Summary
The SaaS business model provides an ongoing revenue stream through good times and bad. Growth may slow during bad times, as customers become more reluctant to commit, but since no large capital costs are being incurred SaaS companies can do better than traditional license-based software companies during bad times.
Analysis
The SaaS business model works quite differently than the traditional license-based model. From the customer perspective the total costs over three or five years are generally not so different. Buying software via SaaS doesn’t generally save money when total costs are considered for three years or more. SaaS does, however, eliminate the large initial costs typical in a license-based software implementation. SaaS software costs are relatively flat over the term of the contract. There will be extra costs for implementation, but those are relatively small, whereas the vast majority of licensed-based software implementation costs occur either before or just after the software is placed in production.
Spreading costs evenly across several years by buying SaaS has little impact on company profitability, since most project costs can be amortized across several years anyhow. There is a significant difference in cash flow, however, that makes SaaS more attractive to companies with limited cash reserves. In bad economic times many companies will want to preserve cash. Those companies will heavily prefer the SaaS model.
There is also a psychological impact that makes SaaS attractive. Although in accounting terms the total cost over three years may be the same with both models, there is a psychological barrier to spending large sums of money while times are bad. It’s frequently easier to convince an executive to spend $200K/month for two years than to spend $2M immediately.
The SaaS model provides a cushion for the vendor in bad times, since the contracts are typically for two or three years and the revenue is steady through good times and bad. License software vendors, by contrast, see their revenues fluctuate wildly between good times and bad. When customers stop buying license vendors see their revenues drop to near zero, while SaaS vendors may see their revenues stop growing, but they won’t decline for a long time. Only if the bad economy extends for a year or more is it likely to actually reduce revenues for SaaS vendors, since a decline won’t happen until contracts come up for renewal.
There is one exception to this good news: If customers start to go bankrupt in large numbers SaaS vendors will get hurt badly. The SaaS model is based on spreading revenue over the life of the contract. The contracts lock in customers for two or three years, so the SaaS vendors are protected. But when a customer fails that contract no longer locks them in and the vendor loses that revenue stream. Also, since license vendors get money all at once they typically are better able to build up reserves of cash during the good times. Since SaaS vendors’ revenues are spread over the life of the contract it’s much harder for them to build a cash cushion. In bad times license vendors that have saved money can live off their reserves. License vendors that haven’t saved money die quickly. SaaS vendors don’t generally have such a cash reserve. Large numbers of customer failures will dramatically reduce continuing revenues for SaaS vendors. If that happens they may fail quickly due to lack of cash reserves.
This risk makes it important to understand the customer base and cash reserves for SaaS vendors to accurately estimate their viability. If their customer base is largely Fortune 1000 companies they’re probably safe, since Fortune 1000 companies probably won’t fail in large numbers. If their customer base is largely SMB the risk is greater since SMB companies are more likely to fail in bad times.
SaaS vendors cannot be considered “recession-proof”. Perhaps “recession-resistant” would be more accurate.
