SaaS for the win: Why we focus on B2B SaaS startups

At Senovo we focus on B2B startups with a SaaS business model. We believe that SaaS this is by far the most interesting and dynamic segment of enterprise startups. Here is why.

In principle, there are 4 primarily used business models for B2B startups:

1. SaaS

2. On Premise / Perpetual License

3. Open Source

4. Hardware Products

SaaS is winning the enterprise

Traditionally, the main business model for software companies was the on premise model. Since the 2000s, however, the SaaS business model is gradually taking over. The reasons why SaaS is winning are twofold:

· Product perspective: as a “managed service” it prioritizes convenience and reliability and has a more efficient and agile development process

· Economic perspective: the customer value is created over the time and a subscription based cash flow is much better aligned with the received value by the customer (…and generally more favorable than short term, volatile cash flows)

The leading market research organizations such as Gartner see the same trend:

“By 2019, more than 30 percent of the 100 largest vendors’ new software investments will have shifted from cloud-first to cloud-only.” [1]

Forrester, IDC and TBR agree and forecast the SaaS market to reach USD 100bn market size in application spending in the near future. At the same time the on premise model, however, is losing market share. [5]

SaaS Marketsize according to Forrester [2], IDC [3] and TBR [4]

Consequently, most traditional software companies which predominantly use the perpetual license model have started to migrate to the cloud. Prominent examples are e.g. Microsoft with Office 365, Adobe with their Creative Cloud product line or the recent acquisition of Netsuite by Oracle.

Bye, bye bloatware: How SaaS solves the innovator’s dilemma

On a more detailed level the benefits of the SaaS business model are:

· Long-term cash flow aligned with customer value & usage

· Easy to break even

· Low integration & maintenance costs

· High long term product quality

· Agile & data driven product development

A big drawback of the perpetual license model is that it is very vulnerable to the innovators dilemma: The problem of one time revenues, albeit higher in the short term, is that you can only generate significant cash flow / sell new versions when new features are introduced. This pressure very quickly leads to bloated products which do a lot of things but have a less than stellar user experience.

SaaS-based businesses circumvent this by focusing on the value which is created for the user. Therefore, if it makes sense to remove features this is much easier done with SaaS products.

Finally, these decisions can be taken based on detailed data by small and agile teams instead of steering-committee based decisions with ambiguous or even no data.

Innovator’s Dilemma

Open source and hardware based business models

While there is a clear move from the declining on premise model to SaaS, the other two main B2B business models will continue to live alongside SaaS — and in the case of open source are even complimentary since almost every SaaS business runs on a significant part of open source software.

Open source has significant advantages when part of the strategy is to become an industry standard. Typically, the decision maker is a developer who decides to integrate an open source product into the new project he is involved in. The result is a two-fold “sales process” so to speak:

1) The race for mass adoption by open sourcing the product or parts of it

2) The commercialization phase: some projects which use open source have grown into products or become mission critical enough that certain operational guarantees are required

The result is a risky transition process from pure open source into the commercialization phase which is not always clear and difficult to manage. In addition, an open source startup is required to fundraise large amounts of capital to cover their costs in phase 1 and can’t rely on revenues in a meaningful way early on.

Lastly, there is the hardware business model which is recently getting a lot of attention since it is often part of IoT or Industry 4.0 products. In contrast to the previous software models, hardware has the challenge of a supply chain which needs to be managed as well as reduced margins due to a bill of material and production & handling costs. Besides of different KPIs there is also the strategic challenge that in hardware production scales of economy are a key success factor — and not one which is usually to the advantage of a startup.

Summary

In summary, SaaS is central to a huge paradigm shift in how enterprise software is built, sold, and used by the customer. It is the business model which brings the biggest advantages for modern B2B startups since it has superior unit economics, long term cash flows and helps to build high quality products. It is the largest and most dynamic enterprise market and as a B2B investor we ❤ SaaS.