aSaaSination revisited

Jason Wood looks at the Netsuite IPO in some detail.

Given the dearth of attractive software IPOs, there’s little question that NetSuite will be a sought after issue and get banked by the top bulge bracket banks. But is it reasonable to expect investors to pony up a valuation similar to what CRM received?

I will leave the valuation to the experts, but I was struck by the size of the marketing and sales spend

In a filing with the Securities and Exchange Commission, the provider of on-demand enterprise-resource planning software reports solid revenue growth: from $17.7 million in 2004, to $36.4 million in 2005, and then $67.2 million last year. But up until last year, sales and marketing costs always exceeded revenue: $27 million in 2004, and $39.2 million in 2005. Last year, sales and marketing costs were $43.9 million, or 53% of revenue.

That’s not unusual. Salesforce.com’s sales and marketing costs, for example, typically hover between 50% and 70% of revenue, according to past financial statements. That’s huge compared to traditional software vendors where sales and marketing costs typically run between 20% and 25% of revenue

What happened to all of that bit of the creed where SaaS would be driven by viral user adoption rather than herds of sales people? 

Phil Wainewright picks up on the relatively high running costs

bigger problem for NetSuite though is its cost of revenues, which is what it spends on running its hosting operations and on professional services. When Salesforce.com had its IPO, it was reporting costs of around 18% of revenues (it has since risen to 24%). NetSuite’s costs were 34% of revenues in 2006, falling to just below 30% in Q1 2007. Unlike Salesforce.com, NetSuite doesn’t break out the professional services element of that figure, but that is likely to be the larger component and it’s difficult to see it reducing significantly in the near future since NetSuite has been targeting larger customers with more complex implementation requirements. Meanwhile, NetSuite faces higher hosting costs in 2008 as it plans to add a second hosting center — something that Salesforce.com already did a year ago

If marketing and sales are running at 53% of revenue, and the cost of running the system is at 34% then that doesn’t leave a whole lot over for R&D.

Those that challenge the “traditional” vendors ought to have a field day with these numbers. To paraphrase “Where is the innovation in the dollar invested if more than three quarters of revenue goes on sales and marketing and hosting costs?”

I’m not dismissing SaaS.  It is a very effective way of delivering applications, and by my reckoning it will become more and more important. It is already disruptive. Josh has a thoughtful look at Netsuite here. (Not sure about the iphone bit though)

Meanwhile, as disruption is looming in the maintenance side of enterprise software, NetSuite is heading to market with an on-demand ERP offering that tries to disrupt the key delivery model of enterprise software. Of course, NetSuite is just the latest in a list of disruptors, starting with Salesforce.com and SuccessFactors, and I have always felt that NetSuite is missing a lot of what would make it a truly competitive offering vis-à-vis the suite applications that it competes against.

But with the smart money pegging this as a potential billion-dollar IPO, the “on-demand ERP for the mid-market” disruptors are firing all over the market. And no where more strongly, and disruptively, than at SAP itself.

I refer, of course, to SAP’s much-vaunted A1S – the iPhone of enterprise software. This on-demand ERP system, which deploys in a fully-model driven way, is, in my opinion, a real NetSuite killer, once it hits the market. The demo I saw of A1S was truly impressive, and I believe that it will meet expectations when it hits the market later this year or early next.

SaaS isn’t magic though. You still need to sell and run it. Call me old fashioned but a bit of profit, or at least the hope of some isn’t a bad thing either.

 

Whatever happens with Netsuite and its IPO, we are in for interesting times….

 

 

 

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4 thoughts on “aSaaSination revisited

  1. Thomas,

    Unfortunately, the majority of software firms which invested more in product development lost out to those which invested a greater proportion in marketing. Am sure if someone did some analysis on this, my theory would be proven!

    Sunil

  2. Sunil,
    not necessarily.
    Spending more than you earn on marketing is not a sustainable model.

    software success is often linked to the right marketing strategy, but this doesnt equate to marketing spend. I’d guess that Apple spent plenty on marketing the Mackintosh, but the problem was one of strategy not spend.

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