Software + Service = Service Only?

The more I think of SaaS (Software as a Service) model, the more similarities I see with Web 2.0. Both target the “long tail” in their respective markets: SaaS, in the enterprise market and Web 2.0 applications like Flickr and You Tube in the consumer space. Both depend on the rapid reduction in production and distribution costs. I think of the long tail in the enterprise market in three different ways:

The SMB End
SaaS providers will target the small and medium business segment with standard business application suites and applications. Examples include Salesforce.com, RightNow and NetSuite (for CRM solutions) and Bluetie with its mail and collaborations solutions.

The Niche Application End
This comprises of applications that are not completely or adequately covered by the major software vendors. Examples include Human Capital Management (SaaS providers: Workstream, Authoria, Employease and Taleo), Supply Chain Management (Kinaxis), Expense and Payables management (Concur Technologies, Expensewatch.com, Razorsight), Product Life Cycle Management (Agile Software offers a subscription option), Analytics (Nsite acquired by Business Objects) and Postage solutions (Stamps.com) These companies typically target companies of all sizes.

The Niche Business End
This comprises of specialized applications targeted at focused business segments. Examples include sales and information tracking applications for chip manufacturers (Platte River Systems), preconstruction management services for the construction industry (iSqFt). These companies typically provide additional value to their customers other than software leveraging the business community effects of players all using the same system.

These are my 2007 predictions in this space:

Prediction 1
There will be considerable venture capital activity in the last two categories as innovative entrepreneurs exploit gaps in the enterprise software market space even as the SaaS pioneers like SalesForce.com establish their leadership in the first category.
Prediction 2
ISVs will be work extra hard to get their SaaS strategies in place. This will be a non-trivial task as it would require re-architecting their product to move to a multi tenancy environment and juggling internal sales, implementation and invoicing processes. Existing ISVs which will succeed in a SaaS strategy will, in all likelihood, do so via acquisition of pure play SaaS vendors or by way of developing a completely separate business focus.

The stake in the game for ISVs will be high. My analysis indicates that the market already places a premium on providers who have SaaS offerings in place. Pure play SaaS vendors like SalesForce.com and Right Now have a price-revenue ratio of 10 & 5 respectively compared to a ratio of 2.5 of more traditional ISVs in the SCM, HCM, Analytics, ERP, PLM spaces. The ratio of 2.5 excludes the large enterprise players SAP and Oracle who boast of ratios of 22 and 6 respectively. My prediction for 2007 is that:

Prediction 3
The market will disproportionately reward companies with SaaS offerings.

The third interesting trend in the SaaS model is the convergence between SaaS and BPO. ADP’s acquisition of Employease and the strategic tie-up between TCS and Salesforce.com is indicative of that trend. My prediction is that:

Prediction 4: 2007 and beyond
As the SaaS market matures, SaaS players will tie-up with traditional outsourcing companies to provide end-to-end managed services to their customers and SaaS investors will strive to exit by way of sale to the IBMs and Wipros of the world.