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SaaS and the renewal question

SaaS providers rely on the stickiness of their services to keep customers renewing time after time. Will they remain viable if renewals get harder to win?

One of the unspoken tenets underpinning the SaaS model is that customers are for life. Forget the mantra that it's a pay-as-you-go relationship from which the customer can walk away at any time. Providers know that once they've captured a client's data and daily routine onto their service, moving elsewhere is a pain. This is true even for individual consumer services like FaceBook or Gmail, but it applies far more tellingly when it comes to business applications. Payroll provider ADP's average customer lifetime is around twelve years, and most of the attrition is due to company mergers and failures or wider software upgrades rather than simply losing out to a direct competitor. That's the sort of customer stickiness most SaaS providers are aiming for.

Woman chasing profit sign

Without that stickiness, there's a fundamental flaw in the economic model of SaaS, which as I've discussed in recent posts, funds the upfront cost of acquiring and provisioning a customer in the expectation of earning back that investment over the lifetime of the customer relationship. Omniture's Josh James emphasized the importance of renewals to his company's finances when he spoke on this topic at a conference last month. He explained that Omniture carefully watches its customer retention rate to make sure it stays above 95 percent annually, and anytime it looks like dropping below that figure, management takes immediate action to trace and fix whatever's causing the problem.

But what if the cost of restoring renewal rates is more than a matter of hiring a few extra bodies in the customer support team? Speaking a day later at the same conference, Oracle's Anthony Lye, senior vice president of Oracle CRM on Demand, suggested that SaaS vendors have got it wrong on renewals. At a meeting a few days later at Oracle headquarters, he gave me an example he's closely involved in. He has made sure Oracle's CRM OnDemand sales team targets Salesforce.com customers in the lead-up to their renewal dates. He claims this is forcing his rival to spend as much effort — and thus money — securing renewals as it does in landing the account in the first place.

While I'm sure he's over-egging his claims — as mentioned above, the incumbent vendor always has an advantage because changing providers is a hassle — it's still true that on-demand by its nature isn't as sticky as on-premise. I suspect there are three distinct factors he's able to exploit in his competitive pitch against Salesforce.com:

  • Inevitably, there are bound to be some discontented customers who want to evaluate alternatives
  • There will also be contented customers who are savvy enough to drive a harder bargain when renewal time comes around
  • As a trend, customers presumably are getting more comfortable with the on-demand model and therefore may be signing shorter contracts than they did when first switching from conventional licensed software with its three to five year upgrade cycles — thus giving more frequent opportunities to renegotiate renewals.

Did we see the impact of Lye's competitive tactics start to show through in Salesforce.com's most recent financial results? ZDNet's Larry Dignan noted the comments of some analysts that cash flow has been falling. "The cash flow worry is this: Salesforce.com could be seeing renewals fall," he wrote. Salesforce prefers to quote an attrition rate of 1%-a-month rather than the more transparent (and significantly better) annual figure Omniture quotes, so it's difficult to know if renewals are getting tougher to win. But there's no sign yet of increased spending on sales and marketing, which in the past three years has remained very consistent at around 50 percent of revenues. So even if Oracle is making the Salesforce.com sales team work harder, the effect on the bottom line isn't yet visible.

Lye of course works in an Oracle business unit that derives most of its revenues from conventional license sales, so is surrounded by people who want to believe the SaaS model is flawed. I think the important takeaway from his argument is to realize that SaaS providers in competitive markets may find renewals a lot harder work than some have been assuming in their business models. It's important to make provision for the cost of pitching for renewals against a credible, aggressive competitor. But much of the work to keep customers loyal has to be done much earlier. Make sure customers are happy throughout the life of the contract, and they're far less likely to go through the disruption of changing provider than if they've already become dissatisfied.