SaaS-implified
“Software is eating the world, in all sectors. In the future, every company will become a software company.” — Mark Andreesen, Founder of Netscape.
I aim to keep this post as a primer about SaaS (Software as a Service) — a new business model for software companies that has brought a wave of revolution with it and has been instrumental in the success of some of the most powerful (tech) companies today.
I am assuming that you understand what the term “Software” means — the only pre-requisite for deriving the most value out of this primer.
Good ol’days
In the good olden days, software used to be stored in physical media (CD/DVD), wrapped around in a box and was sold through retail. This means several things — physical distribution was the key to making revenue off software, the sale was a transaction (as users paid only once during the entire cycle of the sale) and the developers didn’t quite know when users would want to upgrade to the newer versions of the same software. Hence, the model made it difficult to patch security issues, fix bugs and add incremental features. Furthermore, this made it difficult to incentivize developers to keep updating the old softwares and led to dated versions of softwares eventually being used with severe security loopholes across several enterprises.
With the increased proliferation of the internet, the marginal cost of distribution became zero and hence, software makers began to transition away from physical distribution to digital distribution. Customers paid upon the download and installation in their local devices. While this solved the problem of physical retail, the sale process still remained transactional.
Things get SaaS-y
The digital delivery method has evolved over time and has led to what we know as Software as a Service (SaaS). This new SaaS model is different in the sense the users do not even need to download the software into their local devices (computer/mobile). The software is hosted in the cloud and is made accessible by the internet browser — think YouTube, Google Docs/Sheets/Slides, Netflix, Spotify, and the several COVID 19 Dashboards you follow etc.
This then simplifies a lot of things for the users —
- The software lives on the cloud (and not on-premise or your local computers), making it difficult to pirate and easy to push/publish updates in real-time.
- The software is assembled using a browser and hence it frees the user from hardware dependencies (Google Doc works perfectly fine on your laptop with a Dual Core Processor or a PC with a Core i7 processor or on your smartphone with a SnapDragon 835 processor so long as you have a browser and an active internet connection).
- Users pay a subscription fee to access the software, increasing the customer lifetime value, thereby making SaaS a customer acquisition tool.
- The subscription fee aligns the incentives of the software makers with that of the users — since software makers are receiving a continuos revenue from sales, they are incentivized to continue to update and develop the product regularly. Subsequently, users also receive continuous support for the product and pay fewer upfront costs.
- Since the users pay fewer upfront costs, it makes it easier for them to try/use the product.
- Also, as the software lives on the cloud, it continually provides app analytics on several parameters making the feedback loop circular and helping the developers build features to delight the users.
Well-designed SaaS offers economic advantages in terms of much faster onboarding times, orders of magnitude lower TCO (Total Cost of Ownership) and the ability to stay up to date more easily in today’s rapidly changing environment. SaaS solutions are updated regularly based on customer feedback and usage data, so as new trends emerge, vendors can respond quickly to the benefit of their customers.
But SaaS is more than just software. The services components are equally important in building long-term partnerships that provide economic value to both customers and software makers.
Adobe likes SaaS
Most software companies built today to leverage the SaaS business model. However, Adobe is a rare example of a software company that has successfully transformed itself from selling software in a box to a SaaS model. In the old model, Adobe’s product development cycle was ~18 months, producing products costing between the US $1,300 to US $2,600. With the new subscription model, the company changed the pricing to US $9.99 per month for a single product and US $52.99 per month for all apps in the Creative Cloud.
At the end of 2012, the company started selling its products via the SaaS model, and by mid-2013, the company completed the transition to SaaS. It stopped selling the non-subscription version of their Creative Cloud solution altogether. During this transition, the company faced significant backlash from its users. Revenue was flat for over a year during this period. But alas, Adobe’s product was crucial to many people, so users returned to the service.
From the perspective of the investor, the shift to a SaaS company means that Adobe’s business should be more robust. Specifically:
- Adobe should have lower marketing spend (normalized to sales) since the company does not have to market every new release to encourage users to upgrade.
- With the subscription business model, Adobe should be able to gain more revenue per user (due to less customer churn that is inherent in a subscription business model).
- Adobe should enjoy higher predictability of recurring revenue.
And this overall should translate to more cash flow from operations.
An obvious result of Adobe’s shift to the cloud with a key metric that you’d need to measure.
ARPU (Average Revenue Per User) Increased
In the old model, Adobe had customers that would upgrade every single cycle (once every 18–24 months), but it also had customers that would skip multiple cycles. With the old model, Adobe was garnering about US$ 30 per user per month. In comparison, with the subscription business, the company flattened this variability and in Q2 ‘13, the company achieved US$ 37 per user per month. At the end of ‘18, the average revenue per user is over US$ 73 per user per month (albeit this now includes more products as Adobe has managed to up-sell higher subscription packages).
Subscription provides a steady flow of revenue.
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Views expressed in this post are my own and don’t reflect those of my employers, present or past.
In case, you liked this simple, jargon-free overview of SaaS, I’d appreciate if you clap for it and share it with anyone who might benefit from reading this. :)
