SaaS Application Vendors Will Need Substantial Early Investment to Be Successful

During my weekly investigation of what's going on in the SaaS market, I came across an interesting article titled "When to Spend Cash in a SaaS Business" posted by Phil Wainewright on the ZDNet Sofware as Services Blog.

Mr. Wainewright's article is based on a speech given by Josh James, the CEO and co-founder of enterprise web analytics provider Omniture where he revealed to an enthralled crowd at the SIIA On Demand conference the magic formula that helped his company sustain rocketing growth, dwarf its competitors and become the second-largest listed pureplay SaaS provider in the US, with 5,000 customers and annualized revenues approaching $320 million.

Having built and run several SaaS based software companies, the economics are not surprising.  However, it prompted me to remember that although the investments required by the SaaS ventures are substantial, the associated savings by clients that are using SaaS technology is identically substantial.  And therefore, in the current economic climate, SaaS solutions make even more sense for any organizations, in eDiscovery or in the general business market, that no longer have the budgets to invest in new IT infrastructure and at the same time are having to cut back on IT staff.   SaaS is basically the right solution at absolutely the right time.

The full text of Mr. Wainewright's post are as follows:

Josh James, CEO and co-founder of enterprise web analytics provider Omniture, revealed to an enthralled crowd at the SIIA On Demand conference this week the magic formula that helped his company sustain rocketing growth, dwarf its competitors and become the second-largest listed pureplay SaaS provider in the US, with 5,000 customers and annualized revenues approaching $320 million.

The key to understanding the formula is to recognize that SaaS companies bleed cash with every new customer they acquire — the complete opposite of what happens when a conventional software company lands a new account and pockets a huge upfront license fee. Especially if, like Omniture, the application requires significant infrastructure investment but the subscription is billed monthly.

“Every time we add an incremental customer, it costs us more money that quarter — it costs us more cash that quarter,” explained James. “When you multiply that by 250 customers in a quarter, that’s a lot of expense for no money.”

Some statistics illuminate the scale of Omniture’s infrastructure: it operates 15,000 servers for its 5,000 customers, and processes almost a trillion transactions per quarter — that’s a hundred times more than Salesforce.com’s proudly touted 10 billion. The average transaction rate is 125,000 per second, with spikes up to twice that amount. Those are truly petascale numbers (to use a word I learnt just last week) and every new customer means adding more capacity.

The financial consequences look exceptionally dire when expressed according to the generally accepted accounting principles (GAAP) that the SEC mandates for public company financials. GAAP forces the cost to be expensed upfront but has no way of recognizing that each Omniture customer generally starts returning a profit by the end of the year, and much sooner in the case of smaller customers.

As James explained: “When we were really stepping on the gas in 2004, 2005, we were GAAP unprofitable.” In 2005, he said, Omniture’s negative free cash flow was in excess of $22 million — more than its total annual revenue — and it had spiked higher at some points. “It is a scary moment,” he said — even when management understands the game plan and has the full support of its financial backers, it takes courage to plow ahead regardless. “It is really important to trust the math. The investors were saying, slam on the gas, but you have that gut-check moment there.”

Omniture was relying on a simple calculation that produces a ‘magic number’ telling you when you should hire more sales reps to fuel your growth as a SaaS business. The formula takes the incremental growth in the current quarter, multiplies by four to annualize it, and then divides it by the amount spent on sales and marketing in the prior quarter.

So, for example, let’s say your company increases sales this quarter by $750k over last quarter. That’s $3 million annualized. If you spent less than $4 million last quarter on sales and marketing. then you spent too little. $3 million is OK — a magic number of 1 is “pretty good,” said James. But ideally you should squeeze that ratio down to .75, even as far as .5 — “Go hire some more reps,” Be warned, though, if it falls lower or goes negative — in this example, let’s say you spent the $4 million but it produced less than $500k in extra sales (or worse, your sales went backwards), then you have a problem that needs fixing.

“Any time the magic number’s .75 or more, you should invest in more sales people,” said James. “Less than .5, there’s probably something wrong with your business.”

The model works so long as the following three factors are in place:

- Your customers will be profitable over time: “Once you know for sure that each customer you have is eventually going to pay off, that’s when you slam on the gas,” said James.
- Your retention rate is strong — 95 percent or better — and stays that way.
- The market isn’t saturated (which I guess is unlikely for anyone in the SaaS business for a while yet).

“If investors see a company that’s growing at a healthy rate with a great magic number, it’s a money machine. There’s no doubt,” said James. “If you’ve got more feet on the street you’re not leaving opportunity out there for other people to take … If you can get that number down really fast, then you’re really making hay out there.”

James displayed a chart showing magic number calculations for several public SaaS companies and praised Salesforce.com and SuccessFactors for both adopting a similarly aggressive growth strategy. He acknowledged, though, the difficulties of persuading investors to stand by such a strategy in the current economic climate. SaaS entrepreneurs are going to have to pay close attention to their customer profitability and retention rates so that they can demonstrate to investors the merits of funding their upfront cash needs. By the way, although James didn’t explicitly call this out, his formula also underlines the advantages of working with pay-as-you-go infrastructure providers, because that’s a way of spreading the cash requirement instead of having to fund it all out of your own balance sheet.

Labels: Josh James, Omniture, Saas, salesforce.com, Venture Capital

posted by Charles Skamser @ 3:56 PM 0 Comments

New SaaS Player in Early Case Assessment (ECA) for eDiscovery

With the increased legal burden introduced by the changes to the Federal Rules of Civil Procedure driving the litigation market to contain costs related to eDiscovery, Early Case Assessment (ECA) solution providers such as Clearwell Systems have gained a tremendous following. However, at a cost of $150 per gigabyte to assess your case and/or develop strategies for Rule 26(f) meetings, there is still plenty of room for new and less expensive solutions.

And, it appears that Level 9, a software development firm out of Atlanta, GA has come up with a solution called earlyCASE to fill the demand for a lower cost ECA.

earlyCASE is a SaaS based eDiscovery application which uses an on-demand deployment model (runs on your local PC) and analyzes the ESI that your computer can access in-place without the data ever leaving your computer or network. earlyCASE allows you to quickly see and understand all of your data before it is sent on to Electronic Data Discovery (EDD) and document review. It supports multiple languages, extracts metadata, generates hash values, detects duplicates, email conversation threads and creates a local inventory database of documents and emails. earlyCASE allows users to make informed discovery decisions and easily cut down the size of data sets through filter and culling rules before going into the meet and confer, discovery processing and document review.

earlyCASE is offered in three versions, a Basic (FREE) version, a Professional version for a small flat rate charge, regardless of the amount of data you analyze, and an enterprise edition. The Basic version offers 28+ high-quality eDiscovery reports, one which estimates your processing and review budget while providing an immediate understanding of your data. With the Professional version, Lotus Notes and EnCase images are processed, a 26(f) report for meet and confer is available to help clients reduce legal risk exposure by offering a necessary view of the legal case information—custodians, context, third parties, and more.

earlyCASE provides you the tools and results to best understand, define and memorialize the ESI going into the meet and confer. Duplicate document detection, container processing (zip, rar, arc), Lotus Notes NSF’s and EnCase images are the primary reasons most people use the Professional version of earlyCASE.

earlyCASE basic is available for FREE, earlyCASE Professional is priced at $198 per run (unlimited data), and earlyCASE Enterprise licenses start at $8,000.

Having tested earlyCASE on my laptop, I found it to be extremely easy to load, easy to use and fast. It generated a reasonable quote of how much it was going to cost to process the data that I identified, provided an adequate number of standard reports for analysis and review and because it sits on an MS Access Database, I was able to build several custom reports that met my specific reporting requirements. All in all, I identifed and analyzed almost 20 gigabytes of data and it only costs $198 as opposed to the $3,000 it would have cost for the same basic information using other ECA tools.

earlyCASE is not an EDD tool. But, it seems to have filled the void for a lower cost ECA and hopefully has opened the door for more lower cost and easy to use SaaS based eDiscovery solutions.

Labels: Clearwell, Early Case Assessment, earlyCASE, ECA, eDiscovery, EnCase, FRCP, FRCP Rule 26(f), Lotus Notes NSF

posted by Charles Skamser @ 8:08 PM 4 Comments