The Evolution of SaaS
The “Invest Like the Best” podcast interview with Eric Vishria of Benchmark Capital was probably one of the best recent ones I’ve listened to.
Businesses have gone from using software to businesses actually being encoded in software.
So business interactions happen through Application Programming Interface (APIs). Eric highlights a great framework to understand the different generations of SaaS in a fascinating discussion. David Cummings does a great job summarizing this here: SaaS Generations 1, 2, and 3
- Gen 1: Better delivery (vendor hosting) and economic (recurring rev) models
- Gen 2: Better adoption model (user-friendly, easy, cheap = bottom-up, “micro adoption”)
- Gen 3: Encoded in software (from GUIs & price/user to APIs & price/usage)
I’m going to give some more details below.
First generation of SaaS: Big ticket, enterprise sales and major implementation. The key customer segment is Fortune 2000. High cost to failure. Single instance & macro adoption where the executive level and entire organization needs to buy in. Business model Seat & licence and maintenance model. More Sales led. Moats are systems of record & large enterprise sales team.
“The huge innovation is the ability of the software vendor to abstract away most of the customer headaches that come with managing software and deliver it as a monthly or annual fee. This, combined with more efficient product development, due to customers always being on the same version, makes for an excellent business and customer model.” — David Cummings
Oracle, SAP, Salesforce, Servicenow, Peregrine are examples here.
Second generation of SaaS: where the competitive edge was great User Interface UI) /Graphic User Interface (GUI). Human lead and thus go through UI. Very cheap and low cost to failure. Micro-adoption model: “Try and toss mentality.” where only a small part of the organization needed to buy in. Opens up mid-market and SMB market. Huge new changes in pricing model from seat based to transaction & volume based. More marketing led.
“2nd generation SaaS is bought differently than 1st generation SaaS and feels more natural as both a buyer and user of the product.” — David Cummings
Economic model has a much more consumer type level of adoption where the user base is very large. Defensibility has become more like a platform for customers where there are network effects of data or customer usage.
Examples are Zendesk, Asana, Docusign, Slack etc.
Third generation of SaaS: is the extension of second generation SaaS strategies. But the new competitive frontier has shifted to API (Application Programming Interface). So it’s software talking to software via API. The people are being abstracted away. This is pushing the automation of processes in companies and enables speed of digitization in all businesses.
“APIs are the building blocks of modern software development representing re-usable components that make programming faster and more productive. APIs can now power many aspects of software that 5–10 years ago would have been custom.” — David Cummings
Because of this we see the rise of specialist software going after narrow customer segments. Ie. Twilio, Stripe, RapidAPI, ANAplan, Zuora
The big untapped opportunity for more customer value (and lock in) is a cross customer perspective that only the 2nd & 3rd generation SaaS companies can do. If you take some of this anonymized data you can come up with benchmarks or leverage relevant data points to help another customer. This is similar to what Stripe Radar is doing by leveraging anonymized customer IP data from their customers and helping prevent fraud for other customers.
2020 is the exclamation mark to this.
Data on the magnitude of cloud acceleration in 2020 (WSJ): In Q2 2020 alone, enterprises spent $35B on cloud software and services, up nearly $8B compared to Q2 2019.
The Cloud is just getting started, so we are just at the beginning here. VERY Exciting times ahead for SaaS founders and investors.