Why should ISVs embrace the SaaS model?

ISVs (Independent Software Vendors or Software Manufacturers) have been operating under a licensing model for a long time and all of them are now trying to adapt themselves to the new times.

The traditional way (on-premise licenses)

As a customer, you have to buy or rent a software license limited to some variables related to the level of usage (number of users, servers, processors, and many other options). This brings a risk for the customer to buy/rent more or less than really needed, as it’s not trivial to make the right estimation for the license sizing and you don’t have the necessary information yet. Sometimes you provision too much and sometimes you will face an unexpected early upgrade cost to get the real number of necessary licenses.

Additionally, you have to buy hardware to deploy the software and to teach and assign someone to manage it. So your TCO (Total Cost of Ownership) is higher than just the software itself, and once again, difficult to estimate in advance.

But how is this model for the ISVs?

ISVs can make good money in just one sales transaction (especially with perpetual licenses), but the annual maintenance fees (around 20%) can’t cover the revenue growth demanded by the stakeholders. This makes them focus on finding new customers and sometimes they loose attention over the installed base (current customers). They need to grow the revenue, and then must prioritize acquiring new customers versus taking care of the current ones.

This leads to two bad consequences; (1) every new year reaching the sales target becomes more and more difficult (especially in mature markets) and (2) predicting or forecasting the revenue stream per period is a tough obligation, with the known impact on the share price for public companies when the sales results are lower than expected.

The big vendors have large sales organizations and many big and medium customers, but at some point, they can’t sell more to the current customers. This is one of the reasons to understand why big vendors are acquiring more a more companies, as they need to give more products to the sales force to generate new sales opportunities. But many times the acquired products can’t be fully integrated with the former portfolio, as this takes a significant time and effort.

Last point is the cost of maintenance per customer (similar to the TCO for the customer) is growing. When you have many customers, the number of combinations of technical environments and software versions gets huge, and making stable and portable software is almost impossible. Additionally supporting all the software base combinations (OS, Web Servers, App Servers, DB Servers, etc) is really expensive.

The new software selling model (Software as a Service).

There are thousands of lines written about how good is SaaS for the software users, but I haven’t read too many about how good is SaaS for Software Vendors.

When the SaaS model appeared, many software sales people (and some top managers) looked at it as a threat. The initial price for the customer is usually lower, and the sales people need to get more and more customers to keep the sales targets. The reality is different, but there is a transition period.

Basically as an ISV, you deploy your software in your own infrastructure and charge your customers for using your software accessing it through the cloud: pay per use.

In the short term, the software customer will pay less, but the payments will be recurrent. In the long term, the software customer will pay more than when buying on-premise software licenses, but it will pay just if the software is adding value and the vendor is delivering a good service.

This model offers benefits for both customers and vendors:

To me is simple and obvious that SaaS is good for the Software Industry. It needs to get some maturity, but it’s happening now.

I agree with everybody to say that SaaS will grow very fast. Nevertheless there are still many type of software and customers that will need to keep on-premise software licenses: to leverage on existing infrastructure and staff, for security constraints, for financial reasons (asset versus service, capex versus opex), etc.

We will live with both models in the software market.

Your comments are more than welcome.


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2 Comments

  1. Francis Cordon

    Awesome post, Enrique, and I couldn’t agree more.
    I want to talk a bit about the Subscription model from the standpoint of the technical professional, though, because I think it’s an interesting spin.
    As a technical professional for a Software Vendor I find that, because I truly believe I am selling products that solve real problems and help our customers, a very important part of the work is to take care of existing customers. I am not so much talking about billable implementation or training days, I am talking about what happens after that. Who is there to ensure they get the value day to day.
    It’s also highly rewarding: I get to establish and maintain interpersonal relationships and see first hand how the product helps people in their day to day activities. I also get to feel that I am part of it. It’s not always easy, especially if the software in question is not that solid, but it’s a fundamental part of the work. It also allows me to improve my offering. What the customer tells me and what I can see when I visit them is the number one criteria in shaping the future of our products.
    Sounds good? There is only one caveat… the current pricing and traditional licensing model does not promote this work and in fact, sometimes, it actually hampers it. Sure, I can spend time with existing customers but I run the risk of being frowned upon because ‘I should be working with new prospects to close new deals’ unless I can justify that a direct consequence of my involvement with them will be a short term expand deal, which is not always the case.
    My point? Subscription model is the answer. Now we need to *really* take care of customers because we depend on that annual income that will come from their renewal! It sounds a little risky, but from a technical professional standpoint it justifies spending more time doing what I like: making existing customers happy!

  2. Thanks for the article Enrique. The SaaS model is clearly described and the benefits for customers are well explained. I agree that we will still see both models in the software market as some limitations slow down the adoption of the SaaS applications.

    The cloud computing market has long been one of the computer industry’s fastest growing components. Software-as-a-Service (SaaS) is the fastest growing segment of cloud computing and will be instrumental in pushing the cloud market to $25 billion in the next three years according to a report from MarketResearch.com.