Nothing's perfect

(Part one of this series was called SaaS: First, the good news)

While there are many inherently good things about the SaaS (Software-as-a-Service) business model, there are also some unique challenges.

Higher cash requirements (Please deposit $24 for the next minute…)

SaaS companies can be very cheap to start, but because they tend to produce recurring (usually monthly) revenues rather than large lump-sum payments, it’s hard to use current cash to finance future growth. VCs often assume that it takes about $50 million to build a profitable SaaS company. Assuming a 4 year path to profitability, you’re burning through $24 a minute. This problem is made worse by…

…Lower price points (including FREE)

Because they’re typically based on a subscription model, SaaS companies try to maximize lifetime customer value through a low entry price and a long subscription duration. This approach, combined with intense competition and strong customer expectations that online content and services should be free or extremely cheap, means in order to reach profitability…

…You gotta have scale

If you’re entry price point is free (or something close to it) and you’re relying on some advertising revenue plus conversion to higher priced offerings (a conversion rate of 1% of your total customer base is considered typical) then you have to be able to attract and retain a very large number of customers before you’re in the black. That means your infrastructure and application need to be engineered accordingly, of course. But more importantly…

…Customer acquisition will be a major expense

While the online nature of SaaS suggests a pure online selling strategy, the reality is that SaaS companies tend to be very omnivorous in their drive to acquire customers. Between PR, search engine optimization, keyword advertising, webinars, email campaigns, reseller compensation, and other direct and indirect sales efforts, you could easily be spending 2/3 of your money on sales and marketing expense. To get a return on this investment, especially in the early days before your market matures, you’ll need to reach and convert a pool of savvy and influential people who prefer your vision of the future to that of your many competitors. In other words…

…You’re competing for the attention of Influencers, not just customers

Early customers are different. They know that others look to them for guidance about which technologies or services to adopt, and that their opinion counts. They will be very hesitant to risk their reputation on a company that doesn’t deliver a good experience and good value to their friends and colleagues. To be successful, you’ll need to build specific programs and efforts for reaching, influencing and recruiting these early adopters. These programs may be very different (and much more expensive, on a cost-per-customer basis) than your “typical” customer acquisition programs.

More on this in a separate post.