How To Start Up A Software Business Within A Cloud Computing Environment: An Evaluation Of Aspects From A Business Development Perspective
Textbook 2013 100 Pages
Table of Contents
List of Figures
Chapter 1: Introduction
Aims and Objectives
Chapter 2: Literature Review
Business Development Framework
Software as a Service framework
The customer’s viewpoints on Software as a Service
Chapter 3: Methodology
Justification for case study selection
Chapter 4: Results and Discussion
Summary of the results in the literature
Summary of survey results
Summary of case study results
Discussion of research findings
Answers to research questions
Chapter 5: Conclusion
Key success factors
Scope for further research
List of Figures
Figure 1: Diffusion of Innovation
Figure 2: Long Tail
Figure 3: SaaS Sales Process
Figure 4: Recurring Revenues from SaaS Business
Chapter 1: Introduction
The entire software and information technology industry is currently facing a change of paradigm as the era of traditional business software is facing a massive theoretical shift and many common software offerings will be transformed into software service. These circumstances will not only influence the way companies develop software, moreover it will have drastic impacts on entire business models (Saugatuck, 2010). Software as a Service (SaaS) is part of the cloud computing concept and mixes up business-to-business offerings with a consumer-oriented approach (Gross, 2010). Former well-defined limitations between business-to-business and business-to-consumer products have become softer. Users of software and services typically favor well-designed software in terms of both usability and appearance. Experts often mention the terminus “consumerization of IT” in this context (Gross, 2010). Nowadays consumers are in constant touch with software and applications and consumer-oriented applications are typically more standardized, better looking and easier to use than business applications. A typical SaaS offering exists physically just once on one cloud platform and is run in a multi-tenancy environment (Koenig, 2006). In other words this means that there is just one physical version of software that is delivered to all customers. To provide better understanding, Software as a Service (SaaS) is being delivered in a similar way like conventional websites, where every visitor comes to see physically the same website. This new concept of distributing Software as a Service requires a high level of standardization, which is reasonable due to the fact that the target group should be as large as possible and therefor the scope for individualization and customizing is decreasing enormously. Experts are apprehensive that standardization will be enforced to the disadvantage of the level of customization (Schwartz, 2005), and this is just one indicator that the entire software industry is in a state of flux. Another indicator is that one of the most common business models in software business, which consists of a unique license fee plus annual service fees, will be replaced by a variety of pay-as-you-go payment plans. New payment options and dynamic usage plans are just one result of a big change in software business. The market entry barriers into the software industry for new businesses are lower than ever before. On the other hand the way to a Software as a Service (SaaS) offering for an existing Individual Software Vendor (ISV) is not that easy because it goes hand in hand with a couple of risks for their existing business.
From the viewpoint of an Individual Software Vendor it is important to find the right mixture of business development aspects and adjust their priorities in accordance with the SaaS offering.
Aims and Objectives
When establishing a SaaS business the most important aspects of business development probably come from the common business models in the software industry, because SaaS and the concept of cloud computing brings many new opportunities, such as scalability, internationalization and marketing-driven sales as well as with a large number of variations; for instance, a higher cash intake over time instead of a high upfront license sell-off (Ratameta & Veeragandham, 2009, pp. 17 - 21). A new venture will have to consider several factors for a long period before they start to be productive, like stressing the opportunity, creating a sustainable team of creators and followers, setting up strategies and much more (Copeland & Om Malik, 2006, pp. 78 - 81).
The objective of this book was to find out on what aspects of business development successful ventures starting their business particularly in a cloud computing environment paid more attention to and their relevance to start up companies in the software business. The current research was authored to assess what aspects of business development are essential to create a successful SaaS venture and where SaaS business creation differs from the traditional way of software business creation in relation to an on-premise software approach. The analysis concentrated on both research methods and professional ways of proceeding. The data collected was carried out by merging information that was gathered out of evaluating a questionnaire with IT decision-makers on the buyer’s side and compiling a case study with a successful SaaS vendor.
This book focused on the need of new ventures to make decisions in respect of a potential cloud / SaaS strategy. The investigated aspects of business development were primarily corporate strategy, product development, marketing, sales (with a special focus on pricing strategies and models), distribution and the special aspects of business acceleration.
On the other side, it was important to find out what successful companies left undone with intent, as Porter (cited in Oblinger, 2011) stated that it is more important for a company´s strategy to know what not to do instead of what to do. It was an indispensable requirement for this book to research a company that has a SaaS offering available and runs a scalable business (Shane & Kataraman, 2000, p. 223). Founders of start ups need to make decisions about further investments over a long period of time before they see if their new venture is failing or succeeding (Jay & Gregory, p. 391), which requires professional business development. This project should help us to understand what aspects of business development are crucial and what negative effects can emerge when business development is neglected.
Amongst other things it has to be clarified whether successful ventures defined their product/service and if tools like the Six Sigma Product Development Circle (Wilson, 2005, p. 62), TQ/TQM and Lean (Bhasin, 2006, p. 56) were helpful. In addition to the variables named above, which can have an impact on the success or failure of a venture, a further objective of this project was to understand whether some aspects of business development were not just very important to the company, but especially accelerated the organization because of their Software as a Service offering (SaaS).
I hope to answer the question: "What aspects of business development do entrepreneurs of Software as a Service start up companies regard as the most important?" In that aim, the following research questions were helpful:
What business models work well for a SaaS start up?
What characteristics show markets and target groups that are suited to SaaS offerings?
What kinds of new opportunities come along with the offering of Software as a Service?
Which marketing and sales approaches have produced better results?
How important is uniqueness in relation to the business concept?
What steps of common business planning are the most important?
The method is all about researching successful businesses. The author researched a company that can be described as a successful start up with a successful SaaS offering. To get a better understanding of their key success factors, the author completed a couple of introductory interviews with the founders, account managers, partners, potential customers and customers. Furthermore the company provided the author with detailed background information, financial information, business plans and strategy papers. This information was aggregated into a case study. For the purpose of anonymity and nondisclosure the company is called CashOnePro, whereby this name is a fancy name.
Furthermore the author collected qualitative data from interviews with purchasing decision-makers in the software business. The qualitative data includes specific answers to major questions regarding Software as a Service (SaaS) as well as traditional questions concerning on-premise software – especially regarding differences in decision making, customers’ expectations, viewpoints and best practices – in order to increase the value of the results. The research was made up of 35 interviews with attendees of 2012 CeBIT – one of the world’s largest exhibitions for software and information technology.
Chapter 2: Literature Review
The concept of cloud computing consists of three different layers: Infrastructure as a Service (IaaS), Platform as a Service (PaaS) and Software as a Service (SaaS) (Korzeniowski, 2010). Infrastructure and Platform as a Service are more technical concepts that provide computing power and storage capacity, and respectively runtime and development of environments on demand. Over the past years the market for hosting has been surfacing toward on demand offerings on a more elastic, pay what you use basis (Leong & Chamberlin, 2010). Global cloud computing providers established cloud data centers to make IaaS and PaaS available for customers, which are typically individual software vendors (ISV´s) that use the cloud data centers to provide their own Software as a Service (SaaS). SaaS means that an ISV provides software that is run in a cloud data center instead of an on-premise installation at the customer’s private data center (Guo et al., 2011, pp 2 – 3). So the main and obvious differentiation between SaaS and the long-known license selling model is that the customer does not need to care for appropriate servers and administration of the software, because the requirements for the use of SaaS are typically the availability of an internet connection and a frontend device like a computer or mobile device. Due to the fact that software becomes available without the need for one´s own servers and infrastructure, and without the burden to invest in a software license, small and medium sized-businesses as well as entities and departments of organizations become an interesting target group for SaaS providers (Agrawal et al., 2011, pp. 8 – 10).
Business development is a steady process of advancement with the aim of improving the performance of a company. It begins at the stage where an idea is transformed into an opportunity that can be characterized by
1. Adding some kind of value to the customer
2. Answering a certain problem, desire, want or need and the important thing here in this respect is that the customer is willing to pay for it
3. Being positioned into a robust, large enough, growing market that allows high gross margins as well as early free cash-flow, and high profit potential as well as solid, sustainable and trustworthy returns for potential investors
4. Matching with the entrepreneurs in relation to time, marketplace and risk-reward balance. (Timmons & Spinelli, 2010, p. 150)
Furthermore, the aspects of business development include, roughly speaking, the characteristics of marketing, sales, product design, as well as financial planning and corporate strategy. Another approach to business development – especially for the purpose of developing smaller companies and start ups – is an iterative circle of actions that consider the aim of permanent improvement by analyzing the current situation, identifying the potential for improvement and simply doing it (Butler, 2011, pp. 14 - 17). Further points of interest are the relationship between the customer and the service provider, the way the provider attracts new customers and the delivery method of the cloud offering. To distinguish the business development framework from other fields, topics like business process management, business operations management, software development methods, human resource management, accounting and finance, quality assurance or project management are not the subjects of deeper investigation.
Chapter 2 provides the essential information on the concept of establishing a start up company within the cloud computing business environment. It proves interconnections between universally valid knowledge about business development and the specialties that are applicable for SaaS companies. Therefore, in a first step the two frameworks of business development and SaaS are screened and, secondly, the coherences, overlaps and inferences are worked out.
Business Development Framework
Important aspects of business development from an ISV view
Funding by venture capital or angel investors has been recognized as substantial equipment for the creation of new ventures in information technology. Particularly within the first year, a new venture will face very high investments in product development, marketing and sales (Harrison, Mason & Girling, 2004). Depending on what special business the new venture is going to enter into the acquisition of own server farms or the lease of servers in a data center can be connected to tremendous capital commitment.
Having a detailed business plan available is a key success accelerator. The decisive factor with a business plan is not that the entrepreneur is very good in guessing what will happen in five years, but that it has the absolute necessity of setting goals. Entrepreneurs should make sure that they set goals, since it is important to make sure that everybody who is involved knows exactly what the goal is. This is not a question of understanding the overall mission or the vision of product or a service, it is more about the chief architects and designers having a common, detailed mental picture of the product so they are able to transmit both the overall picture as well as break it down into pieces in the puzzle (Bersoff, 1994). Unfortunately, developing good software is just half the battle. The software – assuming that it is delivering value to customers – must find its way to customers through sales. From the point of time when someone is writing the first lines of code until someone pays for the usage of software a long time can pass and this time can require enormous amounts of money. In the case of venture capital involvement the capitalist’s goal is to find out as early as possible whether the software will be successful (Mann & Sager, 2006). When launching a software service in a cloud environment this means that the vendor simply deploys an application to a cloud data center with just a few clicks and makes it available to all potential customers all over the world. The start up would be able to start with a beta version or a friendly user version without any further investments in own server infrastructure and does not need to worry about physical distribution.
The idea behind the new business is that it has to be transformed into an opportunity. A good idea is not automatically a valuable opportunity. Only four out of 100 ideas – presented to potential investors in the form of a business plan – get to become a start up company (Timmons & Spinelli, 2009, p. 111). Software is a very special kind of product, because it is not tangible and its value is not easy to quantify as it typically consists of just a CD-ROM. Business software typically needs to meet a customer’s requirements. The more customers whose requirements can potentially be satisfied the larger the ISV´s potential target group is. This leads to the strategy to create software that is as comprehensive as possible (Kittlaus & Clough, 2009, pp. 47 - 54). Standard business software applications like SAP, Microsoft Office or Dynamics are equipped with a very wide range of features and allow a high level of customizing and a wide variety of upgrading possibilities.
Customizing, upgrading and down streamed service and support offerings are characteristically part of the on premise software business. In particular, support and after sales revenues are typically substantial fragments of on premise business models on the one side, but for the customer on the other side there is a certain form of risk in terms of dependency and unpredictable expenses. Therefore, most large ISV´s have established an ecosystem of software partners and system integrators that care about selling the ISV´s software applications to customers as well as adapting the software to the customer’s specific business processes and requirements (Dinsmore & O´Connor, 2005, pp. 14 – 15).
Derived from the fact that a software customer needs to purchase not only software licenses, but also has to invest in consulting, implementation, server infrastructure and software updates, the aspect of pricing – and associated with that the entire sales strategy – is significant. In contrast to other industries that deal with physical products, in the software business the unit costs are virtually zero. This fact does not make it easier to find the best fitting price for the product, as from the customer’s point of view the value of software – by the meaning of which problems can be individually solved with it – is subject to individual evaluation. The more complex feature stack of an application is, the more difficult the evaluation and therefore the pricing are (Coburn, 2005, pp. 13 - 17). On the other side it cannot be kept as a secret that companies that serve niches or focus on very specialized businesses can survive easier than more general oriented companies, because they are not facing such a large number of competitors and it is easier for them to work out their distinguishing characteristics. As such, specialist corporations generally last longer than broader focused ones (Romanelli, 1989, p. 385). One proof for this can be found in the business concept of Dropbox Inc. The company was founded in 2007 and offers a SaaS solution for sharing, hosting and synchronizing files. No more, no less – but Dropbox generates its easy business concept to very high growth rates (Fowler & Vascellaro, J., 2012).
This richness of features implies that the application is most often in need of explanation by pre-sales consultants. Added to this, customers want to see the software in a realistic environment before they make their decision. This means that high expenses through sales consulting might arise and that the timeframe for making a decision can last for more than a year. So the ISV has to think twice about whether to invest in a sales opportunity and of course has to find the critical mass in terms of the lower limit of the number of potential users. This leads to the situation that designing applications for and selling solutions to large enterprises and the upper mid-sized-company sector is the more lucrative option for ISVs.
According to Rogers (1962, pp. 282 – 283), there are five different types of technology adopters. The so-called innovators are the first movers that a SaaS vendor could win as customers. Roger´s viewpoint was directed towards an end consumer´s behavior and so he characterizes innovators as of young of age, dynamic, prepared to take risks and part of a higher social class. SaaS vendors don´t typically sell their services to end consumers, but due to convergences between business decision makers and end consumers, which can be best described as the consumerization of IT (Gross, 2010), it can be assumed that SaaS vendors can draw back conclusions from Rogers´ findings.The second group that adopts technology is called ´early adopters´ and differs from innovators by an advanced manifestation of opinion leadership though the mass of customers can be found in the early majority and late majority group. Both groups adopt innovations only after a certain period of time, whereby faster success within the first two groups probably could have an impact on the time to reach the majority groups, as they want to make sure that a solution which was proved by others can be achieved by contact with early adopters (early majority) or by contact with early majority (late majority).For the sake of completeness there are also laggards that are characterized by the adoption of technology at a very late stage.
Figure 1: Diffusion of Innovation
illustration not visible in this excerpt
Source: Everett Rogers (1962)
So the aim of a SaaS vendor should be to pass through the first two levels by attracting innovators and early adopters very quickly and typical SaaS business models can be very helpful for that. For instance free beta phases, friendly user phases or free trial offerings help to accelerate innovators and early adopters.
The BCG (Boston Consulting Group) matrix, which is often called the Boston Portfolio Matrix illustrates the correlation between product lifecycle in terms of market growth and relative market shares. The matrix is divided into four squares with four different recommendations for further action:
1. “Dogs” (low market share/low market growth) should be reassessed as long as no progress can be detected after a certain period of time
2. “Question marks” (low market share/high market growth) are typically newcomer products and the question is whether the company should invest or forsake
3. “Cash Cows” (high market share/low market growth) usually don´t require further investment but will deliver constantly high cash flows
4. “Stars” (high market share/high market growth) are the most promising products and the company could try to optimize i.e. with higher contribution margins.
The BCG matrix can be overlaid with Rogers model as it considers the view of relative market share and market growth rate (Henderson, 2005, pp. 43 - 46). Again from an SaaS provider´s viewpoint a relative market share can be increased by selling faster than competitors, which can be achieved by focusing on Roger´s target groups. The market growth rate can be assumed from the feedback that should be generated out of the introduction of the service to innovators and early adopters (Rogers, 1962, pp. 282 – 283).
Knowing and understanding the customer is not only important in product design, but also in selling software applications. The customer wants to feel understood and sales managers have to demonstrate that they understand the customers’ business and bring value to their business as a consequence. This need for understanding at the buyer’s side often arises from the background that the customer does not understand the software at all, but it is easier to make a purchasing decision as long as the decision-maker feels understood by the other party (Foerster, 2009, p. 125). This plays a part in contributing to the conclusion that software vendors tend to focus on dedicated industries, although their solution would fit for other industries too.
Business software is usually oriented towards business processes along the value chain. This opens a wide field for interfaces and complementary products. Even if a complementary product does not have very high sales potential, it could be an enriching feature or have a competitive advantage like simplicity, interfaces to other systems or different usage limitations, which influence the customer’s decision on the overall solution. A competitive advantage is characterized as it is a tactical advance of one company against rivals. ; ; ;(Sengupta, 1998, p. 354). A complementary product strategy can include new possibilities for front-end devices like bar code scanners or smartphone applications as well as supplementary software applications for affiliated divisions or other entities within the customers’ ecosystem. In particular, lightweight applications with a smaller feature stack for the use on smartphones and tablets have seemed to have a more and more demanded implicitness.
Piracy is a tender subject in software industries. According to the Business Software Alliance the worldwide loss throughout software piracy in 2010 was almost 60 billion USD (BSA, 2011). This is a serious problem for ISV´s, because it is very difficult to detect pirated material. On the other side, studies show that software piracy is indirectly responsible for a large part of the acquisition of new customers (Givon, Mahajan & Muller, 1995, pp. 34 - 35). Today most software vendors offer free test versions of their software to counter this situation. To avoid misusage, the free usage of the software is limited to a certain period of time and must be registered via telephone or the internet for safeguarding the ISV (Kittlaus & Clough, 2009, p. 147).
Particularly in the last few years a cultural shift in software business has been detected. Solid literature on venture creation is typically about the importance of USP´s, and sustainable and competitive advantages. Some successful IT entrepreneurs in recent years have come up with a major and different approach whereby it seems like the idea of a USP does not play a very significant role due to the fact that the industry is growing fast. In fact the new big trend in software design is lightweight, simple and easy to understand applications that are distributed via social media, smartphones or tablets. Within this scope apps are typically replaceable by other, similar apps and the differences between the offerings are rather minor and can often be summarized as a matter of taste. What goes against the principles of product development is put in a nutshell by the advice “Underdo your competition” (Fried & Hansson, 2010). With this it is not automatically meant that the offering does not need to be better than competing offerings, but to a greater degree the advice is to make the functionality still sharper, better to understand and better to use. This is one effect that comes along with the trend of the consumerization of IT, when customers favor smart and lightweight applications instead of a feature-overloaded all-round product (McCafferty & Reisinger, 2011, p. 8).
Software as a Service framework
From an ISV start up business point of view SaaS is a big opportunity to enter markets that are typically dominated by large software vendors. Small companies and start ups can be fast and flexible in attracting global customers with a SaaS offering. A business model is a description of the value a company offers and delivers to customers in order to generate profitable and sustainable value (Ojala & Tyrväinen, 2011, p. 2). SaaS means that the customer pays a periodic fee for the usage of the service. Independently from the “pay per whatever” (for instance per user, per month, per transaction etc.) model, the SaaS vendor can assume that a large part of the revenues from one period can be brought forth to the next period. So revenue forecasts build up on summing up existing revenues multiplied with the company´s overall retention rate plus new contract value increase (Saugatuck, 2008, pp. 7-9). This payment model causes a permanent increasing stream of incoming cash and enables the SaaS vendor to generate an overall higher amount of cash than with an on premise offering.
The multi-tenancy approach (Koenig, 2006) allows the SaaS vendor a very easy way to foster software deployment and distribution to customers. Cloud data centers are prepared to handle software requests globally and allow the vendor to offer the software service to potential customers all over the world.
When selling software services online, and initially via marketing channels, the SaaS vendor typically provides free trials or even a free version with limited functionality. To win a customer it is important to provide the opportunity to test the software service extensively (Saugatuck, 2008, p. 23).
Additionally, some SaaS vendors make use of a viralization effect. Dropbox – a very popular US-based software start up with a SaaS offering – makes use of both a freemium pricing model (free basic model or premium fee based offering) in combination with a viral business model. The idea of Dropbox is to easily share and backup files in the cloud. One of the competitive advantages of the service is the integration into the file directory (i.e. Windows Explorer). So the files are saved on the local drive, synchronized with the cloud service and shared from the cloud to others. Whenever an existing user wants to share a file with someone else the other person has to subscribe to Dropbox too. This invite-to-use concept accomplishes further awareness without marketing expenses. New subscribers can use a free version with less capacity but with more or less full functionality. This again causes further viralization, even if the subscriber does pay for the service, but new subscribers will be attracted again.
Apart from the fact that expenses for software development arise in any case, a cloud based software distribution model ensures scalable infrastructure expenses. The SaaS vendor does not need to care for their own technical infrastructure and the cloud data center providers would charge only the real consumed capacity (Espadas et al., 2011).
This pricing model is typical for cloud computing and enables the SaaS vendor to offer the service at a comparatively low price (Saugatuck, 2008, pp.11 - 12). A pricing strategy is important to a SaaS venture, but it is typically not part of the set of competitive advantages, as a pricing model is too easy to imitate. Based on this cloud pricing model four different payment schemes for the pricing of the SaaS offering can be determined:
1) Base fee + usage fee: this is the most secure and probably most profitable pricing scheme. It guarantees the SaaS vendor a consistent stream of income throughout the base fee. The usage fee generates additional revenues and cares simultaneously for risk reduction because the usage fee would typically cover all data center costs that are associated with the user´s consumption.
A variation of this model is the inclusion of a limited service package inside the base fee. Typically the base fee is equal to the usage fee plus a little encore.
2) Usage only fee: compared to model 1 this pricing model is very closely related to the generated expenses in the data center. It does not generate consistent revenues but the real pay what you use model can be a competitive advantage against other vendors.
3) Monthly, quarterly or yearly fixed amounts are very popular for services with predictable usage behavior or with at least predictable overall usage behavior with the result that the SaaS vendor does not run the risk of ;generating higher cloud data center expenses than revenues from the SaaS business. In addition, a monthly amount is typically connected with some kind of quantity (i.e. monthly fee per company, per user or per fixed number of employees).
Added to this, SaaS users typically have to subscribe for a certain period of time (i.e. one year).
Acceleration is one of the driving factors for SaaS vendors. Globalization, higher bandwidth and the technological progress on cloud infrastructure offer a meaningful framework for creating new cloud services and to speeding up revenues very quickly. In combination with a high market demand SaaS can be like a take-off ramp for startups: In the year 2012 80 percent of the Fortune 1000 companies will be subscribed to cloud services (Gartner, 2011, p. 5).
The case becomes even clearer when taking a look on the supplier’s side of the market. Almost 90% of new software startup companies show up with cloud services or cloud related services and even up to 80% of new products of traditional ISV´s are cloud services or cloud related services (Gens, 2010, p3).
Comparing the efforts for a startup company with a cloud-oriented approach to a start up with a traditional on premise licensing selling model the on premise start up will be facing higher upfront investments. The potential higher return on investment for the cloud business can result from both lower upfront costs plus the opportunity of higher revenues throughout their marketing driven sales approach (West, 2011, p2).
The customer’s viewpoints on Software as a Service
The above described multi-tenant platform approach encourages a marketing driven sales strategy to offer services to the long tail of the markets (Elberse, 2008). The long tail as a target group also means a paradigm shift in product design for the entire IT industry. Whilst common software vendors typically design software with a market focus on large companies, SaaS providers will address more and more small and medium sized-businesses. This requires them to place the business value of the service upfront within the solution and then offer a transparent payment plan that creates room for the customer to make an easy decision (Browning, 2011, pp. 4 – 5).
illustration not visible in this excerpt
Source: Thomas Buchegger (2012) referring to Chris Anderson (2010)
From a customer´s viewpoint this is a very important factor because small businesses in particular get a great chance to make use of valuable software service in fields where on premise software vendors would not take the effort of a sales pitch upon themselves.