SaaS Is Killing Old Software Companies, But It Isn’t Straightforward

The other day I listened to Scott Kupor (Andreessen Horowitz Managing Partner) and Ron Gill (NetSuite CFO) discuss what SaaS is doing to software sales. Ron Gill equated the change happening now in software to the shift from mainframe to client-server architectures. Specifically, Ron pointed out that the challenge is not just a software-architecture one, but also a business model one.

You see, companies founded before Salesforce.com (and even some founded later), basically sold perpetual licenses for their software. Their thinking was simple: the software hardly changes AND it really helps with revenue recognition (the entire amount is recognized instantly). If the software did change, they’d charge for upgrades, and of course, support.

Salesforce.com changed that – they charged monthly or annual fees for a software that changed at a similar rate as the original, perpetual license software, did. The difference was not in the software architecture, but rather the fact that someone else was running the software for you. That means they took ownership of the servers, the network bandwidth, the on-going operations – which tend to be more OPEX (operational expenditure) oriented. Hence, it made sense to pay them monthly to run the software.

Making the move from perpetual licensing (CAPEX) to subscriptions (OPEX) is very hard, to almost impossible, for software vendors to complete. That is what Ron Gill was pointing out. Think about it – these huge ships needing to completely change how things work while still hitting their numbers. Take SolarWinds (NYSE: SWI) for example. They are a large (though not huge) software vendor operating in our space, where a sales force comprised of hundreds of people is used to selling perpetual licenses.

  1. How do you convert a sales person who is used to selling one thing to another?
  2. How do you do this conversion while still growing at XX% year over year in revenues? (remember, perpetual license revenues are recognized instantly whereas subscription ones are recognized linearly over time)
  3. How do you explain to your customers that your software, largely unchanged, makes sense to buy under the subscription model if your customer is still required to run it on premise and it changes at the same (slow) rate as the perpetual licensed software did?

That last question uncovers a greater complexity – you can’t just take the same software and sell it in a different model. You need to change how your software is delivered and what the value is. Specifically, you’d want the value to increase from month to month, to justify the on-going subscription payments. This is what I call SaaS 2.0 but that’s a topic for a separate post.

So – is Ron Gill right? Are all the big software vendors going to die because they can’t change the way they work? Is SaaS going to shut down hundreds of software companies while propelling others to success?

To me it looks like it will.

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