SaaS Professional Services finally finds its footing
by David Hofferberth and Jeanne Urich, SPI Research
The year 2010 will go down in history as the one that Software-as-a-Service (SaaS) professional service organizations (PSOs) trumped enterprise software PSOs. One of the most significant changes in 2010 has been the dramatic shift of embedded SaaS PSOs from cost centers to profit centers.
Based on changes in accounting policies for multi-element contracts, SaaS software providers were forced to unbundle PS revenue from license subscription revenue. This significant change resulted in most SaaS PS organizations transitioning to become profit centers.
Remarkably, the 19 SaaS PS organizations that participated in SPI Research’s 2011 benchmark survey delivered the highest net profit of all PS sub-verticals at 23.1 percent, compared to eight other industry segments (software, hardware and networking, IT consulting, management consulting, accounting, marketing and advertising, architects and engineers, and other PS) with an average net profit of a measly 6.4 percent.
According to Software Equity Group’s Q3 2010 Software Industry Equity Report, “By the close of the third quarter, the annual median trailing 12 month revenue growth rate of public SaaS companies had plummeted to 13 percent from 23 percent a year earlier and 46.5 percent two years earlier.”
Two of the fastest growing SaaS firms, Salesforce.com and Citrix, both grew past the billion-dollar mark. Based on their now considerable size, it is unlikely they will continue to post their early-stage meteoric growth rates. As the SaaS market matures, SaaS providers are making trade-offs between torrid revenue growth and profitability.
The significance of a maturing SaaS market means these firms are starting to focus on running PS more efficiently and profitably. As SPI Research predicted, the shift to running PS as a profit center within SaaS organizations is well under way. It is only a matter of time before all SaaS PS organizations shift to a profit focus.
Turnabout is fair play
In the 2010 benchmark, independent firms significantly outperformed captive (embedded) service organizations, but embedded service organizations came roaring back in the 2011 benchmark! A big change this year is that the best-performing embedded PSO is Workday, a fast-growing SaaS provider of human resource management solutions.
In the past, the best-performing embedded PSOs were always within enterprise software companies, not within SaaS companies that, up until now, had positioned PS as merely a channel to rapidly implement clients so they could secure lucrative multi-year subscription revenue.
The cloud flies high
One of the most interesting trends is the service sector movement towards deploying cloud-based solutions. Both large and small PSOs demonstrate a strong preference for SaaS-based solutions with 39 percent of the organizations expressing a preference for SaaS as compared to 29 percent preferring on-premise applications. The remaining 32 percent had no preference.
For firms planning to move their applications to the cloud, SPI Research found the average timeframe for the planned move was less than two years. This trend is gaining momentum, and SaaS will become the primary method of PS application consumption within five years.
SaaS PSOs take advantage of remote service delivery
One of the primary reasons for the surge in SaaS PS profitability is the fact that these organizations are able to deliver the majority of their projects remotely. This means they can take advantage of lower-cost home-based and offshore resources. Additionally, remote service delivery allows these organizations to achieve much higher billable utilization without the burden of non-billable travel. SaaS consultants and project managers alike are adept at multitasking which means they can handle multiple clients per day.
The trend towards more off-site work has been facilitated by cloud solutions, lower cost offshore and near-shore consultants, client and service provider desire to reduce travel and facility costs, and by the power and ease of use of remote service delivery tools.
SaaS PSOs have a unique advantage in delivering the majority of their services remotely:
- SaaS PSOs billed the least hours on-site (23 percent) while hardware PSOs billed the most (56 percent).
- SaaS PSOs reported the highest number of billable hours per consultant (1,399) while hardware PSOs reported the least (1,251).
- Hardware PSOs spent the most hours per consultant in administration and non-billable project hours (616) while SaaS PSOs spent the least (458).
- SaaS project managers were able to concurrently manage the most projects (6.8) while management consultancies managed the least (2.7).
A comparison of workforce location provides insight into the future world of work in the PS industry. SaaS PSOs are a harbinger of the new world of IT services. Although most have headquarters in North America, 30 percent of their PS workforce is located offshore. Most SaaS companies co-locate offshore PS and engineering staff to take advantage of lower cost and the availability of technical skills. The following chart shows hardware PS providers take the least advantage of home-based and offshore consultants (only 13.8 percent of their workforce) while SaaS PS providers take the best advantage of home-based and offshore consultants (45.3 percent).
For SaaS companies, the ability to co-locate PS, engineering and support groups provides unique advantages in assuring new client requirements and customizations are incorporated and supported within a single multi-tenant architecture. For SaaS companies, co-location of PS, engineering and support improves collaboration and career advancement opportunities.
The dark side of SaaS PS
Unless Saas providers find a better way to capture client requirements and model business process change, the downside of SaaS PSO dependence on remote service delivery shows up in the lowest percentage of on-time project delivery, at 68.2 percent, along with the highest frequency of project overruns in our survey at 23.8 percent. This is significantly higher than the project overruns shown in management consultancies where only 7.3 percent of their projects experience overruns.
Despite the hype, SaaS projects take almost as long (4.6 months with three consultants), compared to enterprise software projects (five months with four consultants) and because SaaS providers generally charge higher bill rates, their projects cost more ($184K on average) compared to enterprise software projects ($154K). SPI Research also found PSOs within SaaS companies reported the highest percentage of billable work that had to be written off in the survey (5.4 percent), while those within hardware and networking companies reported the lowest (1.6 percent).
SaaS providers still have a way to go
Given the “youthfulness” of the SaaS market, as these organizations mature, particularly in estimating, project management, quality and on-boarding, this improvement should positively impact revenue and profits in the near future. For instance, SPI Research found that because the market is still relatively new, the sales cycle for SaaS providers is significantly higher (110 days) than the survey average (98 days).
Fortunately, many SaaS providers have learned from years of experience in other software markets and have constructed their organizations to succeed in the long run. For instance, SaaS providers showed the highest percentage use of a standardized delivery methodology at 67.5 percent, when compared to the survey average of 57.7 percent. They also demand higher sales productivity, with service sales reps averaging slightly under $1.5 million per year in service quota.
And finally, because the market is relatively new, SaaS providers are expanding their new client base at a much higher rate (50 percent compared to the survey average of 37 percent) than their competition in other markets. This expansion will enable them to continue to grow faster than most of the firms in the survey, who primarily rely on add-on sales to existing clients.
Expect the young Saas to last
Software as a service is no longer a fad. As every industry has begun to rein in runaway technology deployment costs, SaaS appears to be the magic bullet. This movement does not assure all SaaS providers of long-term success because eventually their markets will become commoditized and growth will slow. But in the near future, they represent one of the hottest sectors of the PS market and are proving SaaS clients are willing to pay high rates for rapid deployment.
SPI Research believes this market has just moved into the hyper-growth phase. If SaaS PS providers can efficiently deliver high-quality services, there is no reason this market will go anywhere but up.