Killed by the SaaS Love Triangle

October 16, 2018

Here’s a super interesting perspective from Sunir Shah, founder of the Cloud Software Association, a 2000 member organization dedicated to promoting partnerships and business development among SaaS companies that we like a lot.  From the early SaaS days when few believed the SaaS subscription business model could support partners and indirect channels, the SaaS partnership model is evolving to expand distribution channels for SaaS companies beyond direct only channels.  The implication is that the market could be even bigger than currently estimated with a greater expansion of the SaaS value chain.

The Fundamental Business Model of SaaS is Broken

There I said what needed to be said. SaaS seems like it is eating the world, and yet it is broken at a fundamental level. SaaS changed how the world bought and sold software. We used to buy and sell software licenses. Now customers subscribe to Software-as-a-Service providers. In return, customers pay less up front, always have the latest software, never have to worry about IT maintenance, and can reach the software vendor directly for technical support.

In return, software makers fell in love with the glory of “recurring” revenue, of “predictable” revenue, that makes plotting the future fortunes as simple as extending the line just further up and to the right. But at the heart of the subscription business model is a major flaw.

Subscribing Directly Means Selling Directly

In order to subscribe, customers have to sign up directly with the software maker. That means the software company has to provide all customer-facing services directly themselves. SaaS must do direct selling, direct marketing, direct support, direct account management, and direct customer success. That’s on top of having to do the engineering, design, and product management. That’s why you see SaaS companies invest heavily in direct marketing and direct sales channels to grow revenue. Yet, it’s nearly impossible to reach the entire market yourself. You can’t phone every business in America yourself.

Therefore, SaaS companies struggle to efficiently acquire customers. Eventually their ability to acquire new customers directly is matched by the rate they lose existing subscriptions, and the SaaS company hits what is known as the SaaS growth ceiling. While desktop software like Intuit Quickbooks and Microsoft Office and Adobe Photoshop grew to millions or tens of millions of copies sold, SaaS companies rarely break through a growth ceiling of 100,000 subscriptions in the best cases.

Killed By The SaaS Love Triangle

The revolution of desktop software was for the first time software could be marketed through a distribution channel. One could buy software in boxes sold in shopping malls all across the country. That’s because software could be packed in boxes that could be sold to distributors who would sell it to wholesalers who would sell it to retailers who would sell it to the public. Everyone in the chain created real value and earned real margin for their troubles. SaaS does not support a value chain. Instead, SaaS creates a love triangle.

SaaS subscription business model

The SaaS Love Triangle

Why? Again, because customers must subscribe to the software maker, which creates an ongoing relationship directly between the customer and the software maker. This means when a partner like a reseller or a distributor is in between the customer and the software maker, the software maker is motivated to squeeze out their partner. Both are fighting to maintain a direct relationship with the same customer. It’s a love triangle, which is just as bad for business as it is for life.

Channel Conflict Slows Growth

“A platform is when the economic value of everybody that uses it, exceeds the value of the company that creates it. Then it’s a platform.” — Bill Gates

This channel conflict has kept growth rates of SaaS low. Last year the global GDP of B2B SaaS was merely $46 billion. Yet Microsoft alone made $97 billion. And Microsoft makes over 90% of its revenue from partners for the simple reason that they want partners to make 8 times the revenue as Microsoft. Microsoft is a global behemoth because it figured out how to create a global value chain around it, a value chain that is much larger than itself.

A Reseller’s Snapshot of the PC Software Value Chain

SaaS subscription business model

How Did Resellers Build Their Business in the 1980s?

As I mentioned, what Microsoft and its peers in the 1980s got really right was how to work with the companies that bought, sold, and supported software to end clients. Indeed, almost all our partnership jargon today comes from the early 1980s. In the 1970s, it was common for hardware manufacturers to just include software as part of the product. However, the 1980s ushered in the era of “independent software vendors” (ISVs) that wrote software independently of the hardware companies.

These ISVs would work with consultants called value-added resellers (VARs) that were hired by end customers to build systems. The VARs would buy and bundle hardware from Original Equipment Manufacturers (OEMs) and software from ISVs, then system-integrate (SI) the lot into a much bigger whole product solution to solve a customer’s unique problem, such as an office management system or a manufacturing process.

However, in the 21st century, this model has become much more difficult. It’s very hard to buy and bundle software as a value-added reseller because customers must subscribe to software maker directly. And while value-added resellers still try to stitch together integrated systems to solve business problems for their clients, the friction of not being able to buy the components of the system directly themselves has frustrated the reseller model.

A Vision for a SaaS Reseller Value Chain

SaaS subscription business model

The Future of How Agencies Will Buy and Sell Subscriptions

Reselling subscription services is a different concept than reselling equipment. It may sound like a totally new model for software, but really it’s a very old model. Consider the same problem but without computers. People hire agencies all the time to handle business operations such as accounting, marketing, logistics, maintenance and support and so on. These agencies in turn subcontract to other service providers to fulfill parts of the contract. For instance, they might hire bookkeepers, designers, lawyers, trades, and so on.

The future is to align with this model. A customer should be able to hire (i.e. subscribe to) an agency to run their sales, marketing, IT, dev ops, and so on. This agency should be able to hire (i.e. subscribe to) software services to fulfill their contract. This model is already happening, but manually and very inefficiently.

Making it easier to build new services out of other services (software or otherwise) will greatly expand the market for SaaS.

Let's Evolve the SaaS Partnership Model to Grow Revenues for Everyone in the Value Chain

This is just an outline of the problem and what is possible in the SaaS distribution market. There’s a lot more to say.