Sidney Hill, Jr.: SaaS economics seem to favor users more than vendors

NetSuite closed out 2007 with one of the year's most successful initial public offerings (IPO). It also sparked some questions about the future of the Software-as-a-Service (SaaS) model.

On December 10, the company that offers an on-demand suite of applications for managing small to medium-size enterprises announced it would auction $6.2 million shares of stock.

When the auction closed, eager investors had bid the price up to $26 per share. After the investment banks that underwrote the offering purchased an additional 930,000 shares, NetSuite had amassed a total of $185 million and a market capitalization of $1.5 billion.

That's pretty impressive for a company that posted the relatively modest sum of $76.8 million in revenues for the first nine months of 2007—and has never turned a profit.

Investors apparently were attracted by the pace at which NetSuite's revenues are growing. That $76.9 million for the first nine months of 2007 represents a 63-percent increase over the same period in 2006.

Salesforce.com, the most well-known SaaS vendor, reported 48-percent year-over-year revenue growth for its most recent fiscal quarter. It expects to top $800 million in revenues for fiscal 2008, after recording $497 million in fiscal 2007.

But Salesforce.com—like most SaaS vendors—has had trouble showing consistent profitability, and that's why some industry observers still question the viability of the SaaS model.

The major point of uncertainty is whether the subscription pricing method—in which companies pay relatively small monthly or annual fees for each person who uses a SaaS application—can bring in cash quickly and steadily enough to sustain a vendor's business operations.

That's a valid question when you consider that more than one million people at more than 35,000 companies are tapping into the Salesforce.com platform on a regular basis, yet the vendor still struggles to turn a profit.

This issue has caused SaaS vendors to take a few different approaches to the basic business model. NetSuite, for instance, offers a comprehensive suite of on-demand applications—ranging from accounting and ERP to CRM and e-commerce—on the premise that the small and medium-size companies it targets want to get all of their solutions from a single vendor, even if those solutions come on-demand.

But Mike Braun, CEO of Intacct, a supplier of an on-demand accounting package, says SaaS applications, which are naturally packaged as services, render issues of integrating disparate applications moot, and thus free companies of all sizes from having to adopt suites of applications that may or may not meet all of their needs.

Salesforce.com sits somewhere in the middle. Its primary offering is an on-demand CRM suite, but it also has created a major ecosystem for linking all sorts of applications to its CRM solutions.

The SaaS vendors' growth figures are a clear indication that users are intrigued by the basic model. The question is: which variation of that model will vendors have to adopt to make it profitable?