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Customers come first. It's a claim that most businesses like to believe they uphold but often struggle to demonstrate. And nowhere is this more true than at software companies, which traditionally have had business models that rely on rolling out successive versions of their products. The result: an emphasis on product development, not interacting with end-users.
But at FreshBooks, a small Toronto-based startup with just nine current employees that offers an online accounting program, customer service plays a critical role. “We have a triage [process] here, in that customers and their needs come first, and then everything else we're doing really comes second, even in terms of development,” says Michael McDerment, FreshBooks co-founder and CEO. “So if it's a busy day, and people need a lot of help, the first thing we're doing is answering the phones.”
It's a whole new attitude toward how a software company does business. But FreshBooks' focus on customers is a natural outgrowth of how it sells its wares: as a service. Increasingly, software does not come on a CD-ROM, or pre-installed on a desktop computer, or even downloaded over the Internet. Instead, customers access software applications like FreshBooks' invoicing program via a web browser, and pay for it on an annual, monthly or even per-usage basis.
This so-called software-as-a-service (SaaS) delivery model, or on-demand software, is transforming the industry, particularly the segment that targets business users. The flag-bearers are Salesforce.com, which has redefined the market for customer relationship-management software, and NetSuite, which offers small and medium-sized businesses a suite of applications, including accounting. In both cases, the value proposition is straightforward: SaaS offers an easier way for companies to buy and use the kinds of tools that previously were too complex and required too much upfront investment for all but large corporations.
IDC, an IT industry research firm, estimates that SaaS garnered some 1.7% of the global software market in 2006, and will be worth US$14.5 billion in 2011. Here, SaaS will be a more than $100-million market in 2010, according to IDC Canada, and will be growing faster than 30% per year. “When you look at the total scale of it, it's hard to see it registering in a way that has fully moved the market,” says Nigel Wallis, a research manager with IDC Canada. “What it has done is scare the market, and you see the major [independent software vendors] changing in response.” Software giants Microsoft, SAP and Oracle, which have built up multibillion-dollar businesses around licensing models, can sense the ground beginning to shift beneath their feet; each has initiatives underway to respond to the emerging SaaS landscape.
The software-as-a-service trend is a reflection of growing demand by corporations to find simpler and more economical means of using IT to their businesses' advantage. As is true with any disruptive business model, it's entrepreneurs—and the early-stage financiers backing them—who are in the best position to exploit it, and a new breed of Canadian software firms is quickly emerging. “As a new enterprise, there's a definite advantage to looking at how you would do the software-as-a-service model,” says Wallis. “Going back to shrink-wrapped CDs and having licensing and everything else, that imposes a cost and a burden on the independent software vendor. There is no reason why you wouldn't go to that [SaaS] model first and foremost, and design the application for that.”
At FreshBooks, the business model was a natural evolution of McDerment's original enterprise, a web development consultancy helping small businesses improve their online presence. McDerment first conceived of FreshBooks as a way to invoice his clients via the web, and over time he developed a more polished version that went live in May 2004. It is now used by about 185,000 clients, mostly small service-industry businesses themselves. But offering FreshBooks as a service was never in question. “Honestly, it seemed like kind of a no-brainer,” says McDerment. “Maybe it was second nature, because we were online and consuming the services from other providers, but that didn't seem revolutionary.”
McDerment has since discovered, however, that selling software as a service comes with some distinct benefits. “I love the business model because we have consistency of cash flow,” he says. It is more stable than billing per hour for consulting projects, and the revenue stream is much more predictable than licensing software. “You sell a thousand licences, you really get somewhere very quickly,” says McDerment. “You could do that in a month. But then you don't know what's going to happen next month.”
Of course, the flip side is that you don't get big influxes of cash from sales that you could then immediately reinvest. “You've got to be a lot more patient, and a lot more diligent about your engineering because you don't have that upfront profit,” explains Michael Gregoire, the Canadian-born and -educated CEO of Taleo Corp. (Nasdaq: TLEO), which sells talent-management software under an SaaS model. “All the characteristics of an on-demand software company are much more focused on cash management and retention,” he says. “It's hard to show the profitability signature as quickly as you can as a [licensed] software company.” Taleo, based near Silicon Valley but with its R&D facility in Quebec City, is emerging as one of the next marquee names of SaaS. Its stock is up 90% over the past year, the company has a market cap of more than US$500 million, and its annual revenue is on track to handily surpass US$100 million this year. “The reason Wall Street likes the service model is...I walk into each and every quarter, and I've got 90% of my revenues locked,” says Gregoire. “That's very comforting to investors.”
Venture capitalists like the SaaS model for the same reasons. “We have a bunch of these in our portfolio,” says Joe Deal, vice-president of JMI Equity, a prominent VC firm in Baltimore and San Diego. (It's currently poised to reap a windfall as one of two parties selling major online ad company DoubleClick to Google for US$3.1 billion.) “You look at the monthly revenue charts and it's beautiful: it's just up and to the right every month because they have the existing business and they're adding new business.”
SaaS companies are generally able to control how they scale their businesses. A startup selling licensed software will usually have to spend ahead of revenue to get sales reps out in the field who then have to close large, time-consuming deals. But the SaaS model allows software vendors to approach the market more incrementally. Eloqua, for example, a thriving Toronto-based company that JMI Equity helped finance in 2005, provides online services for generating sales leads. It won over Finnish telecom equipment giant Nokia by first signing a measly $24,000 contract with the company's Toronto-area office. But as the software reaped rewards, word spread to Nokia's other regional offices around the world, until Eloqua was able to approach the head office for a global sales deal. “The on-demand guys tend to price their offerings in a way that lets clients dip their toes in,” says Deal, whose firm also financed Empathica of Mississauga, Ont., which sells online services to help brick-and-mortar retailers track their customers' experiences. “They don't have to elephant hunt as much on the sales side, which means their revenues tend to be more predictable.”
One reason this is even possible is because of the offering itself: software services delivered over the web don't require extensive installation and configurations on customers' servers or desktops. As added benefits, SaaS companies keep all their customers on the most current version of their software, which lowers support costs and allows them to closely track how the product is being used. “That's the data you couldn't get in an on-premise model,” says Deal, “and that's extremely valuable for figuring out where you need to focus the development effort.”
More than ever before in the software industry, the on-demand model puts greater emphasis on pleasing the end-user—and that's long overdue. “The business model is catching on,” says Taleo's Gregoire. “The thing that I like the most about it is it forces us to have a better relationship with our customer. It is all about renewal. You can't take any of that for granted.”
McDerment certainly doesn't. Despite its small staff, FreshBooks offers phone and e-mail support, and it maintains an online forum. “We really believe that it's a service,” says McDerment. “People deserve to be able to call somebody up and get answers if they need them.” And in the end, McDerment is confident that will only improve FreshBooks, and help grow the business. “We have years of experience from feedback and supporting this product now, so we're very much in-tune with our customer base, what they need and what they want,” he says. “If you're staying ahead of the game like we are with customer service, you can see these things coming, and you can scale to accommodate to them.” Positively refreshing.
Companies offering on-demand software
Eloqua
Lead generation, launched 2000
Improves quality and
quantity of sales leads
by integrating e-mail,
direct mail, website
analytics and other
marketing functions.
Freshbooks
Invoices, launched 2004
Automates time tracking
and invoicing for service
businesses — even
sends out hard copies —
and lets clients accept
payment online.
Empathica
Retail surveys, launched 2001
Provides detailed
customer experience
data to help restaurants
and retailers improve
service and reduce
mistargeted promotions.
Dabble DB
Databases, launched 2006
Allows databases to be
managed online, with
clients able to quickly
restructure, filter and
summarize data from
multiple perspectives.
Taleo
Talent management, launched 1999
Organizes hiring process
by distributing job
postings and handling
applications, then filters
the candidates and saves
it all for future recruiting.
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