A marketing professional asked me recently how much capital is required to successfully market a software-as-a-service (SaaS) solution.
What first popped into my head was the beautiful Irving Berlin standard, "How deep is the ocean? How high is the sky?"
Access to capital to fund customer acquisition is undoubtedly one of the more significant challenges for SaaS companies. The root of the problem is timing. You need to spend money on sales and marketing now, but the payoff is stretched over the lifetime of the customer's subscription. You need to fund that gap between current expenses and future revenues.
So how big is the gap?
I looked at the experience of two well-established publicly-held SaaS providers for insight. Salesforce.com provides on-demand CRM and is a high-profile SaaS pioneer. Concur delivers an on-demand expense management solution and made the transition from a traditional on-premise license model to a SaaS model in the late 1990's.
I focused, in particular, on the companies' annual spending on sales & marketing relative to their annual subscription revenue. It's not a comprehensive assessment of capital requirements and it does not account for their requirements to fund development, operations, or other functions. That said, however, when sales & marketing expenses exceed subscription revenues, capital from some outside source is needed.
1. Required ingredients: an effective customer acquisition model, capital and courage
In the case of both salesforce.com and Concur, their sales & marketing expenses exceeded subscription revenues during their early years, sometimes by as much as 500%.
Both companies persisted however to spend aggressively, confident that they had a well-functioning customer acquisition model in place. That is, they believed that feeding one dollar into the sales & marketing machine would generate more than one dollar in revenue over the lifetime of the customer.
In addition to an efficient sales & marketing machine, both companies had substantial backing from outside investors to fund the initial spending on customer acquisition. Concur also had resources from its existing on-premise license business.
Access to capital to fund customer acquisition, in fact, represents one of the most challenging barriers to success for any vendor in the SaaS market. They should expect that sales & marketing expenses will exceed development, operations, or any other corporate expense.
In the case of salesforce.com and Concur, the access to deep pockets of capital was matched by a deep well of confidence. Company management and patient investors had the confidence and courage to fund early losses, and resisted the urge to "lift off the accelerator."
2. The crossover point is typically in year three
For both salesforce.com and Concur, annual subscription revenues first exceeded annual customer acquisition expenses during the companies' third year as a SaaS provider. At this crossover point, one dollar spent on customer acquisition yielded one dollar in subscription revenue. The companies needed adequate capital resources to fund more than two years' of feeding their sales & marketing machine before realizing a positive return.
3. Spending reaches a plateau
Once they reached the crossover point, both salesforce.com and Concur have continued to spend substantially on customer acquisition. Saleforce.com's sales & marketing expense has remained consistently above 50% of subscription revenues, and Concur consistently spends nearly 30% of revenues on customer acquisition. In other words, while development and operations costs have declined proportionately as they're spread out over a larger customer base, spending on sales & marketing remains consistently high.
There are certainly some economies of scale for sales & marketing spending: a webinar for 1000 people doesn't cost much more than a webinar for 100 people, for example. But SaaS companies should expect to continue to aggressively fund their customer acquisition efforts. Like sharks, even well-established firms need to keep moving forward or die.