Traditional software companies – and most tech companies in general – are building Software-as-a-Service (SaaS) businesses. Enterprise SaaS revenue is hitting the $100B run rate, according to Synergy Research in its most recent report. That’s still only 20% of the total enterprise software market, but it’s growing quickly.
An increasing number of customers demand the benefits of services delivered via the Cloud. Equally as important, recurring revenues from subscriptions are more highly valued by investors than traditional, perpetual license revenues.
The average revenue to market cap multiple for the Cloud companies in the Bessemer Cloud Index as of this summer was 11X – and top companies were valued at more than 25X times revenue.
Further, Cloud technologies are advancing rapidly and can help traditional tech stay competitive in terms of product development, delivery and business model.
Traditional tech companies follow a variety of paths to embrace the SaaS business model: acquiring pure SaaS companies or transitioning on-premises product lines to SaaS. Think Adobe transitioning all its products over to the Cloud or Microsoft Office moving all its Office customers over to Office 365, versus Oracle or IBM acquiring myriad pure SaaS companies.
To Manage a SaaS Business, You Need to Track SaaS KPIs, Not Force a SaaS Business to Report Traditional Software KPIs
The SaaS business model has ramifications for every part of the company, from Sales to R&D, from Marketing to Strategy, from Finance to the business systems used to run the business. Traditional tech needs to re-think every operational aspect of their business in order to fully execute on a SaaS strategy. And in order to manage the SaaS strategy and execute on that strategy, companies need to completely rethink the KPIs they track in order to manage their SaaS strategy execution.
Sync Up the Chart of Accounts with SaaS KPIs
We see large tech companies having significant problems adjusting their internal reporting systems and Chart of Accounts to feed into their existing management systems. Most traditional tech companies tend to force SaaS acquisitions to squeeze their reporting into the parent company’s structure. The difficulties are far more significant than most companies anticipate. The biggest areas of concern tend to be:
- COGs (and hence Gross Margin)
For example, if you don’t structure your Chart of Accounts in Sales and Marketing to correctly feed into a Customer Acquisition Cost calculation, you’ll never fully understand your SaaS unit economics. Common SaaS Chart of Accounts issues include:
- Hosting expense for prospect marketing (OpEx – CAC)
- Hosting expense for freemium offerings (OpEx – CAC)
- User conference (if most of the participants are customers, should NOT be part of CAC)
- Credit card processing fees (could be added to COGs)
- Installation and Onboarding services (can go either way, CAC or COGs, requires accounting advice)
- Customer Success – are they primarily a sales function or a customer engagement program? The answer helps define whether these expenses go into OpEx or COGs, but not into CAC
- Indirect employee expenses associated with either acquiring new customers or for COGs, with supporting existing customers
Plus you’ll need to be able to separate out expenses associated with new customer recurring revenue from expenses associated with renewals and expansion revenues, among other SaaS activities that traditional tech doesn’t normally do or track.
We’ve written a quick Cheat Sheet about some of the key operational and contractual differences between traditional enterprise software models and the SaaS model. We work with companies all across the software spectrum, from fast growth, pure SaaS companies, to hybrid companies to traditional tech companies making the transition to SaaS. Using benchmarks in the budgeting and planning process helps companies reduce the risk of failure and less than optimal business results.