SaaS cloud pricing: Can it ever add up?

SaaS cloud pricing: Can it ever add up?

Summary: Vendors of software as a service aren't making money. So what will happen to SaaS pricing when they decide to try and turn in a profit?

SHARE:

It's easy to see the appeal of software as service. Organisations like its relative cheapness and apparent flexibility. But some are now asking how long those advantages can last and are recognising the risks in browser-based short-termism.

"SaaS pure-plays and those who are moving to a SaaS model, they're not pulling the profits and many of them can't see when they are going to. So a change has to come" — Angela Eager, TechMarketView

The SaaS market appears to be in rude health. Analyst firm Gartner reckons spending on SaaS will hit $22.1bn in 2015, up from $14.5bn in 2012. Yet SaaS vendors aren't making money, according to Angela Eager, research director for enterprise software and application services at TechMarketView.

"SaaS pure-plays and those who are moving to a SaaS model, they're not pulling the profits and many of them can't see when they are going to," she said. "So a change has to come."

Eager's take is largely based on profits as defined under generally accepted accounting principles. Excluding things like stock option expenses, acquisitions and other items, SaaS vendors are profitable. Wall Street goes with non-GAAP results and would argue against Eager's take. Simply put, there's a big difference between GAAP and non-GAAP results:

Consider the following:

  • Salesforce reported a net loss for fiscal 2013 of $270.44 million, or $1.92 a share, on revenue of $3.05 billion. But when you exclude stock-based compensation, one-time tax allowances, amortization of purchase intangibles and interest expenses, Salesforce reported an annual profit of $1.63 a share.
  • Netsuite reported a fiscal 2012 non-GAAP profit of 26 cents a share on revenue of $308.8 million. Including stock options and other charges, Netsuite reported an annual loss of 50 cents a share.

Eager does not believe that the lack of SaaS profits is because providers are in an investment phase and just covering their upfront infrastructure investment costs.

"It goes deeper than that. If it was just upfront costs, maybe it would be easier to predict when you would hit that upfront profitability. From what I can see, a lot of the vendors are just not able to," Eager said.

According to Eager, we are in a period of the market where the traditional drive for profitability is not seen as a priority. "But that point is going to come and it may not be too many years away," she said.

Focus on acquiring customers

SaaS vendors are clearly focusing on the acquisition of new customers, rather than profits, according to Ovum principal software analyst Roy Illsley.

"SaaS at present is still doing a bit of a land grab," he said. "It's still getting people to use its services with the view once you're hooked up and using them, your exit strategy is pretty minimal — you can't really go anywhere, can you?"

Illsley also thinks that sheer volume of new customers will help providers move towards profitability.

"As they get more and more people using their services and their servers get utilised better, then their per-unit costs on that side will come down and their profitability will increase," he said.

But Illsley argues the mechanism will only go so far to making SaaS vendors profitable. "That's only going to go part of the way. It obviously depends on what their infrastructure and hosting arrangements are like," he said.

"If they were a very efficient operator that scaled their operations to meet the demand and they sweat their assets as much as they can, it's not going to be great for them."

Low-priced software

One of the key factors in the profitability equation is people's perception that SaaS should be low cost. Dr Will Venters, lecturer in information systems at the London School of Economics, believes that perception has its roots in consumer technology.

"The idea of the iTunes apps and the economy associated with those are so focused on low costs that we've seen a plummeting in expectations on the amount we'll spend on software," Venters said.

"The consumer of a software service is just as reliant on the provider of the software service making money as the provider is itself" — Dr Will Venters

"There's become an expectation in society that software is a lot cheaper than perhaps we're used to it being."

Yet, according to Venters, at some level we have to pay for software and particularly enterprise software if it involves significant investment in its construction.

The trouble is the old relationship between the user of the software and its vendor has changed under SaaS. "The consumer of a software service is just as reliant on the provider of the software service making money as the provider is itself," he said.

"You can't have one without the other, which is perhaps slightly different from [on-premise] software where you used to be able to have escrow and you could continue to keep nursing an old piece of software even though the company providing it had gone bust — not great policy, not a great idea — but that's not the same with SaaS. You are reliant on where that IP goes."

Change in SaaS business model

So what can SaaS providers do to make those profits on which the consumers of the software unwittingly rely? TechMarketView's Angela Eager believes there has to be a change in the business model.

"That can go various ways — maybe adding additional services like the expert services is one way of going. That's inevitably going to lead to rising prices," she said.

Read this

Winners and losers in the new cloud revolution

Winners and losers in the new cloud revolution

Cloud computing is becoming as important as water or electricity. But which companies stand to gain from this shift, and which will lose out? Read ZDNet's complete guide.

"Another option is obviously increasing that baseline price. But given the way that SaaS pricing is perceived, I can't really see that going down well with the customer base. So I don't think it's going to be feasible to do a straight increase. It's going to be necessary to add additional value services instead and increasing the revenue that way."

Eager also thinks the concept of paying for flexibility is missing from the present SaaS model. "You see that in other industries where you have to pay for flexibility. But it's the other way round when it comes to SaaS pricing," she said.

"If you book an airline seat, and you want flexibility in terms of the date you travel and the routing and the ability to change your flight with no penalty, you've got to pay more for it."

Along with possible price hikes in the short term, more expensive services are the way forward for SaaS providers, according to Ovum's Roy Illsley. "The long-term strategy of the SaaS providers is to get the installed base, get their costs down so they can run their operations much more efficiently and deliver the change and then upsell as they move out of just SaaS," he said.

"If you look at Salesforce, they are now platform as a service, they've linked up with lots of other people, [like] BMC Remedyforce. They're expanding, so the whole space is becoming less of an individual, isolated SaaS application that you use and more of that SaaS application being part of a platform and a bigger service. That's where you're going to find the value for the providers."

Lock-in and SaaS profits

The LSE's Dr Will Venters sees the issue of lock-in as central to SaaS vendors' profitability plans. "In SaaS you are often locked into the development pathway of the SaaS provider. You can't stick with XP the same way we all stuck with Windows XP because we didn't like Vista," he said.

"So if you're being driven along that pathway and that pathway involves a future where you're going to be paying a higher amount for software, it's very hard just to say, 'Well, we'll just stick with the legacy for a continued period until we work out what we're going to do'," Venters added.

"At some point we're going to end up with a consolidation if nobody's making any money" — Dr Will Venters

"I suspect there's some of: 'We'll drive our SaaS product in way that in the future that it becomes more locked-in for our clients and provides opportunities for us to upsell significantly."

Venters also thinks analysing their customers' usage could also be a source of profits. "The other side is the data analytics argument that says, 'We'll have products to sell by our access or our understanding of how clients are using our service' — the Facebook kind of economic model, where Facebook is not going to make money out of the consumers of its service. It's going to make money out of selling those eyeballs in some way," he said.

It may not be in the short term, but SaaS providers will need to show a profit at some point. "That they haven't got economic models doesn't necessarily mean they can't continue as long as their investors are prepared to shovel money into it," Venters said.

"But at some point we're going to end up with a consolidation if nobody's making any money. That might be the point at which we start to need standardisation because there will be companies that are left reliant on SaaS companies that are not economic. Then the price will be determined because they'll either have to decide to switch to an alternative or pay for that SaaS company to become profitable."

SaaS market slow-down

Angela Eager also believes changes to pricing are not imminent. "With any market there's going to be a limit when things are going to start to slow down. We're a long way off there now," she said.

"We're still way into double-digit growth for anything SaaS-related. So SaaS has got a long way to go, but inevitably there is going to be some sort of slow-down because it's more than just low-hanging fruit. It's the number of applications and businesses that are prepared to go that way and what type of applications they're prepared to port."

Changes to pricing and SaaS approaches may occur over a longer period, but Eager still thinks the present business model will result in short-term consequences.

"This is going to be a make-or-break year for several companies, several technologies, several approaches to the market and it certainly is potentially for some SaaS companies," she said.

"There are a lot dimensions to it. Is SaaS going to break into ERP in a serious way? Are they going to break into some sort of profitability or at least move towards it?"

Topics: Cloud: How to Do SaaS Right, Cloud, Enterprise Software, Salesforce.com, Software

Kick off your day with ZDNet's daily email newsletter. It's the freshest tech news and opinion, served hot. Get it.

Talkback

10 comments
Log in or register to join the discussion
  • Good article

    Hi Toby,

    Excellent article. I liked your idea about how a customer has to buy into the product roadmap and, naturally enough, it will travel in a way to increase profitability.

    One thing, given the ease of getting out of a SaaS contract (normally speaking) means that publishers have to deliver and demonstrate value much more than an on-premise publisher who has to sell a maintenance contract once per year. If they don't do that then their customers vote with their feet and, whatever level of profitability they bring, it is lost to the publisher.

    Rgds,

    John
    http://centriclogicblog.wordpress.com/
    Centric Logic
  • Affordability

    Toby - thanks for the thoughtful article pointing out that many SaaS vendors are not profitable yet. Do you have any specific statistics? Softletter - Rick Chapman - has done some very good work in analyzing the SaaS market - you might want to converse with him. He's also just written a book "SaaS Entrepreneur" which I'm in the process of reading; so far it's excellent.

    Another issue to consider is whether the business buying these many apps can in the end actually afford all of them. Each app vendor is trying to maximize their revenue in a vacuum, while each subscriber is trying to get access to all the apps they need, at a total affordable price. An interesting example of this is the comic strip tool Pixton.com (business version). I needed this tool once, for a few days, for a special business project I was working on. And I needed the premium features. But there was no way for me to pay-for-value; I was forced to pay for a long term subscription. That may be the goal, but it creates churn and hesitation to ever jump over the "penny gap" (Josh Kopelman's term) since one gets stuck paying for stuff that isn't used that much and managing a mass of subscriptions that have different payments cycles, etc.
    http://redeye.firstround.com/2007/03/the_first_penny.html

    I've looked deeply into the whole SaaS freemium scene - I am the lead organizer for FreemiumSFBay (www.meetup.com/freemium and www.freemiumsfbay.com). Freemium is a path many SaaS vendors are taking - a few successfully; moany with very low conversion rates from freemium to premium.

    Cynthia @Kachingle
    "Bundling, Billing, and Co-Marketing Platform for Apps"
    www.kachingle.com
    cynthia3
  • Lots of Pieces

    Very interesting article that highlights the interesting position of being a SaaS provider that serves other SaaS providers or those transitioning to SaaS in an effort to help them monetize better and grow. Clearly, understanding the customer better in this new world is key and playing your cards on a customer centric approach is surely going to pay off in the long term – we take this approach ourselves and offer it in the types of services our customers need for both the B2B and B2C markets.

    One of the main customer-centric approaches to a healthy SaaS business is offering additional – sometimes third-party – services that complement your main offering. A great example of this is Comcast, which recently started selling third-party apps to its SMB customers via an app store. Not only does this create additional revenue streams, but it also highlights a better understanding of customer needs on the part of the provider – anticipating what ancillary items will make their overall experience better without adding additional procurement steps on their part.

    Customer-centricity requires solid understanding of how to retain those customers as well. Once you have that installed base, you can do many things to improve retention – services play an important part here, but so does automation and self-service; allowing the customer to be addressed whichever way they please across all touchpoints they have with the provider. Servicing the customer in-context like that as a retention strategy does require a level of transparency and flexibility between vendor and customer that hasn't been available before. Customers want to see all of their data and expect vendors to act on it, anticipating and adjusting for their needs at a given time, which is a demanding task for the provider to log all the proper data and not skip a beat but it's what's expected to make money.

    To Cynthia @Kachingle’s note on Rick Chapman – he’s indeed a SaaS chap. Happy to ping him to provide commentary since he surely has something interesting to add.
    Michael Ni - CMO/SVP, Marketing and Products, Avangate
  • SaaS and Profitability

    First, I would like to point out that this article doesn't really say that SaaS aren't profitable. What is says is that several publicly held companies have stated they aren't profitable after various non-business costs are factored in, such as stock option, one shot acquisition costs, etc.

    Softletter has been conducting research on SaaS companies since 2006 and we have, and more extensive info on such issues as revenue growth and profitability than *anyone." Here are some revenue growth numbers from our 2013 SaaS Report (these numbers also appear in my book "SaaS Entrepreneur: The Definitive Guide to Succeeding in Your Cloud Application Business."

    Did your company's SaaS revenues grow from this period in 2010/2011 to this period in 2011/2012? (Please include revenue ONLY from increases of sales of SaaS products and services)

    1% to 5% 4%
    6% to 10% 11%
    11% to 20% 25%
    21% to 30% 15%
    31% to 40% 6%
    41% to 50% 6%
    50%+ 2%
    75%+ 2%
    100%+ 29%

    Note the number of companies reportin 100%+ growth. Not a sign of an industry not making money.

    We also asked about profitability:

    Is your SaaS company or business unit profitable?

    Yes: 62%
    No: 38%

    We drilled down into these numbers by a number of criteria, including development stage, revenue size, years in business, etc. These numbers are available in the Softletter SaaS Report (more info at www.http://www.softletter.com/Research/SoftletterSaaSReport.aspx).

    I'd also like to point out that publicly held companies often should be measured with the understanding that they're playing a long game. Sales and marketing expenditures are typically twice that of privately held firms. Companies often are aggressive acquirers. All of this is driven by the need of a publicly held firm to demonstrate revenue growth, which in turn drives up stock prices. Public firms often have a strategy of eschewing short term profitability in return for dominating a market segment.

    It's also important to note that the growth of SaaS is not driven by enterprise acceptance of SaaS nor by the belief that SaaS systems are cheaper to purchase than on premise software. Rather growth has and still is driven by the fact that the SaaS model opens up new markets that are not reachable by the on premise model.

    Another point to remember is the concept of "service." I don't think SaaS companies are going to show the levels of profitability that Microsoft and other on premise and desktop companies enjoyed in the 80s and through the 90s. SaaS companies must sustain an ongoing service infrastructure that on premise companies don't. And, unlike desktop companies, who have succeeded in almost completely off loading support to, well, whoever, SaaS companies can't do that. The operations structure of SaaS firms is very different in many respects from on premise companies.

    Rick Chapman
    www.softletter.com
    www.saasuniversity.com
    Author "SaaS Entrepreneur: The Definitive Guide to Success in Your Cloud Application Business"
    Read Excerpts from all 10 chapters at http://www.saasentrepreneur.com
    Mchapman29
    • Questions

      Sound businesses view "making money" as turning a profit not revenue growth hence your table is non sequitur. Polling (mainly) private companies and asking them if there revenues are growing is not exactly sound science. Calling stock-based compensation a "non-business expense" is wrong. That's why the SEC changed the rule.

      These opinions are mine and not of my employer, wife, dog or 2 year old son.
      coach74
      • Revenue growth

        "Sound" VC's and investors will frequently invest in companies based on revenue growth, particularly if it's strong and consistent. Only someone with no experience in the industry would argue the point.

        And I guess you missed the profitability chart?

        Rick Chapman
        www.softletter.com
        www.saasuniversity.com
        Author "SaaS Entrepreneur: The Definitive Guide to Success in Your Cloud Application Business"
        Read Excerpts from all 10 chapters at http://www.saasentrepreneur.com
        Mchapman29
      • Revenue growth

        Oh, and the survey broke out companies by public and private categories as well.

        Rick Chapman
        www.softletter.com
        www.saasuniversity.com
        Author "SaaS Entrepreneur: The Definitive Guide to Success in Your Cloud Application Business"
        Read Excerpts from all 10 chapters at http://www.saasentrepreneur.com
        Mchapman29
  • market share / land grab

    Interesting thoughts in light of MSFT's recent push / promo to include Office365 in every enterprise VL deal (with a pretty high attach rate form what we've seen and heard). As I keep warning clients - it's unrealistic to expect these intro prices to stay so low, so when you run your build v buy calculations you should assume dramatic price increases in the future renewals.
    ScottBraden
  • Complete disgrace

    Your comment contains words or phrases associated with spam and will not appear on the site until it has been checked by a moderator.

    Fix this ZDNet
    Cayble
  • Saas is here to stay

    Very interesting article. Cloud computing is here to stay for a long time. I have started using hostpinger.com, a cloud based product for monitoring my web servers. they are providing providing reasonably good services at a very low cost. I signed up free and got 50 tests of cloud host and local host free.
    Ethan9355