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| Home - Industry Article - Jul 03 Issue |
Calling all 'Software as a Service" Deals
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Looking to the future, an example of a company that BAVP follows, but is not invested in, is Salesforce.com. Salesforce.com provides sales force automation software via a web-browser. This is especially helpful when trying to manage mobile and remote salespeople since basic connectivity is all that is needed. Salesforce.com charges $125/user/month for its enterprise product, and saw Q103 revenues of $19.1M, double that of 2002. This level of success demonstrates the appeal of the software as a service business model.
On the consumer side, BAVP is also interested in software as a service. End users are even more likely than enterprises to want information and communication services to be simple and require as little upfront effort and investment as possible. This fits the profile of software as a service perfectly; great example are internet dating sites. According to the Online Publishers Association, match.com is second only to Yahoo in paid online content revenues, beating out the Wall Street Journal Online. The Internet dating sector as a whole made $302M in 2002.
Based on our early hypotheses, key software as a service sectors where BA Venture Partners actively seeks new investments include business applications such as: sales/marketing; collaboration; analytics; and customer service to name a few, as well as applications for end-users such as: communications/messaging; media; games; imaging; and advertising.
The BAVP Software as a Service Survey
The second phase of the project is more about how to drive value in an investment rather than what kind of company to back. We intend to help our companies learn by example from similar companies" best practices. But they're a small sample set so we intend to survey other service vendors. Though we're funding the research we'll syndicate it back in aggregate form (as our portfolio companies will see the results) to participants so they'll profit from participating. If you'd like to participate, contact my colleague Stacey Curry at Stacey.E.Curry@BankofAmerica.com.
Rule number one in a service deal is that if you want "annuity revenue" it has to keep coming back year after year. Customer retention is the single biggest driver of revenue growth and profitability. If the company builds a book of business that grows every month, good things happen. But if there's a hole in the bottom of your bucket and you lose existing customers, the company will be in an even worse situation than a traditional licensing vendor that lives from deal to deal because each individual customer delivers less revenue and more cost.
While the PlaceWare financials are not disclosed, their closest competitor, Webex, is publicly held. The following chart demonstrates Webex's steady, predictable revenue growth and their steady predictable decline in sales and marketing as a percent of revenue. They continue to spend fewer and fewer dollars to deliver revenue because they retain and grow their existing accounts.
Customer retention is the product of many interrelated company operating tactics. But it's also chiefly related to how good the service is—if it fails to satisfy customers, no sales practices engineering in the world will deliver a good result. I've written before for the Sterling Report that "product is destiny." Offering a service and trying to hide ugly stuff from customers will haunt you in the end. Build good features on a robust architecture or die. This view is the key reason we say "software as a service" regularly rather than ASP or MSP—we only target companies built from the ground up as a service, with scalability, security and availability as key deliverables. Offering your standard licensed software, or worse yet—someone else's, as a service doesn't appeal to BAVP.
But given a good service, the providers" internal practices can skew results toward strong retention or not. Here's another brilliant insight: customers will only pay for what they use. Even if a service is theoretically great, the vendor has to work to drive adoption to create an opportunity to retain the customer. This problem is well recognized among traditional data/service providers, but less internalized in the land of hit and run enterprise sales and million dollar shelfware.
BAVP's research project seeks to understand the best practices of successful service providers, including what works and why, for:
Customer contract structure. Pay up front, or bill monthly. Charge by user or by some other volume metric. Term of typical contract (month to month up to multi year), evergreen, self-renewing, or fixed-term.
Sales organization strategy. Hunters and farmers, or lifecycle account managers. Who drives new accounts, retention, and account expansion.
Sales compensation strategy. Pay upfront, or monthly or hybrid. Recourse for early cancellation or not.
Adoption. Who drives usage and how. What's the right amount to spend at various stages of company/market development.
Marketing, both to prospects and customers. What best drives business.
BAVP has engaged an experienced BDP (Best Demonstrated Practices) consultant from a top firm to lead this analysis. But we need help from execs in the trenches, so please contact Stacey if you'd like to share your company's expertise and benefit from seeing the results.
Advantages for BAVP
Like most investors, we're doing this to make a buck. The "software as a service" business model is attractive to BA Venture Partners for several key reasons, but mainly because we can make better returns in this sector than others. Portfolio companies can gain customer acceptance rapidly based on low entry costs, relatively fast sales cycles and quick implementations. As fixed infrastructure costs of hardware and software have declined, and as scale increases, companies in the "software as a service" sector benefit from gross margins comparable to the traditional software licensing model, but without the margin drag of costly professional services. Furthermore, the resulting stable revenues and book of business is more valuable to acquirers and the public markets.
The research project we have undertaken does not only pertain to BAVP or our portfolio companies. The results will provide a clearer picture of where the software as a service market is headed and the impact that this market segment will have on the overall software industry and how business is done. The research project is expected to take approximately 2 months to complete. In the meantime, we will continue to keep our focus on investing in new and emerging companies in this space.
BA Venture Partners, a venture capital partnership, leads start-up to expansion stage investments in networking, semiconductor, software, medical technology and biotechnology companies. The firm closed BA Venture Partners VI, a $500 million fund, in 2000. BA Venture Partners" sole limited partner is Bank of America. Visit our website at www.BAVenturePartners.com.
At BA Venture Partners, Sharon Wienbar works with enterprise software and Internet infrastructure and services companies addressing high value business issues. Sharon sits on the board of Stratum8 Networks and works with BAVP's investments in PlaceWare, OuterBay Technologies, and XTRA Online. She can be reached for comment at: Sharon.Wienbar@BankofAmerica.com
 
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