For the SaaS industry in its current scale Covid-19 is the first global crisis to weather. We’re now 2,5 months into the crisis, quarterly reports are coming in and we are starting to have enough data to take stock on the fallout — or rather: the lack thereof.
The stock market started to react on 20 February:
The Bessemer Cloud Index (https://www.bvp.com/bvp-nasdaq-emerging-cloud-index) is a great tool to track around 50 public SaaS stocks. Yesterday, (07 May), this index completely recovered from the market correction and reached a new all-time high.
Of course there are some widely reported winners such as Zoom (https://www.cnbc.com/2020/03/21/why-zoom-has-become-darling-of-remote-workers-amid-covid-19-outbreak.html) or Slack (https://www.cnbc.com/2020/03/26/coronavirus-slack-ceo-tells-the-story-of-how-crazy-things-have-been.html) due to quarantine enforced remote work.
But since Q1 2020 reports are coming in, a bigger picture is starting to emerge. The recovery of the index is not driven by a few companies profiting from the crisis, but it is a broad recovery, with an average gain of 48% since 20 March. (the absolute bottom of the index was on 16 March, but I didn’t have the data available for the calculations).
And as a result, the gap between SaaS companies and the wider S&P 500 market is opening further and has now grown to 31% since mid March:
Which brings up the question: why?
Of course, I don’t have all the answers, and will only know with certainty hindsight 20–20. But having read through the Q1 reports of SaaS companies and our own experience as an investor there are few clearly identifiable drivers:
The right business model
SaaS means a vendor is planning to engage with the customer in a long term relationship. The financial success of a SaaS vendor is dependant on a customer renewing contracts and as a result the aim of a SaaS vendor is to reduce complexity for their users and to delight them.
This means, that the incentives are very different from a “box shipping vendor” or companies with a similar transactional mindset and culture.
Shift from CAPEX to OPEX
The above-mentioned complexity reduction means that SaaS vendors are providing much more then just a “license in the cloud”. They are also taking over data center operations, procurement of hard and software needed to run the solution, monitoring and updating, recruiting and training of the operations personnel and so on.
In normal times, when internal teams do a TCO (https://en.wikipedia.org/wiki/Total_cost_of_ownership) and compare their costs to a SaaS vendor they often come to the wrong assumption that it is cheaper to do it inhouse. Why is this the case? Because a well done (and that is already rare to be honest) TCO includes all the points I mentioned above. What it doesn’t include is the distraction caused by having huge cost centres with hundreds of millions in budgets and more in areas which aren’t the expertise of a company.
As a computer scientist by training, I find it quite funny that many companies seem to assume they can build, run and maintain software with equal efficiency as a software company, even though their line of business is sausage manufacturing (yes, I’m German 😉), or making cars. Or to turn the argument on it’s head: I don’t know any software company which produces their own cars, just because the purchase price of all the individual components is cheaper then buying in bulk from BMW (unless you see Tesla as an actual software company who happens to be in the car vertical, similar to how Apple disrupted the entertainment electronics industry with it’s iOS + App Store Software vendor approach” — but that’s a whole nother story)
In a crisis, budgets are tight. And you need to react. Fast. Let’s have a look at each of these:
Cash is king when times are tough. Even if your TCO on running internally would be true, it might make sense to spend EUR 200k now instead of EUR 1m which amortizes over 10 years. There will be dire need for the EUR 800k you just saved as a customer to get through a crisis as fast as possible.
But this is only half of the truth: As you can see below the average annual contract value (ACV) of a SaaS company is just USD 28k as you can see in this chart from Meritech. More over, 70% of SaaS vendors have an annual cost for their customers of less than USD 100k. (https://www.meritechcapital.com/public-comparables/enterprise#OperatingMetrics). There is not much you can run on a USD 100k budget including licenses and all.
Time to market
If you decide to spend money in a crisis you want immediate impact and there is no point in making cash available now which will have impact in 2–3 years.
There is no time for systems integrations work. And this is where SaaS really shines: you can deploy solutions in days or weeks. SaaS vendors reduce complexity and the customer can focus on getting his core business operations in order instead of defocussing software development and deployment.
As a result, in the software industry a crisis means an acceleration of the shift from On Prem & CAPEX to SaaS & OPEX.
Digitalization means a shift towards more agile organizations, numbers replace gut instinct and drive operations and strategy. When the sky is blue and all order books are full, the benefits make sense but there is little urgency to act. Most companies know who their customers are, there are time tested and good relationships and everyone is happy.
The definition of a crisis, however, is a sudden, sharp and unexpected shift in demand and/or supply. Companies who have the right tools in place to aggregate, analyse and act on data will have a clear competitive advantage. Now one can argue, that this can also be done with on premise solutions. After all data simply means some numbers in a database, independently where hosted. True.
But this would take into assumption that you know from where the next crisis will emerge and impact you. If someone would have told me in January that by March our company and all of our portfolio firms would be working 100% from home I would have not believed it. Similarly, if this person would have wanted to prepare a larger corporation for the eventualities of a global pandemic there is little chance, he would have gotten the budgets to shift all work process into the on-prem cloud.
Cloud vendors, however present an array of “ready to run solutions” for all kinds of corporate needs. Data is a natural “element” for this new generation of software solutions and they use this to quickly adapt their own products as well as to enable customers to react to operational changes by being easily scalable and insights driven.
In summarization, I am quite optimistic about SaaS. SaaS vendors are providing significant advantages to their customers and accordingly a crisis accelerates the shift to these vendors which provide a better ROI when all things are taken into the account.