A Guide to Migrating to SaaS
Business as usual in the software industry is coming to an end. Today’s environment is one in which customers want to use a web browser, rather than on-premises software, to meet their needs. Customers want to be able to access applications from almost anywhere; they want low initial costs, painless upgrades, and even seamless integrations. To meet all these demands, traditional software providers are increasingly finding the need to turn away from selling software and towards becoming Software-as-a-Service providers. This is a dramatic business change for most software vendors because it means a change from selling products to selling services. Unfortunately, many SaaS providers focus all of their energy on changes needed in their technology and ignore a critical factor in the success of their SaaS product: changes to the business environment.
In the traditional software sales model, software vendors rely on relatively large initial cash influxes from an initial sale in order to fund the implementation and service efforts that follow. This puts the risk of loss squarely in the hands of the customer. Whether or not the customer continues to use the product, the software vendor already has customer’s cash in their bank account. In the SaaS model sales are typically subscription based, and the risk of loss shifts to the SaaS provider. Customers enjoy the benefit of little or no initial investment in the product as revenue is spread out more evenly over the life of the subscription. Customer retention now becomes the name of the game for the SaaS provider in order to recover the cost of the sale over a longer period of time. SaaS providers must also carefully evaluate core business components, such as sales and marketing, service, and finance to reduce costs on the front end of the sale that impact cash flow. Finally, in every area of the business there must be a paradigm shift in the way the company measures success.
Sales and Marketing
SaaS providers need to get creative in terms of generating leads. The delayed cash flow caused by the subscription model may prevent the provider from investing in traditional advertising and marketing efforts (which may not be the most effective marketing methods anyway). Luckily for SaaS providers, they have instant access to how consumers use their application. This valuable information should be used by the provider in their development efforts to give consumers what they want based on their own behaviors.
SaaS providers must decide on a pricing strategy. Pricing in a SaaS environment should never be “set it and forget it”. Pricing should be reevaluated as providers enter new markets, add new features, and add new products. The pricing should be simple as well as easy to understand and measure.
One trend in SaaS is referred to as Freemium. Rather than spending money on telling consumers about the features and benefits of their applications, SaaS providers can give away a simplified version of their application for free. This allows the consumer to become familiar with the application before spending any money. Often, the consumer has an investment of time in the configuration and/or data input when using the free version of the application which makes it much more likely that the consumer will upgrade to the paid version of the application when the need arises.
Whether pricing is flat rate or based on users, transactions, features, or storage, most SaaS providers offer a “try before you buy” option. This allows the customer to understand the true value of the application before they purchase a subscription.
Face to face selling by traditional salespeople can cause the cost of sales to be prohibitive in a SaaS environment. Service sales are typically driven by referrals, so customers become an important part of the Sales Team. Everywhere you turn as a consumer these days, you are being asked if you would recommend XYZ product or service to a friend or colleague. This question comes from years of research by Fred Reichheld, Bain and Company, and Satmetrix who determined that customers can be classified as promoters, passives, or detractors. Promoters are customers who are considered loyal enthusiasts and will proudly promote a product or service that they have benefited from. Sales resulting from these referrals are ideal for a SaaS provider. Accordingly, investing and focusing efforts on providing exceptional service to create loyal customers is an excellent way to increase revenue and lower sales and marketing expenses.
Creating Customer Loyalty
Customer renewals are critical to the success of a SaaS provider; therefore, keeping customers is just as important as getting them. That fact requires SaaS providers to behave less like software providers and more like service providers. Successful SaaS providers focus on their customer’s success and satisfaction. SaaS providers must ask themselves questions like “What can I do to help my customer’s business grow?” and “How can I give my customer the tools they need to succeed?”. Delivering programs that drive customer adoption by providing those tools is a great way to gain sales while helping the customer. These programs can include webinars, online resources, training, etc.
In order to measure success, SaaS providers must have open communication channels with customers. Applications should include functionality that encourages and makes it easy for customers to provide feedback. In addition to inviting feedback when transactions occur (transactional feedback), customer loyalty should be measured through regularly sending surveys to customers (relationship feedback). The information ascertained from the surveys should be maintained in a database and analyzed regularly for new opportunities. A system needs to be implemented to address negative feedback immediately in order to repair the customer relationship.
In addition to direct feedback from customers, efforts can be made to track customer activity within the application. Trends can be identified to indicate which customers are successfully using the product and which customers have the potential to be unsatisfied with the solution based on their usage. As with surveys, followup with these customers is vitally important.
Because of the cash flow cycle inherent with a SaaS offering, where revenue is collected over the course of the contract rather than up front, finance must be handled differently than that of a traditional software company.
When it comes to properly accounting for revenues, expenses, and assets, the areas of revenue recognition and capitalization of software development costs specifically need to be addressed.
Software revenue recognition guidance often doesn’t apply to SaaS arrangements because customers usually do not have the ability to take possession of the software at “any time” during the hosting arrangement. Therefore, software vendors will need to rely on alternate guidance to ensure revenue is recorded properly.
Capitalization of Software Development Costs
Because the technology developed in a SaaS environment is done so to support the service offered by the SaaS provider, a portion of the development costs should typically be accounted for under ASC Subtopic 350-40, Internal Use Software. This differs from the way independent software vendors record software development costs.
Despite the many advantages to the vendor of a SaaS offering, the fact that cash is not received as quickly in a SaaS environment as it is in a traditional software environment requires those in finance to pay very close attention to metrics that will predict future revenue and cash flow. One of the most valuable metrics to review is churn rate. By knowing which customers failed to renew their subscriptions, finance leaders can not only more accurately forecast, but also manage the measure and use the information to reduce the churn rate. Remember, customer retention is the name of the game in a SaaS model.
Given the cash challenges that can present themselves in a SaaS model, special attention needs to be paid to shortening the order to cash cycle. Just a few areas to focus on to accomplish this are invoicing and collecting receivables. Automated billing and automated payment tools should be employed to increase administrative efficiencies and collect cash from customers as quickly as possible.
On-premises software providers should be asking themselves if they could benefit from investing in the modifications needed to migrate from an ISV to a SaaS provider. If so, proper attention should be paid to product engineering as well as the core business functions necessary for success. How a SaaS provider generates leads, what pricing strategy will be used initially, and methods to utilize customers as referral sources need to be explored.
Because customer renewals are critical to success, creating loyal customers through excellence is service delivery is also a must. Finance in a SaaS environment should be viewed through a new lens. The accounting treatment advantages inherent in the SaaS model should be exploited, new metrics should be analyzed, and processes should be streamlined. There is no denying that SaaS is the way of the future for delivery of many software products. Independent software vendors can certainly thrive in a SaaS world if they focus on the changes that need to be made across the business as a whole.