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The SaaS market: as bad as Larry Ellison says?

In a recent earnings call, Oracle founder Larry Ellison "dissed" the SaaS industry, calling it a laggard that isn't really living up to the hype. "If you look at the leader, Salesforce.com, they don't make very much money and they've been at it for almost 10 years," he said in widely-reported remarks, adding that "it's hard to point to any software-as-a-service provider that's doing a good job of improving its profitability."

The irony, besides the fact that Larry has sunk a lot of his own gelt into Salesforce, is that Oracle finally made money from its own on-demand applications this past quarter.

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He admitted as much: "We continue to get better at it and grow the business," he said. "[But] it's not really growing any faster than our overall business," and it certainly isn't growing as fast as some had predicted, he noted sourly.

Well, what does go exactly as predicted, other than presidential elections in some communist countries? Is the SaaS business model, which is of great interest to CRM vendors, really destined for mediocrity?

"I bet if you dig around you will find a quote from Ken Olsen on microcomputers and personal computers that will look pretty similar," said Denis Pombriant, noted CRM analyst with Beagle Research when asked for his take on Sir Lawrence's judgments. "The point is that it's a paradigm shift, and early birds in these shifts don't always get wealthy, at least not right away."

Chris Selland, VP of Marketing and Business Development for more traditional software vendor EasyLobby and a long-time keen observer of the CRM scene, noted that currently, at least, "he's not wrong. SaaS is ultimately an economies-of-scale business--the first client is very expensive to bring up, but each additional client on a SaaS platform should have a much smaller marginal cost."

Profit margins should increase faster than revenue as the company scales, said Selland, "as opposed to traditional software where the relationship is more linear."

Marc Benioff, the former Oracle exec who runs the very Salesforce that Larry called out, shot back with both barrels. "I recommend you look at the continued organic growth annualized rates of our revenue, profitability, and free cash flow over the last decade versus traditional enterprise software companies achieving annualized growth through acquisition--backing out acquired revenue--versus annualized growth of acquired companies with the acquirer."

Greg Gianforte, CEO and Founder of RightNow Technologies, one of the more prominent SaaS firms in the CRM space, conceded Ellison's point--for now. "Ultimately, the SaaS business model will be similarly or more profitable than the traditional model due to the annuity nature of the SaaS business," he said.

Currently "SaaS firms are investing for growth and grabbing land," he explained. "If Larry could find a way to grow his business north of 30 percent I'm sure he would invest too. The fact is that his applications business and database business can't grow that fast due to their market maturity."

Most of those consulted agreed that we're at the beginning of something that's going to be a lot bigger in coming years, so ride out the low profits now. "The [SaaS] shift is compelling to the customer and the vendors are forced to streamline and sell greater volume," Pombriant noted. "That's the way of markets. If you wait around until a new paradigm is profitable I guarantee you will miss the market."

CRM guru Bob Thompson drew a historical parallel, saying "Amazon.com took the better part of a decade to turn the corner, as I recall. He's right that SaaS vendors aren't making much, if any, profit so far, but that's not unusual for fast growing companies. Even conventional software companies struggle in the early years. Internet businesses need time to scale."

SaaS is still at a relatively early stage of market development and acceptance, Selland pointed out: "As SaaS becomes more widely accepted, industry profitability should increase as well. I'm sure Marc Benioff would say the same thing."

Part of it is just structural, the nature of the beast. "Given the way revenue is recognized by SaaS firms versus traditional perpetual license firms, over the life of the contract versus all up front, SaaS firms will not generate lots of profit until these fast growth opportunities slow," Gianforte pointed out. "This is due to the way the revenue flywheel spins up in a SaaS firm ... I believe you will see margins continue to expand across the entire SaaS industry in well-run firms."

And as Thompson noted, it's one thing to listen to Larry, always an interesting interview, but "consider how Ellison invests his money. A different picture emerges. He's the major investor behind NetSuite, which recently went public and earned him a tidy increase on his investment. If not a true believer in SaaS, at least he's hedging his bets!"

And who says SaaS is the end of the road anyway? "Clearly the market sees potential for long-term profit in SaaS, which is part of the Next Big Thing--Cloud Computing," Thompson added.

Larry himself isn't a complete doomster either, truth be known. He sees hope. "We think that [SaaS profitability] is going to change over time," he conceded. "But the entire on-demand industry has to get better at making money in selling on-demand software."

--David Sims is contributing editor, Customer Interaction Solutions magazine.

by David Sims,

Contributing Editor, Customer Interaction Solutions
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Title Annotation:CRM, BPO & Teleservices
Author:Sims, David
Publication:Customer Interaction Solutions
Date:Sep 1, 2008
Words:895
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