Tuesday, November 04, 2008

The Prospects for SaaS

On Thursday night Bessemer's SaaS practice team Byron Deeter and Philippe Botteri hosted a CFO dinner at John Bentley's in Redwood City, where we discussed the prospects for SaaS in the context of a global recession. My squash gnocchi was delectable, but the portion size was stingy (a sign of the times). Fifteen CFO's participated, about half of whom work at Bessemer portfolio SaaS companies (Cornerstone On Demand, Intacct. Lifelock, LinkedIn, OneStop, Perimeter and Retail Solutions).

The mood could best be described as cautiously pessimistic. Despite hypergrowth in the SaaS industry, the outlook for 2009 is sobering. Among the 13 public SaaS companies, the multiple of enterprise value over current year sales has dropped from 6.6 one year ago to 2.2 today, shaving 60% off market caps year to date. Obviously the market expects growth rates to fall dramatically. SaaS companies grew on average 48% in 2008 but in 2009 Omniture will lead the pack with only 14% growth, according to Goldman Sachs uber analyst Sasa Zorovic, who joined us for the dinner. (Yes, Goldman's SaaS analyst is really named Sasa.)

With slower growth and expensive capital, SaaS companies need to adjust expenses to optimize for cash efficiency, not growth. It's especially important now to assess the profitability of new business, which is tricky in SaaS companies. For each customer, the inflows are the time-discounted billings including expected upsells to the point of expected churn. The outflows equal the sum of upfront sales costs and the time-discounted cost of service delivery and any sales cost for renewals and upsells.

Although we're planning for the worst,  we at Bessemer still believe that the shift to SaaS represents the most important secular shift in enterprise computing since the advent of client-server. The SaaS value proposition of reducing capital expenses as well as total cost of ownership should ring even louder as corporate budgets come under pressure. That's why we predict the downfall of software companies whose addiction to license revenue discourage them from embracing SaaS...
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