software which lowers their margins slightly. This provides a simple measure that reflects the financial outcome of the earlier questions.
Many people confuse SaaS as solely a subscription based pricing model. They think converting to SaaS means simply converting from perpetual licensing to time based subscriptions. This misses many of the real drivers of financial performance that come from a SaaS architecture and technology including rapid development and deployment, innovation, simplicity, reliability and scaleability. The rewards of being a real SaaS business are well worth it and become even more critical the larger the organization gets. Don’t be fooled by the impostors.