Why you should be paranoid about SaaS entrants and competitors

Image Credit: https://www.youtube.com/watch?v=BQPfsB652L4

In 1996, Andy Grove, former CEO of Intel, published one of the most famous management books in history: Only the Paranoid Survive. The book’s premise is that companies must remain paranoid about the competition — and other external factors — no matter how big and powerful they become.

Grove argues that every so often there are “10x” inflection points that dramatically change the current business environment. Companies that fail to recognize these inflection points will ultimately fail. Examples include the personal computers, the Internet, and low-cost production methods in China (all of which enormously impacted Intel’s strategy). This paranoid mentality was also behind Andy Grove’s annual “SLRP” meetings with his management team, in which he outlined his view of all the competitive risks to the business and how they can be addressed. These meetings often ended with monumental shifts in strategy to address external conditions.

Other great technology leaders have had a similar penchant for paranoia. Steve Jobs and Bill Gates’s own versions of it were heavily studied, alongside Andy Grove, in Strategy Rules: Five Timeless Lessons from Bill Gates, Andy Grove, and Steve Jobs. In the book, which I highly recommend, paranoia is used to explain Jobs’s obsession with secrecy and Gates’s hyper-competitive business practices like bundling Internet Explorer with Windows.

While the FTC would eventually call Gates’s strategies “anti-competitive” and “abusive”, at the time Gates recognized Netscape as a key 10x inflection point. In 1995, Netscape had 80% of the browser market share and was on its way to becoming a web-based operating system that could compete directly with Windows. While Netscape only had ~$5m in revenue in early 1995 (compared to Microsoft’s $8B!), Gates still felt it was a threat to Microsoft’s entire business. Gates responded by using his leadership position with Windows — where he had 95% market share — to offer a free, competing browser with every purchase of Windows 95. According to a VP at Intel, Steven McGeady, Gates’s intention was “to cut off Netscape’s air supply.” It worked. Netscape’s revenue base eroded, and by 2002 Microsoft had 96% of the browser market share. In the end, Microsoft’s paranoia over a small, l0w-revenue company positioned IE/Windows to be the market-leader in browsers and operating systems for many more years to come.

Credit to: https://en.wikipedia.org/wiki/Browser_wars

At this point you may be wondering why I’m writing about old-school software battles on a SaaS blog. The answer is simple: Netscape was similar to most modern-day SaaS businesses, and many lessons can be learned from Microsoft’s paranoia and how it responded. Remember, Netscape relied on the cloud, it was cheap, had minimal development costs, and had low revenues in its early days. In other words, it looked a lot like your current SaaS competitors. Gates identified Netscape as part of a 10x inflection point and responded with great force, which ultimately made his company the category winner for the next decade.

The SaaS Threat

SaaS businesses have had enormous success because they have low startup costs, they grow and pivot quickly, and they can attack any sector. SaaS businesses are therefore threats to every industry and every business model. Healthcare, education, real estate, law, and countless other verticals are currently being disrupted by SaaS, not to mention the horizontal disruption from companies like Salesforce, Hubspot, Ultimate Software, Zendesk, etc.

SaaS companies also have a very low barrier of entry: a couple of engineers, a S&M person, a small AWS contract, and a few tools. They generally spend the first 2 years getting market fit, but after that they are off to the races and speeding into your rear-view mirror.

Median in black; Zendesk (as an example) in green. Courtesy of Tomasz Tonguz and Christoph Janz

On average, over the last ten years SaaS companies have ~$1m in revenue by year 2, ~$20m in revenue by year 4, and ~$65m in revenue by year 6. Amazingly, they are only getting better and growing faster over time.

Credit to: http://tomtunguz.com/saas-revenue-growth-rates/

The cited revenue numbers are small next to Microsoft, but huge compared to most private companies. The growth rates are stunning no matter how you look at them.

If you lack paranoia, it’s easy to ignore these companies when they only have $1m in revenue after year 2. But if you wait too long to respond, it may be too late. By the time they hit $20m in revenue at year 4, they will already have great market position and be well on their way to a $100m run rate and a huge chunk of your market.

If this all seems a bit far-fetched (perhaps paranoid?), you needn’t look further than the public markets. Examples of SaaS disruption are easy to find. At one point not long ago, each of the following was a small player in the enterprise software space dominated by the Oracles, SAPs, and Microsofts of the world: Salesforce, Marketo, Hubspot, SuccessFactors, WorkDay, Concur, Ultimate Software Group, Zendesk, and more. Now the total market cap of those companies is $65B, including the sale prices of SuccessFactors and Concur (even after the huge market downturn for cloud businesses in early February, 2016). The first of these, Salesforce, was only founded in 1999.* That’s a quick path to a $53.8B market cap, which SFDC hit in December 2015.

Parting thoughts

Regardless of your industry and business type, be aware that small companies can quickly turn into major competitors. SaaS companies are especially dynamic and should be given extra attention. Follow Andy Grove and Bill Gates’s lead and set aside meaningful time in your week to investigate — and crush — the next big thing that could threaten your market position. In short, be paranoid.

*A follow up on my statement that Salesforce was the first public SaaS company: Concur was actually founded in 1995 but started with CD-ROM sales before transitioning to SaaS in the early 2000s. Therefore, Salesforce was the first true SaaS product traded in the public markets.

Concur’s Income Type Over Time, courtesy of Tomasz Tonguz
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