For those interested in getting a good overview of perpetual vs. SaaS business model I highly recommend Dave Kellog's post on the topic. He discusses both the operational and valuation impacts and walks through an example of a hypothetical startup under both models.<p>kellblog.com/2011/01/26/perpetual-money-vs-perpetual-license-subscription-saas-and-perpetual-business-models<p>Summary:<p>1. Wall Street "sees through" the differences in models and value perpetual and SaaS companies roughly equivalently. SaaS companies are worth 1.8x the revenue multiple of perpetual companies (he walks through the math in the post)<p>2. There are many good reasons for perpetual companies to move to SaaS models but valuation isn't one of them<p>3. You get roughly twice the EV/R multiple as a SaaS model but building the revenue stream is just about twice as hard. CEOs who have done the transition from perpetual to SaaS say it takes 3 years to makes the transitions and it must be a top 3 company goal for that entire period.<p>4. SaaS dampens revenue volatility - for better and for worse. Makes it harder to grow the revenue stream quickly and makes it harder to change once established. (This has an impact on investor psychology and reactions to a bad quarter can be very different in a SaaS model vs. perpetual)<p>5. Sales compensation is a tricky issue with SaaS model. Sales people still want dollar compensation similar to a perpetual sale despite ratable revenue profile of SaaS.<p>6. The implicit assumption that an annual subscription to use a service should cost less than equivalent perpetual license can be invalid when looking at the product from a customer Total Cost of Ownership viewpoint. (Companies are also outsourcing the capital intensity of having perpetual software)
Great post. Superb introduction to the concepts with helpful illustrations. Adding a few ideas to the mix...<p>Typically a mature SaaS business has about 50% of its revenue from new customers and 50% from renewals. Early on that number is skewed to growth but if a company doesn't invest in retention early on, the company can go upside down, fast. Watching cohorts each month as their subscription expires is a good way to catch this early. Especially if you're in accrual accounting, because you can't recognize new revenue right away.<p>The 3x CAC for LTV is a good rule of thumb but does require you think about what LTV is. In the late 90s companies acquired customers using a 5 year LTV assumption which led to some really inflated valuations and lopsided businesses. I am conservative in my own startup right now, no more than 1-2 year LTV assumption for now to preserve cash flow until product market fit and retention are more consistent. one great reason for taking investment is to take some risks in acquisition on LTV, Gambling intelligently that you can improve your retention enough to match.<p>Early on, the ratio is likely to be even higher until you can drive the inefficiencies out of the spend. And as cost per click goes up in a given market you have to think very, very hard about it. If you're in an enterprise SaaS business, especially in marketing, it's really ugly for top of funnel terms. I've seen some terms at $11-$12 a click.
They also did a podcast on this subject. Well worth a listen as well: <a href="https://soundcloud.com/a16z/a16z-podcast-valuing-todays-fastest-growing-software-companies" rel="nofollow">https://soundcloud.com/a16z/a16z-podcast-valuing-todays-fast...</a>
This is a good article and, although many people will know these concepts separately, it's good to have them all stitched together.<p>For me the question raises how to get through the dip when your cashburn is higher than your revenue because you haven't accurately established your LTV.<p>The second part of that is knowing how to price your service so that your LTV will exceed your CAC. You can control both parts of the equation (through efficient customer acuqisition) and by modifying the product price. But they don't work separately on each other - an adjustment in one will reflect in the other.<p>I guess there is no magic answer to that and it depends on your customers, your competitors and whatever precedents you think may be applicable.
I heard A8n on a BBC podcast trying to explain that bitcoin was important not because it was a currency, but that it solved the Byzantium Generals problem, and so was a break with most other ways of paying people.<p>This is another we-thought-about-this-for-a-long-time-to-work-it-out article. Not A8N quality, but close.<p>Edit: this repeats pretty much the accepted wisdom as MicroConf et al - Get the customers paying yearly <i>now</i> so you can use that cash to go acquire another customer. Nice to see Rob Walling / Jason Cohen are ahead of the curve still :-)
Most SaaS pricing pages give you the impression that pre-payment is prefered to month-by-month (hence the discount you get for buying 12 months today). With this in mind, isn't the old enterprise model just the ultimate future payment, and thus the ideal pricing model? You get all the cash immediately and there is zero churn risk.<p>The SaaS model is great for the customer and bad for the business. Maybe <i>that's</i> why the market doesn't like it so much.
Great article! A few comments:<p>> <i>In the perpetual license model, in-house IT staff managed all software instances and thus could incur the internal costs to switch vendors if they so chose.</i><p>This argument is flawed. There are switching costs no matter if it's SaaS or on-premise. This is why big companies outsource IT - it's easy to get rid of 100x Accenture consultants who specialize in SAP and replace them with 100x Accenture consultants who specialize in SalesForce. The switching costs are normally around process change, change management and training.<p>> <i>Budgets are much more decentralized now, because departments often adopt SaaS technologies and make purchasing decisions independent of the centralized IT organization. In the past, the tops-down technology sales model made it very easy for a CIO to unilaterally replace application vendors.</i><p>Which makes them <i>less</i> sticky. Team frustrated using the $150/month PM tool that they chose? Good, they can get rid of it. LTV goes to zero.<p>> <i>This is why many SaaS companies today invest aggressively in sales and marketing when adoption is high, even though it puts pressure on current profitability.</i><p>SAP and Oracle did too at one point. They're milking their ~90% gross margins on support contracts today. BUT, they <i>still</i> spend a shitload on cost of sale. I don't see cost of sale going down[1].<p>> <i>As a general rule if LTV is 3X or greater than CAC, that’s a good sign that the business model is working.</i><p>The fundamental problem today with SaaS is that I have yet to see to that a scalable and sustainable LTV exists (i.e. "winner take all"). As the OP points out, we can insinuate (not completely prove) a 3x LTV for Workday, but what exactly are they doing that SalesForce hasn't done in the last 15 years? Lastly, if this is a winner-take all situation, then shouldn't we stop talking about SaaS, since "SaaS" = "Workday"? Or perhaps, is this simply pointing out that if you're a SaaS your sole position should be to spend donkey-loads of money on marketing/sales, because you'll just end up getting acquired for your customers anyway?<p>[1] - <a href="http://www.techdisruptive.com/2012/11/28/how-are-we-going-to-make-enterprise-cloud-profitable/" rel="nofollow">http://www.techdisruptive.com/2012/11/28/how-are-we-going-to...</a>
Just a note: as far as I know only 20.3% of Oracle's revenue came from the sale of new software licenses and hardware while four times that much, or 79.7%, is from annual maintenance fees and services (basically some kind of subscription). It is very dangerous to assume that these big companies are stupid.
Part of the distaste is that many of these SaaS stocks are trading with valuations as if they're already at the far end of the J-curve. The market, evidently, agrees with Marc, so I'm not quite sure what he's complaining about.
I've seen these LTV / CAC ratios before, but what about when CAC is zero? That is often the case for startups that don't spend any money on sales/marketing...