Sunday, September 23, 2007

Hard Reality: SaaS - Efficiency = Failed Business Model

As consultants we often see situations where software as a service (SaaS) and e-commerce companies' business model expectations are felled by cold hard technical realities.

The naive business point of view usually goes something like this (with obvious simplification for illustrative purposes): Revenues will rapidly grow at an exponential rate (either through organic growth, traffic acquisition, or adding new business lines) and costs will slowly grow at a steady linear rate. Sounds great, doesn't it? Despite protests from the technology group that those aren't sound fundamentals, executives will surprisingly forge ahead with this kind of thinking when drawing up their business plans and forecasts.

But as things unfold they face the reality that costs are growing just as rapidly as revenue and operational complexity is bogging down the business. In some situations the compounding complexity actually gets so bad that they hit an inflection point where costs and complexity can block further growth. In a few situations, such as companies who are lucky enough to have the "oversized" economics of a hit service, this surprising growth in costs can be masked by tremendous profit margins. But for the rest of world, this inability to get (or widen) that separation between those revenue and cost curves ends up taking much of the sheen off of the SaaS and e-commerce business models.

The knee jerk reaction is the obvious one, tell the technology group to cut its costs! If they haven't already done so, the first move tends to involve strategies like migrating to open source software on commodity hardware or moving their expensive "resources" (i.e. their people) off-shore. These moves often provide the big slashing cuts that give a CFO instant gratification. However, their weakness lies in the fact that they are essentially a one shot weapon. It doesn't fix the fundamental problem. Costs are still on the wrong trajectory.

To get to the heart of the problem the focus needs to be placed on making efficiency of operations a core competency. Without these efforts, including the extensive implementation of formalized automation, the long-term success of most SaaS and e-commerce business models will fall into question. And this effort, which doesn't come without expense, needs to be applied upfront. We see too many cases where automation and efficiency are mere afterthoughts to development and marketing.... until its too late and the business is already under dangerous strain.

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