The Missing “S” in SaaS firms Go To Market Strategy

Traditionally, software product firms have relied on license fees as main revenue stream. It provided a healthy gross margin and a product can be reused. With onset of SaaS based firms, the focus has shifted to consumption/subscription-based model which includes both price of product and its underlying maintenance and support services. However, several firms count SaaS revenue as product revenue. Thereby there has generally been a confusion between product and service revenue.

As SaaS product firms sell their products to enterprise customers, they recover most of their product cost initially, but over time the revenue shifts towards services.

However, the revenue composition in Software Product and SaaS firms are changing at rapid pace. In last decade or so, we have seen several firms including giants like SAP, Microsoft etc. shifting their focus towards service-based revenue.

Product revenue eventually falls behind service revenue in the long-term

In a paper written in 2008 by M.A Cusumano, the author has done various analysis and compared product vs service revenue over a period of time. His main intention of the research was to validate if fundamental changes in business model are behind the gradual shift to Services revenue. He concluded that optimal mix of product vs service revenue is in ratio of 70:30 (product to services). However eventually the product revenue will fall behind services revenue.

That was 2008. Fast forward 12 years to 2020. Recently Cisco announced its quarterly results where product revenue was down by 13% and while service revenue was flat (due to Covid), it gained as a percentage of overall revenue. Cisco saw growth in its maintenance business as well as support services.

Services revenue are growing because there is lot of focus on implementation, support and advisory services. Many product firms use alliances and channel partners like SI and consulting firms to tap in the expanding market. That’s why you see firms like Oracle, SAP etc. move beyond product and now have full-fledged services arm ranging from consulting, SI and support.

Days of Free Software

Software Product/SaaS Industry have revolutionized several times in last few years. The firms are focused on delivering software at low costs to increase customer footprint. The idea is to commoditize software so that prices are cheap for customers to buy them and revenue shifts towards services. We already see several free software/SaaS products with indirect revenue model through advertisements as an example. The future may really be about free software or inexpensive. Some-day soon, firms may offer various software or hardware for free and just sell services or some kind of subscription. The cell-phone industry is an example.

But why is there a shift toward services? In the same study by M.A Cusumano, he argued that it is happening because software firms are getting older and after existence for around 2 decades it’s likely that service and maintenance revenues exceed product revenues. The other reason can be that growth rate of service revenue is faster perhaps because the as number of new customer falls, product revenue has a steep fall.

The missing “S” in software product/SaaS firms. Shifting to Services requires planning.

As product firms shifts towards services such as product customization and complex integration work, or strategic consulting and training, it can become a drain on profits until the product companies gain enough scale and experience to perform these services efficiently. Several firms struggle to maintain the right balance. SAP and Oracle would pass this test. Both are very profitable and have only about one-third of their revenues coming from new product license sales

Initially the shift towards “Services” can be drain on profits generated through products sale. However, a well planned strategy will result in scale of service operations

This means that software product and SaaS firms should treat services as a strategic area and should take advantage of it, and not just let services “happen” because their product business declines.

By contrast, too many product firms seem to treat services as a necessary evil and manage them as a cost centre, without much creativity or effort to grow that part of the business.

What can SaaS firms do to build right focus towards Services?

First and foremost, SaaS firms needs to put Service strategy in forefront as they embark on the growth journey. It is essential to build right sales team who can sell annuity-based product and associated services. The firm will need to focus on building partnerships and alliances with SI and consulting partners. It needs to invest in customer servicing and onboarding.

Sales cycle for software product is long and mostly requires to be savvy with IT leadership. Service/SaaS sales is quicker and expects faster streamlined service. The buyers range from IT to business. The investment in building inhouse teams to support service sales will include developing joint offerings, POC’s and solutions with partners. Partner ecosystem for on premise is mature and is combination of system implementation and maintenance and upgrades.

As SaaS scales, cost of customer acquisition goes up resulting in cash flow problem. Initial cash burn out is high. Balance between revenue and growth is key. Focus on long term economics and short-term profitability. Investments impact profit in short term but important for long term.