4Q11 was a Late-Breaking Quarter for Trident Capital’s SaaS Portfolio

The typical 4Q budget flush that most IT companies have learned to expect didn’t come in the same extent this year.  As a result, public and private SaaS companies had a tougher quarter than they expected; certainly a much tougher quarter than 4Q10.  We are still not seeing as much exuberance about the economy as some of the recent reports would have you believe.  Certainly during 4Q11, based on checks I made with some of the prospects and customers of our SaaS portfolio companies, I got the sense that the SMB sector has not yet fully recovered. But, pleasantly, I have started seeing more evidence that the larger corporations (Fortune 500) are starting to fully embrace SaaS (more on that later).  Our SaaS portfolio companies did a little worse than planned with 85% of them achieving their revenue and booking targets (compared to 90% during 3Q11).

The public SaaS companies appear to have faced similar market conditions during the quarter, i.e., they had harder time making their numbers.  None pre-announced (positive or negative) but a couple missed their numbers (Realpage, SciQuest), with the rest, e.g., Netsuite, comscore, Concur, Cornerstone onDemand, Kenexa, reporting inline results. The big acquisition news for the quarter were Oracle’s acquisition of Rightnow (Oracle also announced the acquisition of Taleo but that’s a 1Q12 transaction), SAP’s acquisition of SuccessFactors were the really big news.  IBM’s acquisition of Demandtec, the leader in SaaS pricing optimization solutions, added another analytic application to IBM’s portfolio.  Salesforce’s acquisition of Rypple demonstrated the company’s continuing strong interest in social applications.

Positive conclusions from our SaaS portfolio performance:

1. The annual growth for the SaaS companies continues to surpass that of the on-premise software portfolio companies.  During 2011 our SaaS companies experienced 30-150% yoy revenue and bookings growth.
2. Renewal rates remain steady at 85-95%.  Upsell rates were at 20-45%.  This was better than expected and a good indication that customers are finding value and good ROI from the use of SaaS applications.
3. Most of our SaaS portfolio companies were able to increase their license pricing 10-20% during the quarter; another indication of the value customers experience.
4. Discounting remained at 20-25% for multi-year deals and 5-8% for 1-year deals.  Upfront payment terms held steady with customers paying 1 year in advance for the multi-year deals and 1 quarter in advance for the annual deals.
5. Analytics-driven applications, social applications, and mobile applications with vertical focus continue to be in high demand.
6. The portfolio is seeing accelerating demand from large enterprise clients (Fortune 500 including Fortune 50 companies).  I’m sure this was one of the major reasons that Oracle, IBM, and SAP have started acquiring SaaS companies.  Our companies have continued to receive strong inbound interest for their solutions from foreign companies (Australia, New Zealand, Singapore, parts of Western Europe).
7. System Integrators (SIs), including several of the large ones, are becoming more interested in providing services around packaged SaaS applications.  This is something that I couldn’t have imagined a year ago.  However, with the increasing interest of F500 companies in SaaS applications it should have been expected that the larger SIs would come calling.  The question is whether they will use their traditional model (calling for services that cost 5-7x the licensing cost) to deliver services around SaaS applications or whether they will create a new model.  It will also be interested to see the SIs will be able to change their customer onboarding model and make it more compatible to the fast onboarding models used by SaaS companies.

The characteristics my partners and I didn’t like from the quarterly performance of our SaaS companies include:

1. While large enterprises are starting to adopt SaaS applications more regularly they expect a sales process that is more similar to the on-premise enterprise software sale, rather than to what we have been typically seeing with the sales of SaaS application software to SMB customers and mid-upper enterprise customers, i.e., a 2-4 month sales process.  The longer and more expensive sales process (requiring field sales people with enterprise experience, more demos and pilot projects), has a negative impact on margins.  This is an issue we plan to work on with our relevant SaaS portfolio companies during 1Q12.
2. The monthly sales targets were not achieved according to plan.  For our SaaS portfolio companies we would like to see 20% of the quarterly target to be achieved during the first month of the quarter, 30-40% during the second month, and the remaining the last month.  During 4Q11 we saw a new pattern.  During October and November the companies were able to achieve only 20% of their quarterly target (10% each month).  Another 10% was achieved during the first half of December.  The remaining 70% was achieved during the last two weeks of the quarter.  This is the reason some of our SaaS companies run out of “runway” and couldn’t get all of their contracts done, resulting in some to miss their quarterly targets.  Sales productivity slipped.
3. Hiring was difficult during the quarter because the SaaS companies have a high demand for the same type of people as Internet companies: engineers, sales people, product managers, services people, and data analysts.  If this trend continues, it will negatively impact the aggressive growth plans our companies have for 2012, as well as their costs and margins.

Some additional observations from the quarter:

1. Once again customers showed that they don’t care about the SaaS solution’s “purity,” i.e., is the solution multi-tenant, is it built on a single technology stack, but they care about the solution’s ease of deployment, overall economics and the time to ROI.  If a solution’s purity leads to faster deployment, better economics and faster ROI then they are all for purity.
2. IT organizations are finally taking SaaS seriously.  They are starting become very involved with SaaS licensing decisions.  In addition, they are also starting to worry about how to instrument their corporate IT infrastructure so that they can better monitor the performance of such applications and improve their performance.

Looking to the next 12 months, I’m expecting a more muted 2012 with flat budgets for IT solutions (compared to the 3-5% yoy increases we had seen the last couple of years) and tougher sales cycles, decreasing contract values and more discounting.  While I expect continued strong M&A interest in SaaS companies, I don’t foresee more blockbuster acquisitions like the ones we saw with Rightnow, Taleo, SuccessFactors and Demandtec.

(Cross-posted @ Trident Capital Blog)