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Understanding the “SaaS Gold Rush”

There’s plenty of speculation about just how much opportunity remains in SaaS, whether today’s seed funded startups can still “strike it rich”. No, the Gold Rush isn’t over. It’s just changing shape, changing direction. And taking a look back at the evolution of SaaS helps explain where we’re headed.

I’m going to preface this article by stating that we should all be skeptical of industry commentary like this. They have a tendency to generalise and imply that we’re unable to set new precedence, which is not the case. Anyone fortunate enough to work in our industry has the potential to do great new things, regardless of any wider industry trends.


Salesforce is 17 years old

From the birth of SaaS, we’ve seen three generations take shape, and we’re currently in the third.

Even in the second generation, founders sometimes didn’t realize that there could be such a huge opportunity ahead of them. Here’s an early email exchange between Zendesk co-founder Alexander Aghassipour, and Zendesk’s angel investor Christoph Janz, discussing their Series A round. The first message is from Aghassipour, the second from Janz.

SaaS Gold Rush
Source: Christoph Janz’s blog, The Angel VC. And disclosure: both Christoph and Alexander are investors in ChartMogul.

This is a founder of Zendesk, at the point when the company has ~1,000 customers, doubting that they could grow to be a huge company. Now, in hindsight, it seems inevitable of course. We’ve seen Zendesk grow to having over 80,000 customers, all while SaaS steadily takes over the software industry.

But it seems, at this point in time, we’re questioning the opportunity in SaaS again. Nearly all new business software being built today is SaaS. But in conversations amongst peers and in articles on Medium, people are asking, “Is the SaaS gold rush over?”

The answer is no. There are still enormous, unrealised opportunities ahead for SaaS.

SaaS Gold Rush
[Source: Bessemer Ventures]
Spending on on-premise software has been contracting at 3%, while SaaS has been expanding at 18%. This leaves an aggregate growth rate of about 15% for enterprise software — it’s all being driven by SaaS. Growth in the future may well be more aggressive.

“IDC expects cloud software will grow to surpass $112.8 billion by 2019 at a compound annual growth rate (CAGR) of 18.3%. SaaS delivery will significantly outpace traditional software product delivery, growing nearly five times faster than the traditional software market.” – IDC

So you could say the gold rush in SaaS can’t be over — we’ve only got 30% of the market and it’s growing like crazy. We’re definitely not at peak SaaS. So the more apt question is: How much of the market that’s still up for grabs is going to be taken by new SaaS companies, rather than soaked up by existing SaaS players? E.g. public companies such as Salesforce, Zendesk, HubSpot or Workday, or some of the larger private SaaS companies?

Will SaaS companies being seed funded today be able to go big?

The answer here is yes, but it’s tricky. The dynamics are completely different from what came before. To understand our current environment and the opportunities on the horizon, let’s look at the evolution of SaaS through these three generations.

First Generation SaaS

What drove it?

The technology and business model of Software-as-a-Service was brand new and disruptive. It allowed upstart companies to encroach on territory held by on-premise giants. The value proposition was clear: SaaS removed the need for on-premise installations and ongoing maintenance.

Who were some of the players?

  • Salesforce in CRM, competing with Siebel, SAP and Microsoft
  • NetSuite in ERP, competing with SAP and Oracle

Advantages and disadvantages to being in this generation of SaaS

The greatest advantage to being in the first generation of SaaS was that every vertical was a green field. But to take over some of that territory, these players faced the obstacle of educating customers on the SaaS model and convincing them away from long-standing, trusted on-premise solutions.

What was the result? How did it change the game?

As both customers and other software companies became aware of the benefits of the SaaS model, legacy vendors began releasing their own SaaS offerings, e.g. Quickbooks Online, sometimes via acquisitions. The SaaS model was here to stay, and it would keep spreading.

Second Generation SaaS

What drove it?

Here things really started taking off. The second generation still rode a similar wave as the first. The SaaS value proposition still included that there is no installation or maintenance. When I joined Zendesk back in 2009, we still had to explain to many customers that there’s nothing to download, that it’s “Software as a Service”. This was a new concept for many buyers.

But beyond this, new trends emerged that added even more value and fed a lot of growth for the second-generation companies. The second generation of SaaS ignited the consumerization of enterprise. The consumerization of enterprise is the ongoing shift in enterprise software towards lower cost and ease of use, trends pioneered in the consumer world. Users began demanding a friendly interface with a self-service and ease of use that legacy providers couldn’t adapt and provide quickly enough. So a new generation of SaaS rushed in “to satisfy this human desire for well-designed products.” (Forbes)

“2014 is proving to be the year […] with a large wave of new-generation SaaS apps that really deliver on a delightful user experience. Employees and managers are taking notice of these new user-friendly tools, causing adoption to explode from the bottoms up.” – David Skok, ForEntrepreneurs.com

The ability to deliver software via the web browser (and the release of frameworks such as Ruby on Rails) was the technology shift that helped ignite this trend. At this point, the value proposition expanded to include better design than existing solutions, a better user experience, more cost savings and simplicity.

Who were some of the players?

  • Zendesk in Customer Support
  • Box in Storage
  • Hubspot in Marketing
  • Basecamp/37Signals for Project Management

Advantages and disadvantages to being in this generation of SaaS

A “consumerized” SaaS product is easy for potential customers to try, use, and buy on their own. As a result, the addressable market for these software categories is much broader than before. Second-generation SaaS could scale down further to the SMB and capture parts of the market that on-premise and first-generation SaaS couldn’t or wouldn’t.

“The danger here for the Salesforce.com’s of the world is that corporate managers will choose which software to purchase based on what their direct reports use the most. Better interfaces are making it easier for startups and new companies to displace entrenched competitors.” – Darian Shirazi, Forbes in 2013

What was the result? How did it change things?

The consumerization of the enterprise set new standards for UI/UX in enterprise software. First generation SaaS began adopting better design, or attempting to. But second-generation SaaS really took design seriously and combined this with a lower starting price. And ultimately, this combination of design and low cost opened up markets so that SaaS growth began to rocket past other software models.

Third Generation SaaS — where we are now

What’s driving it?

Some of the main drivers of our current generation of SaaS are the further consumerization of enterprise and the low costs of both development and customer acquisition. New markets and customer types are opening up for SaaS solutions. You can organize them into the following three general buckets:

1. A few large categories still in transition. I can speak to the analytics market as that’s our field at ChartMogul. There’s no public pure-SaaS analytics company today. Tableau and Microstrategy, while have some cloud offerings, are still shipping Windows software. Perhaps this is because analytics has to work with fragmented and siloed data sets, which makes it harder to do a one-size-fits-all product; the onboarding and integration barrier is just higher.

2. Vertical SaaS. There are many verticals that were previously too small for a dedicated solution to make economic sense, but now — with the lower cost to develop and distribute software — they can support lucrative businesses.

EasyKeeper SaaS
An agricultural SaaS product for goat herders: www.easykeeper.com

Product differentiation is difficult in major categories, so the easier (and perhaps necessary) route is to go to a virgin vertical or market that doesn’t have a SaaS solution yet. This generation is seeking out green fields of sorts, verticals where the main competitor is often just Excel.

3. New categories that are only possible because of the cloud.

  • New communication and collaboration methods: Intercom, Slack
  • APIs: Clearbit, Algolia and Contentful

Advantages and disadvantages to being in this generation of SaaS

There’s been a lot of venture capital flowing into early stage SaaS companies. The SaaS market is also larger and more connected, with a lot of word of mouth between startups, which makes it easier and cheaper to get to $1M in ARR than ever before.

However, opportunities may appear to be smaller. Most of the market remains dominated by first and second generation SaaS. Crowded markets can mean less efficient growth, which means a rockier path to profitability and a longer shot at a successful exit. As a result, while it might be easier to get to $1M ARR than before, it may be harder to get to $100M, as at this point, there simply aren’t as many huge markets sitting there without a SaaS solution on offer. To murder a metaphor, there are fewer green fields but a lot of green gardens. Third generation SaaS companies will need to fight hard to find ways to break out of their cohort.

How are things changing?

This generation is shaping up to be the true consumerization of enterprise. Many first and even second generation SaaS still have poor UX and a high price. They were easier to use and cheaper than their original on-premise competitors. But the majority of these early SaaS companies still ignored the SMB space and instead focused upmarket, the more profitable end, but where elegant design is usually neglected.

Today’s SaaS is made for the “everyman” company, with pricing levels that favor the customer and suit practically any budget.

Also, on the other hand, the rise of API-based SaaS has given way to a whole new breed of product, one without any visual UI at all.

Beyond third generation SaaS: what’s the next frontier?

More vertical SaaS

Most new SaaS companies I’ve seen in the last couple of years are vertical SaaS. SaaS products today are much cheaper to build and distribute than previously, so one can now launch a vertical SaaS in almost any industry and have it be a viable small or medium-sized business, and a few will almost certainly scale into large organisations. We’ve still only scratched the surface of what’s possible. There are many untouched or unsaturated verticals, markets that are only starting to transition to SaaS, such as education.

Mobile-first SaaS

Very few mobile-first SaaS companies really exist yet. At ChartMogul we’ve asked whether desktop will remain king, or if a device-centric view is even relevant today, given the omnipresent nature of web services. For now there are mobile-first SaaS solutions for the construction and engineering industries, such as Closeout from Bridgit — for work and project management that must be done on the go. But whether a SaaS company can truly scale in mobile-first remains to be seen.

Innovating on existing legacy SaaS, a.k.a. SaaS Cannibalisation

We’re seeing this happen already in a few areas:

  • Typeform taking on SurveyMonkey
  • Pipedrive taking on SFDC
  • Slack taking on Yammer, Skype

The innovation catalyzing the disruption of legacy SaaS will likely have to do with shifts in UI or UX, such as a shift to voice or chat UI. Automation is also likely to play a large role. Companies that figure out how AI can perform part of functions like customer service, sales, or bookkeeping, could be highly disruptive to incumbent SaaS players.

Conclusion

The “SaaS Gold Rush” isn’t over — it’s evolving, finding new markets, models, and advantages. The latest generation of SaaS startups are tapping into new verticals, inventing new categories made possible by new technologies, and iterating on existing “legacy” SaaS solutions.The low hanging fruit (if it ever existed) is gone and the competition is so intense the opportunity to “strike gold” might be narrower, but can be just as real.

What remains to be seen is how much of the market will be taken by startups being seed funded today versus one of the public SaaS or top 300 private cloud companies (some listed here are now acquired or public).

That’s how gold rushes go. The possibility of striking it rich draws all of the hopefuls and upstarts to the field — but only a few will truly find success. The incumbent SaaS companies still have relatively modern technology stacks and the global sales and marketing teams to secure their current hold on the market. But if SaaS startups can innovate in such a way to disrupt this hold, as previous generations have done before, then the sky’s the limit.

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