Ray Lane, of Kleiner Perkins writes, More than a change in pricing or business model, software as a service is an inevitable, fundamental shift in enterprise software culture. Excerpts from the powerful article with edits and my comments added:
Software as a service is transforming the IT industry. It’s more than a new way of pricing or a business model change, it will drive a whole new mindset for enterprise software suppliers and customers. Software as a service does not refer to ASPs – although they are a big part of it. It is defined as tying supplier revenue to a business outcome- the supplier sees the client’s end result, measures its success, and receives revenue based on the results achieved. This doesn’t necessarily mean success-based pricing, however. It can be subscription, or even license based. In some cases, a company offers to sell a service. Negotiations can take place around buying the intellectual property, but the company can buy a software license and pay the supplier to operate it. There exists a lot of examples of companies that are offering a service with very complex software behind it (Amazon, EBay, iTunes, SalesForce) - even if the customer owns a license (Elance, Oracle Online, Siebel On-Demand). These suppliers focus on selling knowledge – not bits.
In the past, discussion between customers and sellers were about not "pricing", but prices: They’re just too high. Now it’s a different conversation: Do we have a pricing model problem? Do we have a business model problem? Do we have an impedance mismatch between price and value? Would there be a competitive advantage to having a subscription-style pricing model? Customers are in control. They’re forcing suppliers to compete with each other; they’re demanding lower prices and more accountability for results. A service delivery and pricing model gets software vendors out of the "hockey stick" sales dynamic at the end of the quarter. It gets the customer out of having to buy something before they can use it. A move to a service model means the reputation of the software industry improves. If the transition occurs gracefully, customer satisfaction will grow, profits will grow and become more predictable and, ultimately, the industry will grow from real demand by customers when the technology is actually needed and consumed. How does a large supplier avoid a share price haircut when converting to a service model?
- First, this doesn’t happen overnight.
- Second, it requires education of public market analysts about the development of long term profits and cash flows.
Analysts recognize that if you’re a software company that can grow 10 to 15 percent a year and increase profits and free cash flow, that you’re a good investment.The days of make money quick is gne, but the software industry is still a better investment than most any other industry, and will be for a long time. Ray's advice to startups: As a startup, if you’ve got the right funding, start off as a service business, using subscription pricing. You won’t have to defend your history. No problems of changing business models. You will need to invest up front before you see the benefits, but once you do, it’s beneficial to customers, investors and management. It’s a much more predictable model. And it’s the way we’ll all be doing business in the future. Software-As-A-Service is the future reality and early embracers would benefit a lot - as we wrote previously The Paradox Of Technology Industry Solutions As Commodities continual innovation and high growth shall ensure the constant evolution of the IT industry and the service revolution would add a new dimension to the growth of the industry.