Charles Zedlewski is one of a handful of bloggers I selfishly wished blogged more often (before the jokes start, yes I realize I firmly deserving of that label too, of late). Every time he puts fingers to keyboard, I know I'm in for thought-provoking analysis.
With the recent rash of SaaS filings, Charles decided to look at the costs associated with the SaaS model and whether or not the "pull" aspect was in fact playing itself out.
What struck me with all three companies was the losses. The first order explanation is quite simple: all the companies spend a ton of money on sales & marketing (between 65% and 100% of revenues). Most of these businesses are the farthest thing from the oft discussed but seldom witnessed “pull model” that’s supposed to lead to superior profits.
The root cause for the losses is a little more subtle. In a recent article, McKinsey consultants asserted that the primary cause is scale. In fact they go so far as to say that these scale economies are nearly identical to those of on-premise software companies.
It's hard to argue with Charles' conclusion, which is that, at least to date, SaaS vendors have foregone margin as a trade-off for growth.
I also wholeheartedly agree with him that it's a question of scale and, Salesforce.com is approaching a point where they will need to make good on the promise of margin delivery. As long as the incremental spend translated one-for-one to the top line, one could make a logical case to continue, but now that the marginal utility of each additional SG&A dollar is driving less than a dollar in revenues, show me the profits.
Note: This is not a recommendation to buy or sell any publicly-traded security nor is it a recommendation to participate (or not to participate) in upcoming IPO offerings of Constant Contact, SuccessFactors, NetSuite or any other company. This discussion is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, maintained a long equity position in CRM and, through a passive investment in a venture capital firm, have exposure to SuccessFactors (privately held). We may, or may not, have interest in participating in the IPOs of these companies or other securities listings. At times, we may maintain derivative options as a hedge on underlying positions.