The ninth law in Bessemer’s Top 10 Computing Laws is all about accounting and how to recognize revenue. In the traditional software business, the software license revenue is recognized at the time of delivery, while in the SaaS world the scenario is very different. I mentioned in my prior posts that I have been/I still am in enterprise software sales (besides SaaS), and have to deal with both of these models. Let’s review this law in greater detail what it means for a SaaS company. In my prior blog entries about Bessemer Top 10 Cloud Computing Laws and the Business Model Canvas, I have opened the financial side of a SaaS vendor, but in this case we will be looking at how the overall revenue recognition is seen in the SaaS world.

Law #9: Mind the GAAP! Cloud accounting is all about matching revenue and costs to consumption…well, except for professional services!

With enterprise software, revenue is recognized at the time of the delivery (like for example with a CD/DVD) and the software vendor can immediately have that sales in the income statement. This is both good and bad for software vendors. The good side of the thing is that large deals can fund further development and some of the money can be funneled back into marketing. The bad thing is that large deals can also put the software sales organization to sleep, almost paralyzing the entire organization. I have been part of this so many times so this statement is based on my own experience. The other negative side of these large deals is that enterprise software sales is very cyclical with long sales cycles: A software company might be going without deals for months and then gets a large deal that kind of saves the entire year. Yet again, I have personal experiences of this as well. In the enterprise software deal, the support/maintenance revenue is typically recognized on monthly basis based on the length of the maintenance contract. So if you have an annual contract, the support/maintenance will be recognized each month for the entire year. In similar manner, services revenue is recognized after delivery of the service and the common billing cycle is either biweekly or on a monthly basis.

Let’s look at the revenue recognition of cloud computing revenue. There are typically two types of revenue streams in a cloud computing: subscription revenue and professional service revenue. The subscription revenue is recognized based on consumption, whereby the SaaS vendor can start recognizing the revenue when the end user organization starts using the software. What is very different in the SaaS world when compared with the enterprise software world is the revenue recognition of professional services. Based on best practices and audits by the top for auditing companies, revenue recognition of professional services should be recognized with the length of the contract, and some recommendations say that even over the lifetime of the customer. The practical amortization time for these types of contracts is 5-6 years if the customer churn is reasonable. Within the GAAP (Generally Accepted Accounting Principles) world, the SaaS vendor should match revenue with the corresponding costs and this might not be the case in this kind of 5-6 year amortization scenario.

Also, there is an exception to any rule in life. In cases where the software company trains the end user client either 3 months before the delivery of the solution or after the renewal date of the contract, this revenue can be considered as it can be said not be tied  or associated with the delivery of the solution. This rule of 3 months seems to have been approved by the top 4 auditing companies as best practices based on the Bessemer blog entry.

The final mention from Bessemer is to exclude deferred revenue from Quick Ratio calculations as this is booked as liability in the balance sheet. Quick Ratio is calculated by dividing total assets with total liabilities. This ratio shows how quickly the company can cover the liabilities with cash or quick assets that can be quickly liquidated.  Another term “Acid test” is when you add up cash or cash equivalent, marketable securities and accounts receivable and divide these with current liabilities you get a number that shows you whether you can cover you current liabilities… when the ratio is 1 or better it is considered to be a feasible ratio. Less than 1, you have more debt that you can currently cover.

This makes sense to me as it is revenue that the company (excluding customer churn) will recognize throughout the lifetime of the contract whereby the liability /deferred revenue gets smaller by being moved to income statement whenever the revenue is recognized. Obviously in high growth cases, the SaaS company deferred revenue should only grow as new contracts are signed. This suggestion is specifically important for companies looking for venture funding to avoid financial covenants. Getting paid from customer in advance is a good thing and should not be seen as liability. Let’s review how this law impacts the Business Model Canvas.

 Summary of our findings in respect to Business Model Canvas

This law has a direct impact on both Cost Structure (CS) and Revenue Streams (RS) as the law has to do with money and how it is recognized. When you review the Business Model Canvas, the two building blocks are side by side to remind us that the costs of running and serving the client needs to be aligned with the revenues that are generated from the end user client. The only big thing in my mind, and slightly surprising, is the need to recognize the revenue from professional services for the entire lifetime (or 5-6 years) of the contract. In the old software licensing world, this type of thinking would be out of question and the invoice for the entire install is expected to be paid and recognized at the very latest when the work has been performed. Not so in the SaaS model.  Some SaaS vendors have made their contracts shorter to be able to get around this issue, but if the entire lifetime of the client is taken as foundation, it really does not matter if the contract is split in my mind.

I wonder how many starting ISVs recognize this and know this rule. Phil Wainewright discusses of this issue in his blog entry  “Auditors backtrack on SaaS revenue recognition” by giving the example of Taleo’s restatement of financials that made auditors nervous in the SaaS field. The Taleo case was widely reported by Reuter as well as other news sources such as Barron.

There is a set of blog entries by Jeffrey Werner of questions that were posted after a web-cast concerning revenue recognition. These five blog entries and topics were as follows:

Blog 1 – Upfront Fees

Blog 2 – Estimated Selling Price

Blog 3 – Monthly User Fees

Blog 4 – Stand-Alone Value for Delivered and Undelivered Items – Part 1

Blog 5 – Stand-Alone Value – Delivered and Undelivered Items  -Part 2

These five blog entries demonstrate extremely well that the area of revenue recognition is not easy and there are lots of possibilities to different interpretation on this issue. Also, based on the information in the blogs, one of the key things that seem to be important is whether the item that has a price tag is needed as part of the SaaS solution delivery. If so, it is considered as part of the revenue recognition rules set for SaaS delivery. If not, then one can always argue that it is a separate item that can be recognized at delivery.  This has also been the case in traditional software delivery. Auditors have always wanted to know if something that was delivered was needed for the software to function properly and in these cases it was about tax laws (could be even state specific in the US) that kicked in some scenarios. What I have learned from the past is to talk to auditors to make sure that you do everything according to the book.

The purpose of this blog entry is to demonstrate that there is still lots of room for best practices and only time will tell how auditors and practitioners will interpret the accounting rules/revenue recognition of different types of revenue in a SaaS delivery.

I am now in the eight law in Bessemer’s Top 10 Computing Laws with an emphasis how to be able to monetize and utilize the data asset that the SaaS vendor is accumulating by users that are generating a wealth of information and all of this information is accessible for the SaaS vendor if the contractual agreement allows the use of this data. 

When reading about this law my memories from my youth crept to my mind when studying in the Swedish School of Economics in Helsinki (Hanken) where each student in the accounting/management accounting class had to analyze public financial statements from Finnish companies as part of the advanced classes. This analysis was then used to compare different companies in the same vertical and to create some base-line standards for analyzing and comparing companies. This analysis gave me a perspective on accounting and how it really works. This learning has helped me throughout my life and especially now as an entrepreneur. The power of cash-flow statements can’t be underestimated which has been a reality for many software vendors the last couple of years.

However, during that time (1984-1989), the data was stored in Lotus Symphony spreadsheets, so most of the analysis and data entry was manual and very labor intensive. Companies at that time were still using green screen terminals and only a few companies started deploying personal desktops, but laptops were still not on the market as far as I remember. The first real PC with MS-DOS that I used was Italian Olivetti with two floppy stations. I can’t believe how far we have come since then.

This law (#8) is a reminder to me of the changes in business models and how cloud can provide new business model opportunities for organizations. Ten years ago, the notion of “data asset use” was very rare and if you had the possibility to accrue information from companies in the same vertical, you had a tremendous asset in your hands. I know a company owner in the US that sold his company for a few millions by having collected financial data for financial institutions over time and then sold the assets to a larger company as part of an exit. Let’s view how this law impacts software businesses and business model canvas overall.

Law #8: Leverage and monetize the data asset

Imagine having access to a massive amount of data that your clients are generating in your cloud application. Image to have access to performance metrics for a given vertical market segment such as banks at large and their performance. Wouldn’t it be valuable for somebody to be able to compare banks with each other from different perspectives and maybe even sell this data to external parties? Imagine being able to service this through Microsoft Dallas service that enables developers and information workers to easily discover, purchase, and manage premium data subscriptions in the Windows Azure platform.  Maybe this collective information serves as benchmark information for other companies in the same vertical and enables these companies to compare how well the perform in their respective business?  The Bessemer blog entry gives examples of this kind of benchmarking by referencing the leading expense management software company Concur where companies in the same peer group can compare for example expense costs such as travel with other companies.

Another successful example is the company Mint.com that used to compete with Intuit Quicken by providing a free SaaS solution for consumers to track expenses automatically. The Mint story is very interesting; it was started by Aaron Patzer, Matt Snider and Poornima Vijayashanker in Mr. Patzer’s apartment. Two years later the company was acquired by Intuit for $170 million. The story is simple and amazing at the same time. The founders felt that it was too difficult to track personal finances online and that people had to spend far too much time in setups and entering data. The founders felt that once the Mint.com is linked to the credit card statements and bank accounts, most of the daily stuff should happen automatically. I found out about this service as part of my own research and decided to test it out. It is as easy as Mint.com claims and today I get updates from the system on regular basis. The business model that Mint had initially was to use the consumer data to propose better credit card deals etc. to generate leads for credit card companies etc. It is obvious that Mint.com became a threat to Intuit so they decided to acquire them. Mint.com success has led Intuit to replace Quicken Online product in favor of Mint.com. Let’s analyze how this law can be viewed from Business Model Canvas perspective.

Summary of our findings in respect to Business Model Canvas

This law (#8 of Bessemer’s Top 10 Computing Laws) can be linked to any of the nine Business Model Canvas building blocks. The success of any SaaS company utilizing data assets effectively will be based on:

1. How well the company can define its Value Proposition (VP),
2.  How well the information assets can be linked to a specific Customer Segment (CS)
3. How the company can generate revenue (Revenue Streams-RS) from these information assets.

This law extends the use of information that the SaaS vendor can utilize and gives a business opportunity for the SaaS vendor. This model has not been possible in the past as the data has typically been secured by the end user client organizations and their data centers.  Companies such as Concur, Mint.com and many others have identified the opportunity to sell information/service instead of selling software and I think this will be the key differentiator in many of the future SaaS innovations.  The time of having lots of features and functions in a software package might be over and people appreciate solutions that are easy to use and do not require lots of training to maneuver.

The SaaS vendor needs to have an understanding of the analytics behind the data in selected Customer Segment (CS) and this relates back to the need to have the right Key Resources (KR) and Key Activities (KA) that are well aligned with the SaaS vendor objectives.

I am now in the seventh law in Bessemer’s Top 10 Computing Laws and law is about the change of how SaaS companies needs to view software. In the past, it was all about delivering a package using CD/DVD and the software was installed and the software vendor typically had no idea how it would be eventually deployed and used. Today, in the SaaS world, the SaaS vendor can potentially have access to everything that the user is doing and this type of intelligence is something that we could only dream of in the past.  Let’s view this seventh law and how it relates to the Business Model Canvas.

Law #7: The most important part of Software-as-a-Service isn’t “Software” it’s “Service”! Support, Support, Support!

The biggest mindset change that software vendors have to make is not to think about software, but to treat the SaaS solution as service to clients. In my blog entry of Bessemer’s Law #5 of building employee software, I concluded that the biggest mistake that software developers can do is to ignore the client and fall in love with the solution from either technology perspective of some other perspective that has nothing to do with the client needs or wants. SaaS solutions are built for end users and the success of the solution will be based on the adoption of the solution. The question that each SaaS vendor needs to pose is how to minimize the customer churn and how to really understand how the software is used?   A good sales person can sell anything for a year, but it is another question whether the customer will continue the use of the solution if it does not find the value for that. A good comparison to this is from my own business intelligence domain.

Throughout the years, business intelligence vendors have sold user seats that have never been used and these software vendors have kept billing for the annual maintenance fees even though these seats are never used. In the new SaaS world, nobody can escape this scenario anymore. If a seat is not being used, the company will not renew the seat for following years. This is where the customer churn kicks in.

In the SaaS world, the software vendor can build in usage statistics of the solution and this information will then be used as foundation for really understanding how the solution is used. In the old enterprise software world, software vendors tried to build similar functions, but as most of these solutions are installed and run from client’s own data center, the software vendor do not have access to the usage data. With a SaaS solution, the vendor is able to see all of the usage patterns such as how many times each user logs into the system and even automate report generation of cases where a user has very low usage pattern. This could be a result of having usage issues with the solution, or even worse, not having any use of the solution. This type of user will then turn into churn statistics when it is time to renew the contract.

In my past, I have built business intelligence software solutions and we used to build different types of tracking mechanisms of software use, but as these solutions were run at client sites, we as software vendor did not benefit from this. The client/customer got intelligence of what report/cube was used and what could be demolish due to non-use. In today’s SaaS world, software vendors can use this information also internally to see how each client/consumer uses the solution and whether some part of the solution stack is getting less usage.

Bessemer’s Cloud Computing Law #7 gives advice for SaaS vendors to be very open and transparent when there is a system outage of the system. My company is running everything from the cloud and sometimes there are outages whether you want it or not. Recently, Quickbooks Online has been down multiple times with an outrage from users in forums and it was also widely reported in the news. The emails that we got from Intuit were apologetic, but did not really give options to the ones that use their Quickbooks Online Payroll service. This is what I received in my email:

“If you normally pay your employees via direct deposit, we have extended the direct deposit deadline for today only, Wednesday, 7/14/2010, until 7 p.m. Pacific time. If you are unable to process your direct deposit payroll by 7 p.m. Pacific time on 7/14/2010, you will need to pay your employees with paper checks in order to pay them on or before Friday. Otherwise, you can process a direct deposit payroll when the system becomes available and your employees will be paid two banking days later.”

When you really think about it, many organizations had to scramble to go back to the regular check payment routine, which is both antiquated and cumbersome. According to one user, 17 hours of not having access to QuickBooks Online was just not acceptable and I do understand that if QuickBooks Online is used to service clients. Even in our case, we had to postpone some invoicing the day when QuickBooks Online was down.

Any software vendor working in the SaaS world has to manage the client relationships in a different manner when compared with the traditional world. In the past, a client that was not satisfied did not have that many options to do anything about it as they had already paid for the solution. In the new SaaS subscription-based world, the software vendor could lose a client easily when compared to on-premise solutions. However, if the client is happy with the solution, moving to something else is not that simple as everything lives in the cloud and moving the data from cloud to either on-premise or another cloud is as easy or difficult as with any changes of solution.

Based on a recent Information Management article, SaaS adoption is increasing and end user organizations are less concerned about security, response time, and service availability according to Gartner. Business and computing models have matured and adoption has become more widespread. A recent press release from IDC state that SaaS Revenue is growing five times faster than traditional packaged software through 2014. What is interesting in the press release is that by 2012, nearly 85% of net-new software firms coming to market will be built around SaaS service composition and delivery. Furthermore, according to IDC, SaaS-derived revenue will account for nearly 26% of net new growth in the software market in 2014.

Metrics in the SaaS world are still evolving as we discussed in my blog entry about Cloud Financials. Besides the more traditional cloud metrics, cloud vendors are constructing efficiency metrics for account management where the Bessemer cloud computing law #7 states that the most favorable metric is the margin renewed in the quarter divided by the costs of those renewals. The overall equation of this is as follows: MRR dollars renewed/grown in the quarter x GM x 12 (to annualize the revenue), divided by all account management costs incurred in the quarter for these renewals.

I am pretty sure that the metrics will evolve for the next few years as more SaaS vendors get exposure to the best practices and it becomes “business as usual”. The next question for me to pose is how this law can be seen in the light of Business Model Canvas from Dr. Osterwalder.

 Summary of our findings in respect to Business Model Canvas

In the SaaS world, software vendors should view the software as service with excellent support. The main criterion for success is about usability of the solution that reflects in the customer churn (Customer Relationship-CR). It will also impact of how appealing the solution is for a possible Channel (C) that would like to market the solution.  With this, we obviously take it for granted that the solution has the right kind of Value Proposition (VP) for the given or selected Customer Segment (CS)

The Channel (C) needs to know why it should be interested, how much it will make money and how the solution will benefit anything else that the channel prospect is doing. The churn impacts the Revenue Streams (RS) of the company, as bad SaaS solution leads to high customer churn and this will eventually be a downward spiral for the SaaS vendor as online forums and other viral social media mechanism will destroy the reputation of the vendor.

The reliability of the solution reflects also how the customer sees the vendor ability to provide service, not only short term, but also long-term. During the past 5 years, I have used a few SaaS-based services to only realize later on that all of the data and work put into the cloud has disappeared, either by the vendor going belly up or other reasons such as the company being sold to somebody else.

A good example of a service that I am no longer that much interested is Jigsaw as they are now part of Salesforce.com and I can forget the dream that I had to have an integrated solution for our Microsoft Dynamics CRM that we use internally. I am sure Salesforce.com won’t be supporting any competitive solutions even if Jigsaw is a subsidiary of Salesforce.com.  The list of CRM partners does not do any good for Microsoft Dynamics partners.

One could also argue that this law #7 (Bessemer’s Top 10 Cloud Laws #7) has an impact on Key Resources (KR) and Key Activities (KA). The reason for this argument is that any SaaS company has to have the right kind of DNA to be able to build software in the SaaS world with the attitude that is different from the more traditional enterprise software sales world. Building software into cloud environment is not the same as traditional on-premise as there are factors that has to be taken into consideration such as latency etc. Whatever your ambitions, do not treat SaaS as business as usual if you currently work for an established software vendor. It is not business as usual, there are many factors that have changed and you have to change with it.

I am now in the sixth law in Bessemer’s Top 10 Computing Laws with an emphasis in identifying the prospects that you are going to sell to. The old-fashioned way of selling software is changing in a fundamental way and this also reflects how you view software channels like I described in my previous blog entry and that reflects to Bessemer’s forth law (Law #4) of forgetting what you have learned of software channels. Let’s look at what this fourth law really means for SaaS companies.

Law #6: By definition, your sales prospects are online – Savvy online marketing is a core competence (sometimes the only one) of every successful Cloud business.

The reality in today’s world is that people are searching for products and services using search engines and making their buying decisions based on not only the information in the Internet, but also how other people are rating your product/service. Ten years ago when we were selling software for hundreds of thousands of dollars’ worth, CIOs and decision makers of the buying process did not necessarily go to the Internet and search for your track record of delivery and other key factors that are part of the decision making. I remember vividly that some our clients called organizations such as IDC, Gartner and Forrester to ask about the quality of our product as the digital footprint of a typical software vendor was very minimal.

This trend towards lead generation using search engine optimization (SEO), viral marketing, search engine marketing (SEM), email marketing are things that B2B marketers have been using for a while and traditional software vendors are only now trying to figure out to leverage it. Bessemer refers to organizations such as IBM, SAP, Oracle and their traditional ways of sales and how smaller challengers have a better opportunity to achieve visibility when compared to the large players. There are lots of good books about how the marketing and PR is changing like David MeerMan Scott and his book The New Rules of Marketing and PR: How to Use News Releases, Blogs, Podcasting, Viral Marketing and Online Media to Reach Buyers Directly.

What is changing is also that your web-site is no longer about your great looking graphics, but more about the content and relevancy to your audience. What really matters is what you have to say on your web-site and what type of action the site gives for the prospects that have an interest in your solution. Does your site let the prospect to take action? Based on some studies, even some SaaS companies are failing to lead the prospect to take action or even have something to act upon. This is amazing to me and one wonders if these companies just do not have the DNA of a SaaS company and therefore rather just execute on the traditional enterprise software sales methods. These companies will not survive in the long run and need to get new people onboard that have the right type of mentality.

Even email marketing is in a flux and during the last couple of years, I have seen people getting upset with email blasts that are not relevant to them and this will result in recipients becoming angry at your brand. Some people just do not get it, especially if your email addresses are not based on opt-in policy. This morning I was cleaning my email box from a person that seems to be sending crap to me every second day about topics that I do not care about. What gives him the right to do it? I have never requested him to send me anything and neither have I opted in to any of his web-sites. I hope he reads this blog entry and maybe shifts his thinking about his email marketing strategy.

Is email marketing dead? Probably not, but it is changing as we speak. Email marketing companies such as Exact Target and Constant Contact are acquiring social media solution providers to enhance their solutions with social aspects. Exact Target has acquired CoTweet and Constant Contact acquired NutshellMail. I personally believe that this is not only necessary, but it has to happen as the traditional email marketing needs to evolve to something that benefits the recipient and  gives  readers the ability to opt-in in a way that they want to such as using Twitter “follow” functionality.

Sales in the SaaS world have to do with getting your brand known in the social media space. That is where you are most likely going to be finding your new leads and that is where you need to convince your leads that your company and your solution/brand is something that they need to be paying attention to. Also, due to the change in revenue model in the software world, SaaS companies can no longer afford expensive inside sales teams like I discussed in my blog entry about sales learning curve and also about the financials in my blog entry of the top 6 financial metrics  in the SaaS world that you have to be paying attention to.

Finally, the new way of marketing and creating awareness for your company gives you a tremendous opportunity even if you are a small player. Large companies just aren’t there yet with their social media strategies and if you are small and nimble, you can really make it big. Your SaaS sales have to be high from get-go, you have to generate leads and the old marketing methods are just too slow, so you might want to adjust to the new world of using social media.

Summary of our findings in respect to Business Model Canvas

Like in my previous blog entries in the Bessemer’s Top 10 Cloud Computing Laws, my objective is to relate this current law to Dr. Osterwalder’s Business Model Canvas.

When reviewing the nine (9) building blocks in the Business Model Canvas, the most obvious impact that the new sales models in the SaaS world has to do with Key Resources (KR), Key Activities (KA), Cost Structure (CS) and Revenue Streams (RS) but also indirectly on Channels (C) and Customer Relationships (CR). Let me explain my logic behind this.

First of all, the company has to look at their own core competences and if the Key Activities (KA) and Key Resources (KR) do not reflect the new world of SaaS and DNA of SaaS (like I stated in my blog entry), the company will not be able to drive leads using the Internet as a vehicle. You can’t externalize social media to outsiders as each individual in the company have to be carrying the message in the cyberspace of the product. The old-fashioned way of “giving the authority to somebody else” is gone and these types of individuals will sooner or later realize that they are out-of-sync from the rest of the world. This might sound very radical, but it is already happening, you might want to look around that see if for yourself.

With the renewed approach to market using social media, it will have an immediate impact on Cost Structure (CS) as some of the more expensive traditional marketing methods such as having a booth at a conference, press, TV and other outbound activities are less appealing and effective for companies and inbound marketing is getting more relevant. It is not to say that SaaS marketing is free as can be seen in the financial results of companies such as Salesforce.com.

With effective sales and marketing online, the company will see an impact on Revenue Streams (RS) as expected, but the point is more about whether the company has really understood that SaaS sales has different impact on the annual financial results than in former world; a deal closed in February looks radically different from earnings perspective than a deal closed on November for the specific financial year. This is something that is hard to understand if you have only been in traditional software business.

When you are successful in driving leads, this will have an impact on your Channels (C) as well as they might expect you to be part of providing leads for them (if it supports your sales model). The Channel (C) will be different in the SaaS world and most probably you will be looking at organizations that provide domain-specific skills to the solution and these types of organizations might not have an interest in the recurring revenue that the solution generates, but more in providing consulting services.

Finally, the Customer Relationship (CR) is the key to your success and if your target segment is known not to be online users, then you have to take this into consideration as well.  However, I would argue that the new generation of users is also changing this landscape where you can’t really ignore any vertical/market from your online sales initiatives. It is just a matter of time when it will happen and you will have to be prepared to cater your Customer Relationship (CR) the way they expect you to do.

I am now in the fifth law in Bessemer’s Top 10 Computing Laws and this has to with  how the SaaS company DNA needs to look at its employees as users of the solution and not just as “developers” developing for somebody else. I have so far addressed in my blog entry that a SaaS vendor needs to really live the life of a SaaS company, be part of the SaaS DNA, I have looked into the financials of a SaaS company, and sales operations/sales curve for a SaaS vendor and how SaaS and software channels work in SaaS ecosystems.

Law #5: Build Employee Software.

Many of us have been in the software world for a long time, and many of us still remember vividly the times when we built solutions to end users that we felt that “just did not get it”. If you have been around a while, there is no reason for you to not admit that. Some of our clients have been the victims of complexity, horrendous user interfaces and clunky functionality but we still thought the solution was technically the best in the world; it was the users that did not get it.  Let’s think about this for a while. Would you accept clunky software today? Would you spend your valuable time trying to figure out what the SaaS solution that you are trying to utilize was all about? No, I don’t think so. Consumers and businesses have so many options today that it is not worth while spending time on solutions that are obviously not going to cut it.

Let me give you an example of a solution that has really made my life a joy when it comes to my research and book-keeping of my books, both eBooks for my Kindle and physical books that I own. I used to have a desktops solution Collectorz for Books where I cataloged by books whenever I bought them. I loved the solution, but every time I had to change laptop/desktop, it was a pain to move files and keep things updated. Also, I was not able to access my book catalog from other places than this one specific laptop and this would not cut for me in the long run.

Then, by chance, I run to a new SaaS solution recommended by my friend in Chicago and she said she had started using it and loved it. It was Librarything.com and I decided to jump onboard by first trying the Freemium version for 200 books, but as I have thousands, after a trial period, I jumped into lifetime version which is $25. Today, you can find my profile DrSalonen and all of the books that I have bought/listed in the SaaS application. It is not just the application; it is also about social networking with the Librarything.com application. I can see how many other people own the book, I can join different interest groups and I can become friends with likeminded people that read and enjoy similar books. This is an example of an application that is really nice to use and you get passionate of it.

How does this relate back to the Bessemer Cloud Law #5? It is about emphasizing that SaaS employees have to really eat their own dog food, and to make sure that they would be using the solution every day with passion and dedication as otherwise the solution will never be deployed in large scale. Also, SaaS vendors need to create the buying process as easy as possible, by using a credit card as this is the only way to get masses of users testing out your solution. If you wait for the IT department to push for your solution, you might have to wait for a long time. It is the users that rule the world in today’s SaaS world, we have seen it, been part of it, and this trend will become stronger and stronger each day. According to Bessemer, some SaaS companies have had success in selling administrative dashboards for CIOs in companies as many of them have not been able to control the use of SaaS solutions due to low monthly costs and the ability to use a credit card to pay.

Summary of our findings in respect to Business Model Canvas

Like in my previous blog entries, the objective of this series of Bessemer Laws was to relate the Laws to the Business Model Canvas from Dr. Alexander Osterwalder et al. This Bessemer #5 Law has to do with many Business Model Canvas building blocks. The reason I am saying this is that it starts from the Value Proposition (VA) and the usability of the solution to Revenue Streams (RS) as if the solution is not acceptable, customer will not renew the contract after a year of use and it will impact the Customer Relationship (CR) as the bad experiences of the solution will sour the relationship with the SaaS vendor itself.

Based on my personal experiences running a software company, the key to success is hardly ever technology, but the people that you work with. The developers that are talented will create solutions that are compelling and usable. The very famous statement that one good developer can replace 10 bad ones is according to my experiences pretty much what I have experienced. You do not need to have a huge team to create something that is compelling. If this is the case, the most important in the Business Model Canvas is the Key Resources building block that includes your best people and talent that will not only create your solution, but will also sell and market it to customers.

As you can see, it is very difficult to pinpoint any specific building block in the Business Model Canvas as they all relate to each other and this is also the point in business modeling/planning. You iterate continuously until you find a good balance between the building blocks and eventually you might find a balance. What is also important to realize that each change might cause a new “instance” of the business model, as a change in Customer Segment (CS) could create a new Revenue Stream (RS), new Channel (C) etc. I am sure you get the point and just envision multiple layers of business models on top of each other.

I have now concluded five of Bessemer’s Top 10 Cloud Laws and 5 more to go. Stay tuned for more!

I am now in the fourth law in Bessemer’s Top 10 Computing Laws and this has to do with software channels. I have so far addressed in my blog entry that a SaaS vendor needs to really live the life of a SaaS company, be part of the SaaS DNA, I have looked into the financials of a SaaS company and sales operations/sales curve for a SaaS vendor.

In this blog entry, I will be focusing on software channels which in the traditional world have enabled software companies to get scalability to address new markets, new verticals and new geographies.  As with everything that I write about, I want to put context into it and the reference framework from which I am looking at this. First of all, I have run software companies with both direct and indirect (channel) sales. I have built software channels in Europe, US and Latin Americas. I have sold personally large enterprise solutions to end users around the world.

Let’s get to the statements from Bessemer and their view on Software Channels and their applicability in the SaaS world.

Law #4: Forget everything you learned about software channels.

Bessemer views the software channels very black-and-white and I do understand why they are taking that perspective. All of the years that you have built your relationships to major integrators such as IBM, Oracle, HP, Accenture and similar organizations, will not be of use for your SaaS business as the bottom-line is that there is a chunk of revenue that is missing from the SaaS business model when compared with the traditional software business model where the solution is installed either onsite at the client location or in an environment where a third-party organization such as Unisys takes over the IT infrastructure and management of the solution itself.

If we look at the SaaS business from System Integrators perspective (SI) and Independent Software Vendor (ISV) perspective, you have two different worlds. The system integrator lives and dies with the work that they get by customizing solutions for end user clients, tweaking and working with the infrastructure to optimize the performance and all of this is going to be more limited in the SaaS environment. Why is this the case? First of all, the SaaS solution will in most of the cases live in a public PaaS (or IaaS) platform and the SaaS vendor is not letting a system integrator to customize things as they wish, customization will have to be implemented via published application-programming interfaces (APIs) that gives them some flexibility, but not to the extent that traditional enterprise software vendor applications have given them in the past.

The other issue that these system integrators will have is about the customer relationship with the questions about ownership of the customer. Is the ownership of the client run by the ISV, the PaaS platform vendor (such as Windows Azure etc.) or is it the system integrator. What kind of view will the customer have on this? Will they see the ISV as the savior of their issues, or will it be the SI? How about a situation when the ISV files bankruptcy? In the early days, some of the large end-user organizations I sold to wanted to have the source code in escrow. How would you do that in a SaaS vendor scenario? What would the enterprise really be able to do if the software vendor would fold up?

Let’s look at this situation from an ISV (SaaS vendor) perspective. First of all, the ISV needs to become a credible player for people to trust their data into their SaaS solution. Secondly, the SaaS vendor is expected to be able to have direct sales to show success and understanding of the solution. Ten years ago, I got a lesson of this in the US. One successful channel partner told me when I became CEO for the software company to demonstrate our success in selling directly and when I had enough cases, he would then consider representing our solution. The message was very clear from him: show me that your value proposition works and I will be happy to see if I can make some money as well. 

If you think about this type of scenario from a channel perspective that I mentioned above, how would I get this person/company to be interested in selling the SaaS solution? First of all, this person/company expects to get a 30% cut of the revenue as he is a traditional VAR reseller that makes money in selling value-added solutions to his channel. Secondly, he is the one that owns the client relationships that he has been building for years, nurturing them and feeding them with the latest of the greatest. How would that work in the SaaS scenario? Do you think that these types of resellers will be interested in growing a monthly recurring revenue channel for themselves? From a financial perspective, it could be painful as these resellers have a fixed OPEX to manage, telesales people to pay for and office rent to pay for. How would they be able to turn a $30k software licenses commission to a 30% cut on the Committed Monthly Recurring Revenue (CMRR)? That remains to be seen. I am pretty sure there needs to be some extensive financial modeling that has to happen for these VARs.

In the traditional software channel model, you can have many different types of relationships, everything from being a distributor to reseller or even having a practice around the product/solution. The common denominator for all of these relationships is that the customer relationship ownership is by the partner, not the manufacturer of the equipment or the software vendor. In a SaaS setting, this will not be the case anymore as these regular/typical resellers do not have any control of the relationship as the customer will typically get the same level of service directly from the SaaS vendor. I am sure that some of the readers of this blog entry disagree with me on this, but think about it. How much value does an average reseller provide for the delivery of a solution, delivery that will not have any physical elements to it? I am not including the resellers that have built a business practice around the solution and charging for the customization/training of the solution use.

So, what type of resellers/partnerships should a SaaS provider look for? Based on my research, and my discussions with lots of different vendors, SaaS companies should look for what Bessemer calls for “Business Service Channels” that could be accounting companies providing an add-on service for their clients and what is interesting to note here is that these service providers are not that interested in making money in the possible monthly recurring revenue, but more on the services that they can build around it. The Bessemer gives an example of ADP payroll provider, some marketing agencies and accounting firms.  This is an example of emerging, new generation of smaller cloud-based system integrator (SI) companies such as Appirio that provide a solution for integrating systems in a cloud environment. 

Phil Wainewright provides his view on where the channel is going in his blog entry. He sees opportunities for what he calls for “intermediaries”, organizations that take a platform (PaaS, like Window Azure) and add features or extensions to it. These types of applications are then sold on each of the PaaS vendors commercial site where the PaaS vendor gets the benefit of having more people subscribing to the software platform (PaaS) itself. Wainewright gives examples of NetSuite and Force.com combination (SuiteCloud Connect) that enables organizations to build vertical solutions, business processes on the platform itself. Lincoln Murphy gives similar examples in his blog entry Change the (SaaS) Channel Please, it’s a Rerun.

Summary of SaaS world and Business Model Canvas

Based on the experience from many SaaS organizations, a traditional software channel does not necessarily work. That is something that might be hard for many to accept, but that is the reality that software entrepreneurs, venture capitalists etc. are seeing on the marketplace.

Your channel development efforts have to be directed to new types of interest groups that can benefit of your service when providing their own service for clients. Do not expect this type of Channel (C) care about the monies that your solution could bring to them, the SaaS vendor should just care how the Value Proposition (VA) benefits the end user organization.  The Business Model Canvas will be impacted in multiple ways in respect to Channels (C).

First of all, the SaaS vendor has to have a good Customer Relationship (CR) to the end user client or have an effective sales engine that provides leads to be fed to the possible Channel (C). Secondly, the Channel (C) discussion will typically be based on the Customer Segmentation (CS) strategy as I put in my previous blog entries, one of the biggest mistakes a software vendor can do is to try to address the whole world. It will not happen unless you have endless pockets of money to spend and not even Microsoft’s of this world can always do that. As entrepreneurs, we want to believe that we are going to change the world; some do like we have seen in many cases with Skype, etc.

This is now the third blog entry of Bessemer’s Cloud Computing Laws and in this I will be focused on sales and sales learning curve as Bessemer puts it in their blog entry. I have had the opportunity to personally sell software around the world for the past 20+ years, hire sales people (and yes, sometimes fire) and also dealt with a myriad of different issues that has to do with sales. However, in this blog post, I will be focusing on SaaS sales and issues related to it.

Law #3: Study the Sales Learning Curve and Only Invest behind Success.

Software companies live and die based on the success of the sales. I learned very early in my career that technology by itself does not make the company fly, even if I as head of development at the time thought would be the case. Sales people did not have to know anything, they were just sales people. Little did I know, until I was put in the driver’s seat in sales, and it wasn’t in my native country, but here in the United States of America? 

I did not have a rolodex, but I was appointed as CEO for a US-subsidiary of an European software company. That is when I was put into huge test and my view on sales and sales people has never been the same. I love the way good sales people run their business and I admire how they close the sales. It is not easy to hire good sales people, and it is even less easy to make them go when you have lost confidence.  I got some advice from native US entrepreneurs how to look at sales people and their performance and I also learned how to build a compensation model that would make it beneficial for both the sales person as well as the company. Well, that is history now; let’s look at what we can learn from sales in the SaaS world.

We learned from my previous blog entry about Besssemer’s 6C’s Financial Laws that Committed Monthly Revenue (CMRR) is what drives the company. The question that you have to ask yourself is what type of recurring revenue can we expect from sales people in the SaaS world. In the more traditional enterprise software world, the measure that I used was that a sales person would have to sell for at least a million dollars to be called a real sales rep. Some did less, some more, but that was roughly the measurement. The sales quota has not changed since those days and the blog entry from Bessemer suggests that within the enterprise sales business model, the CMRR number should be around $80.000-$100.000 which is around $1-1.2 M in annualized revenue.

According to the Bessemer, telesales numbers can be lower, from $60,000 to $70,000 MRR ($720,000-900,000 annualized). Furthermore, Bessemer suggests that until at least 2 of 3 sales people hit these quotas, the SaaS company has hit some type of repeatable business model and are close to hitting $300,000 in CMRR. Also, the blog warns of scaling too quickly with new hires as the new ones might bog down the more senior ones and take down the sales numbers for the whole team. It is a chicken and egg and this is nothing new from the past. When you have a good sales rep, you have a temptation to give this person a promotion to be sales manager to manage the sales team. Sometimes this is the road for failure. I have seen it so many times. I have even seen sales tank completely by hiring incompetent leadership and get the sales team to quit. This is a certain path to destruction.

Bessemer also separate “hunters” from “farmers” and I will get to this topic in later blog entries, but the idea is that the company has a separate set of sales people for new sales from the account management roles with the objective to renew the contract year after year. The CMRR includes churn every year, so the net impact of your new sales will be impacted by existing clients that do not want to renew. This is why some SaaS companies have dedicated sales team that focuses solely on customer service, renewals and up-sells. Also, this of course drives the behavior of the sales people depending on what their focus and sales drivers are. The new account team should be paid on new CMRR with a standard deal structure and incentives if the customer pays with more favorable payment terms.

The final element of Bessemer’s advice is the internationalization of the solution that is a key element for making it big for the SaaS vendor. How big should the company be when entering international markets? The blog entry from Bessemer gives a US-based perspective with the framework of US business. The claim, which I believe is true, that US is much advanced as a market for SaaS solutions and the company can grow tremendously just in the US home market. Bessemer gives some idea of when to break it from the US market and it is when it hits $1M CMRR ($12M Annual Contract Value) which in European terms is a pretty sizable company already. I know much smaller companies that have been able to create international presence, but I am sure that Bessemer looks at this from an investor/venture capital perspective. If you asked entrepreneurs about this, the numbers would be very different.

Bessemer advices US-based SaaS companies to view European markets as a pre-IPO market and growth strategy and Asia as the company has IPO’d. I do disagree with this view or perspective, specifically now with software vendor having access to PaaS, IaaS platforms covering the entire world and having data centers in all major regions (EMEA, Asia, US, Latin Americas). I want to emphasize that Bessemer’s perspective and view is from a venture capital perspective and I am sure that when you want to make it big and have your investment come back sooner rather than later, their approach seems feasible.

When you are an entrepreneur, living with your own pace and agenda, the approach can be different as have been seen in many cases. You do not have to have huge CMRR to get international access and with current social media methods and viral marketing, you can build a growth story that creates users around the world. Bessemer has a good point in their blog entry about cultural and language related issues when deploying multi-language version of a SaaS solution. Large organizations are known to have issues with this, so smaller ISVs will run into same issues regardless from where you are.

So how can SaaS sales be viewed from Business Model Canvas perspective? In my previous blog entry about the financial models and the 6C’s, the CMRR impacts directly the Revenue Streams (RS), but I would be tempted to say that this Law impacts Customer Relationship (CR), Channel (C) and Key Resource (KR). The reasoning behind this is as follows:

1. The SaaS company’s success is dependent on its ability to understand the DNA of SaaS business and the Key Resources will be the sales people that get this and are able to deliver the Value Proposition (VA) that the solution is claimed to have.
2. The sales people are also key to the Customer Relationship (CR) at least initially until separate “Farmers” are hired to maintain the customer relationships. Regardless of this, a SaaS company will live or die with the customer relationship as there is a direct connection between CMRR, satisfaction of the use of the solution and the renewal rate (or churn).
3. SaaS and Channels (C) is a concept that is causing the traditional VAR (value-added reseller) to wonder how they will play in the whole SaaS field. The margins for the SaaS are not what is expected in enterprise license sales and this will cause many VARs to reconsider their future.
4. Satisfied customer impacts directly Revenue Streams (RS), unhappy customers impact both Revenue Streams (RS) and Cost Structure (CS) and CAC.

 The combination of effective sales, effective product development with leadership team that understands the SaaS DNA is a key for success. One has to remember that venture capitalists are also expected to understand the SaaS business model, and if they don’t, I would not want to be the CEO of that SaaS company.

In my previous post, I introduced Bessemer’s first Law and now I am moving on to introduce the second law that focuses on the financial side of a SaaS vendor. The ISVs that have software products running it with a more traditional licensing model will have to adjust their operations to the new financial realities of the SaaS world and learn to monitor the right metrics in respect to SaaS business model.

The Bessemer’s second Law #2 will address the most common SaaS metrics that are used based on the experiences that they have had with hundreds of SaaS companies and also having invested in SaaS companies. The second law calls these SaaS metrics for 6C’s, but I want to emphasize that there are a bunch of others that can also be added to drive the overall financial condition of the company.

Law #2: Get Instrument Rated, and trust the 6C’s of Cloud Finance

Bessemer’s Cloud Laws focus on six financial metrics and they are as follows:

1. CMRR – Committed Monthly Recurring Revenue
2. Cash Flow
3. CPipe  – CMRR pipeline
4. Churn
5. CAC Ratio – Customer Acquisition Cost Ratio
6. CLTV – Customer LifeTime Value

Let’s look at this metrics in more detail, starting with CMRR that is the driver of the business revenue.

CMRR – Committed Monthly Recurring Revenue

The way Bessemer defines the difference between MRR (Monthly Recurring Revenue) and CMRR (Committed Monthly Recurring Revenue) is that in the latter, you would also include signed contracts but not yet moved to productions on top of the ones that are already in production. If you think about it, that really makes more sense and gives a fuller picture of the financial situation for the company. 

The way the recurring revenue is calculated is by using the Rule of 78’s which is very well known concept from the Telecom world as described well in the BusinessToolsBlog.com blog entry. It is simple math and the formula is as follows:

Full Year Revenue = (Current Run rate) + (Average Monthly Net Installs) * 78

The rule itself is simple, but I have to admit that it is not that obvious with the first look. What it means and the way you have to think about this is as follows assuming that you get a new client each month that pays you $1 in recurring revenue:

• When you get $1 of recurring revenue on January 1^st, you will receive $1 revenue for every month of this contract
• When you get $1 of recurring revenue on February 1^st, you will receive revenue for 11 months of that year
• Etc.

I am sure you get my point here. When you calculate the payments months together, you will have following type of scenario:

 It is easy for you to see that the more you get net revenue to flow in (new contracts) earlier the year, the better you will be off. This is not the case with traditional software license deals. You aim to get a good chunk of cash any time of the year, and things even out itself with time. I still remember vividly the end-of-quarter discussions we had with prospects and the explanations I had to do with my board of directors if something slipped to the next quarter.

From a sales incentive perspective, it did not make a huge difference to me one way or the other, but in the recurring revenue model, the difference of getting a deal in January or June is huge, it is the months of recurring revenue that you will be missing. You can play with the numbers using a spreadsheet, but I am sure you get the point very quickly.

Cash Flow

Cash is king as they say and cash is crucial for any SaaS vendor as clients will pay month-by-month (or other agreed terms) and this will not be enough to support the ISV at least in the beginning stages. Some SaaS executives can increase the incoming cash flow by giving discounts for pre-payments and other things that is available for them. This again, can be simulated by a spreadsheet and we use Invest for Excel to do this job.

CPipe – CMRR pipeline

CMRR and Cash Flow are critical to any SaaS company, but so is the pipeline visibility that a company has of upcoming prospective deals. We believe that traditional software sales model has changed for good and organizations need to be watching the cost of sales as the profit margin can be eaten up very quickly by inside sales teams that do not generate enough leads/prospects to the pipeline. In the past, we could always convince ourselves to keep sales people onboard even if they did not immediately generate results, but in a SaaS setting , this scenario is not that easy. Every month without enough in the pipeline will quickly impact your overall profitability as you will know that every month you are losing money due to the recurring revenue impact. A monthly payment in June is not the same thing as starting to get payments in January! What you have to expect from the pipeline review is full transparency and the CPipe should be a good leading indicator for upcoming CMRR, Cash flow can CAC.

Churn

Churn can kill a SaaS company if not the executives are paying attention to this metric. I have always said that a good sales person can sell anything, but if the product does not meet the standards and requirements of the clients/customer market segment, it does not matter how good the sales man is. Churn also has an immediate impact on the SaaS vendor as a lost client is a client gone forever. With the traditional software license model, clients might still keep the maintenance running even if they do not use the software as the rule of thumb in the enterprise has been that if you drop annual maintenance, you will have to re-purchase the software package.  Based on research and data on good SaaS companies, renewal rate of more than 90% is something that a SaaS company should be able to live with and you really can’t avoid situations such as bankruptcies and acquisitions that create a situation where the client discontinues the use of the solution.

CAC – Customer Acquisition Cost Ratio

Sales will cost and having sales people that do not perform, costs a lot. Having sales people with wrong incentives can be fatal. The question that a SaaS company will have is how much to invest in sales and marketing and how quickly the company should be able to recoup the investment. The “non-official” standard in the market is that the CAC cost should be recouped within a year whereby the following year is to cover the cost of administration, product development etc. If you lose the client in churn during the first year, you will have a negative lifetime value for the client (unless the pricing doesn’t cover multiple years, which is typically hardly the case).

So, how do you calculate the CAC Ratio? It can be calculated by looking at quarterly GAAP P&L and by dividing NEW Annualized Net Gross Margin added during the quarter (gross new CMRR x your average Gross Margin % x 4 quarters) by the sales and marketing costs of the previous quarter excluding any account management costs attributed to the “farming” of the accounts. I will get to this topic of farming vs. new accounts in later blog entries as this has to do with the sales commissions and how sales people are compensated. There is a big difference how sales people behave based on what they are compensated for and what not.

CLTV – Customer LifeTime Value

Based on the Bessemer law, the CLTV is the Net Present Value of the recurring profit streams of a given customer less the acquisition cost. Based on this, a positive CLTV also means that it is profitable business for the SaaS vendor. The Bessemer write-up gives a good example of how this works:

• Let’s assume the customer generates $1 of annual recurring revenue with a CAC ratio of 1.0 (sales and marketing costs are recouped in one year)
• Let’s assume that the company has a 70% Gross Margin and 10% in R&D and 10% in G&A costs (General and Administration).

The result of this calculation is as follows:

•  The $1 of revenue will generate $0.7 of gross margin and $0.5 of profit each year ($0.7 less $0.1 in R&D and $0.1 in G&A costs).
• Over 5 years, the customer will generate $2.5 of profit (5 years x $0.5/year)
•  A CAC ratio of 1.0 means a $0.7 upfront acquisition costs, making the CLTV equal $1.8 ($2.5-$0.7)
• The $1.8 is equivalent to $0.36 of annualized profit ($1.8/5) or 35% profit margin.
• The calculation can be redefined to include some allocation of sales and marketing costs (as part of maintaining current clients) for example with 15% and that would then reduce the CLTV to $1.23 or 25% annualized profit margin

The calculation above gives an overall view how to deal with lifetime values in respect to clients and it is obvious that young companies might not have as good estimation of this in respect to churn as well as estimation of real lifetime customer values. Based on Bessemer, it will take 3-4 years for SMB customer to achieve these types of calculations and 5-7 years for enterprise customers.

 Summary and relating this to Business Model Canvas

The SaaS business model is different and the way one needs to think about it different. Many mature ISVs might do the mistake of running its business “as is”, trying to run a SaaS business the way they have run in the past with enterprise software. The result of this is eventually failure as you just can’t think the same way in SaaS business as you do in enterprise sales.

Some mature ISVs might never achieve full understanding what it takes to make a transition, even if it was a slow one. It will take a specific DNA to be implanted to the company, a DNA that will treat the business in a different way, with different attitude and with different approach.  I think it is specifically hard for sales people that have been accustomed to large pay-checks and now they have to deal with uncertainty of future years and how the client will or will not renew the contract. I will discuss about this in a future blog entry.

Try on a spreadsheet and you will see how it works. Also, once you look at the model you will see that the earlier you sign a client, the better you will be off in respect to the Rule of 78. It is hard to comprehend it without really playing around with the numbers and I did it with Invest for Excel that also gives me an ideal model to simulate cash-flows, different payment terms and the impact of them in working capital and many other similar things. Churn is a key metric as well and the good SaaS companies will have above 90% annual renewals of existing clients.

Where does this fit in the Business Model Canvas and how does the financial consideration impact the overall business for a SaaS vendor?

It is the Revenue Streams (RS) and Cost Structure (CS) elements from a financial perspective, but it has a direct impact on Customer Segment (CS), Customer Relationship (CR), Channels (C) as well as Value Proposition (VP). Let me explain why the financial models might have an impact on all of the Business Model Canvas building blocks.

Let’s start with the Value Proposition (VP). The first year when the SaaS company gets the client hooked in the solution, there is not much the customer can do during the year. It is at the renewal time when the SaaS vendor will know whether the solution has met the requirements and satisfied the needs. If not, the customer will turn into the “churn” category. The Value Proposition (VP) is also directly linked to the Customer Segment (CS), whereby it is assumed that the SaaS vendor understands what market they are serving and what the requirements are in that market. If not, it is easy to see the customer walk away from the solution. Being a software solution vendor servicing “everybody” is not going to work in today’s world without a large sum of money. Trying to be everything to everybody is hardly ever a good strategy. That is regardless whether you are a SaaS vendor or traditional enterprise software vendor.

The Cost Structure (CS) is going to be mostly impacted of the investment that the company is doing in both sales and marketing, but also in other things such as R&D and G&A. We stated some economic ratios that the SaaS vendor should monitor, and these numbers are based on experience and best practices from tens if not hundreds of other SaaS companies. The Revenue Streams (RS) is tied to the Value Proposition (VP) and to the market overall, even if there are some that claim that one should not copy competitors pricing or models. That might be the scenario in the perfect world, but having been in the frontline for 20+ years, it might be difficult to execute in practice.

We have not touched financial numbers from a channel perspective, but one of the Bessemer’s laws is to ignore the traditional channel. I will discuss about the channel, the importance of providing a solution that others can build on in later blog entries.

Needless to say, the financial numbers, the Bessemer 6C’s are all tied into each and every Business Model Canvas building block, so the SaaS vendor has to identify a good and balanced business model that it can live with, both as a start-up as also an established vendor.

If you have been active in the SaaS world, you have most probably heard of Bessemer’s Top 10 Laws of Cloud Computing and SaaS. These top 10 laws are defined to help to navigate in the world of SaaS, specifically for the ISVs that want to transition to the SaaS world and the ones that have a dream of starting a SaaS-based company. Let’s drill into the top 10 rules of Bessemer. These “laws” are built on hundreds of conversations with cloud executives around the world and Bessemer Venture Partners is one of the best known investors in cloud companies. The latest, Winter 2010 release of the Top 10 Cloud Computing Laws are:

1. Less is more! Leverage the cloud everywhere you practically can.
2. Get instrument rated, and trust the 6C’s of Cloud Finance.
3. Study the Sales Learning Curve and Only Invest behind Success.
4. Forget everything you learned about software channels. The internet is your new channel and Technology enabled Service providers are among the few partners that actually care if you succeed.
5. Build Employee Software. Employees are now powerful customers, not just their managers.
6. By definition, your sales prospects are online – Savvy online marketing is a core competence of every successful cloud business.
7. The most important part of Software-as-a-Service isn’t “Software”, its “Service”.
8. Leverage and monetize the data asset.
9. Mind the GAAP. Cloud accounting is all about matching revenue and costs to consumption… besides the professional services.
10. Cloudonomics requires that you plan your fuel stops very carefully.

Each of these laws had lots of detail information and logic behind it and I would recommend you to read the whitepaper that describes all of this in greater detail.

What I would like to accomplish is to portray these 10 Laws in respect to the Business Model Canvas (from Dr. Alexander Osterwalder et al.)  that I described in a prior blog entry ISVs are re-learning Business Models from multiple different perspectives using Business Model Canvas. The business model canvas portrays the dimensions in an overall business model. This Business Model Canvas is an excellent tool/framework to analyze any business, including a SaaS or traditional enterprise software business. I will break this analysis into multiple blog entries and will start by analyzing the first law (Bessemer Cloud Computing Law 1 #1: Less is more!)

Law #1: Less is more!

This law suggests that the software company (SaaS vendor) leverages the cloud wherever it can, both internal systems as well as own product offerings. This enables the software vendor to “eat its own dog food” with the experiences that a real customer would have of the solution use. This law also suggests that the vendor focuses on its own core competence and leaves everything else outside to be managed by others. This relates to at least three business model canvas building blocks: Key Resources (KR), Key Activities (KA) and Key Partnerships (KP) but can also have an impact on Cost Structure (C$). Let’s analyze why I am referring to these canvas building blocks.

Key Resources (KR) in the Business Model Canvas is needed to create the solution that is defined in the Value Proposition (VP) and delivered to the Target Customer Segments (CS). These resources can be physical, intellectual, human or financial. Bessemer Law #1 emphasizes to focus on SaaS vendor’s own core competencies and leave the rest to other vendors to deal with.

Key resources (KR) should not be used to install software, but to focus on key delivery using a PaaS (Platform-as-a-Service) or IaaS (Infrastructure-as-a-Service) platform that others will maintain for the SaaS vendor. Software development of today should be to focus on building value over a software product platform where the value is built using the platform and where the developer can assume to have basic functionality built into it as infrastructure services and these services can be consumed using well-defined application programming interfaces (APIs) and standards.

The Bessemer #1 Law suggests building single instance, multi-tenant software solutions with a single version of code in production. Having been in the software business for 20+ years, this objective is truly something that I would highly recommend if possible. The whole idea behind my 2004 doctoral dissertation was to review how Analytical Application Software could be applied in a product platform setting and using software product line engineering with the idea to create an optimized core platform that developers could utilize in derivative software development.

Key Resources also define how well the SaaS company knows its domain, how well investors think that the SaaS company is going to be able to deliver the Value Proposition that has been defined for the company. The areas where the company does not have skills or are competitive should be left to Key Partners (KP) that can take care of providing the service. This could be outsourced product development of non-key software components and this is where a cloud provider such as Microsoft comes to play as well.  The SaaS vendor should evaluate its key competencies in a realistic way and focus on the areas where they know they can survive and leave the rest to Key Partners.

This type of building value-add is part of a SaaS vendor’s  Key Activities (KA)  and infrastructure development such as building scalable data centers is left for companies like Microsoft that is investing billions in huge data centers around the world and taking the pain off ISVs and software development organizations of having to worry about hardware, scalability and Service Level Agreements (SLA). An example of this is Microsoft Windows Azure  that represents an operating system in the cloud and provides a foundation for ISVs to build value-added solutions.  With this model, the SaaS vendor will save money in infrastructure costs and therefore it has a direct impact on Cost Structure (CS).

The Bessemer’s top 10 cloud computing laws can be viewed through the lenses of Business Model Canvas as was described in this blog entry.  I will continue on this series until all Bessemer’s top 10 cloud computing laws is covered using the Business Model Canvas.

Pricing of any software solution is a pain. During my 20+ year software career and tens of different market entries with both our own products as well as our clients, I have to say that pricing is one of the most difficult decisions to make. I will never forget the “friendly advice” I got from the largest enterprise company in a specific vertical (the CIO told me) that I almost lost a sales case in the US market as I was too cheap and therefore the perceived value and competitiveness was seen as weak. This was 10years ago when I was running a business intelligence software company. I learned from this case how to price for large multi-billion dollar enterprises and how the CIO’s budgeted the acquisition of software. I came from the technology side, so I had to learn how to price our solutions specifically in the US marketplace.

So, what should you be basing your pricing on? Some say that it should not be based on what competitors ask, but rather on what the perceived value is for the client. However, what if you sales does not know how to articulate the value proposition? What if you lose the deal to a competitor as you were too costly? What if you lose as you are too cheap? How should you deal with international pricing? Fortunately, there are quite a few companies that have already tried and tested many different models and there is quite a lot of good data available of these. What SaaS companies and companies that have a desire to enter the SaaS space, need to study and learn of other companies past mistakes. That is always the best way to avoid costly mistakes. Unfortunately, we humans are lazy when it comes to learning and I guess some will always have to go through that hard learning curve. Let’s learn from an interesting blog entry that includes some findings of 103 different SaaS companies.

I read an interesting article from Bernard Lunn, a serial entrepreneur and former COO for ReadWriteWeb. He made a study of 103 SaaS vendors and how they handled pricing. The sample that he had consisted of three types of companies: VC funded (62%), bootstrapped (16%) and publicly traded (22%). The findings that Mr. Lunn was able to identify were fascinating: 30% of the companies had web-sites that were actionable where the sales could be contacted. He did not count the 800 number or other switchboard number that was found on the web-site. Mr. Lunn concluded that the reason for this could be twofold:

• The company is selling with a price so low that it is not economical to have inside sales doing it.
• The company is thinking too much in the old-fashioned enterprise sales way….. Fill the form and we will get back to you…
• The company just does not have the money to build the inside sales force

The study continues to conclude that only 24% show the price online, in a transparent manner like should be done in respect to SaaS solutions. Mr. Lunn mentions Zoho, 37Signals, Constant Contact (we use them), Xero and Timebridge as leaders in the transparency.

Only 6% had a Freemium plan and this is something that I stated in my prior blog entry that it could be a fallacy for a SaaS vendor and that a vendor could even attract wrong types of customers using the solution. Mr. Lunn provides two explanations to why organizations are not using Freemium models: they might have read the work (The Reality of freemium in SaaS) from Lincoln Murphy or the vendors are just too much “locked into” the enterprise sales model of SaaS.

The final conclusion that Mr. Lund provides is data about the CAC Ratio (customer acquisition cost). Based on my research and discussions with companies, this is one of the key metrics that a SaaS company needs to monitor and I am planning to do another blog entry about SaaS key metrics going forward. Mr. Lunn refers to the definition of Bruce Cleveland that he interviewed (Cleveland is a former Siebel executive) and the way he sees CAC Ratio is as follows:

CAC RATIO = ($Total Sales + $ Total Marketing)/$ First Year Contract Value

If this value is less than 1, it means that the customer acquisition cost is paid in less than a year. However, this is obviously something each company has to evaluate themselves and also take into account churn (how many clients disconnect the use of the solution) that has been a key ratio for a long time specifically for telecom companies as Mr. Ulf Avrin emphasized to me today. In any investment calculations, the timeframe under which a company expects to be paid back is dependent on multiple factors such as required return on investment, cost of capital and many other factors. This is where Invest for Excel comes to play that enables organizations to simulate different types of scenarios of pricing, sales forecasts and other key factors that are part of an effective business model for a SaaS vendor.