What Makes SaaS so Special?

Many articles are written, every week, about how to succeed in SaaS. But less often do people write about why SaaS is so special. It’s a business model, applied to a product type that has become a massive focus area. Venture has not seen a category of startups like it before. Some investors create an entire thesis, just focused on software as a service. So, rather than spending this week’s tip on another top ten list of HOW to win in SaaS… instead, let’s explore WHY the category, itself, is so special.

It boils down to three simple reasons: Proximity to customer, measurables and value focus.

1. Proximity to Customer: Part of the brilliance of SaaS is that companies develop a direct relationship with end-users. They often sell directly to them and have an ongoing feedback loop with them. While this provides numerous product and versatility advantages, maybe the biggest advantage is in what this eliminates. Proximity to the customer dis-intermediates traditional channel players. Wholesalers, distributors, resellers, retailers… what intrinsic value do these players provide? None. They reduce margin, for the value creators, and they increase price, for the value consumers. By removing layers upon layers of mouths to feed, the only transaction necessary is between the creators and the customers… thus all the value resides with them.

2. It’s Measurable: When I think of metrics I recall Peter Drucker’s famous quote, “You can’t manage what you don’t measure.” Or you may remember this one from Dwight Eisenhower, “Plans are nothing; planning is everything.” The set of standardized metrics available makes the category much easier to assess. Problems are more easily uncovered. Best practices are readily transferable. This gives both founder and investor a playbook to work from. It helps each identify the root cause of issues and take action against them. The forecast itself may be terribly inaccurate but it drives the right discussions and allows for fast reaction.

3. Value Focus: ย SaaS business typically charge upfront and ongoing. Strong value must exist from customers to pay for the product. And this value must sustain or the customer will select out. With many businesses, the value transacted ends after the initial sale. With SaaS, it’s the opposite. The first transaction is the beginning of a long, healthy annuity. This puts pressure on the startup to provide real, increasing value. And, as I wrote about in a post calledย The Customer-volume value curve, the startup can share in this value as they expand it over time.

It’s no secret that my strategic focus area is not SaaS. I’m a hardware investor. I hunt for compelling startups developing IoT with a recurring revenue stream…. for now, I’ll refer to this as IoTR, standing for Internet of Things w/ recurring. So, why would I knowingly choose something other than SaaS, when I’m aware of its massive advantages over other types of businesses? We can talk about all the merits of IoTR another time, but fundamentally this category shares the same three value drivers as SaaS. Proximity, Measurement, and Value are key strengths as well. And it’s far less overheated than SaaS. Remember the trappings of herd mentality in Venture Capital? In this industry, it often pays to be contrarian.

Many other investors have a sector specialization, which provides them an advantage during startup evaluation. They should be able to pick better due to their strong knowledge of the sector’s success factors. But that sector must also be positioned to outperform other sectors, over the investment time-horizon, to make it worth investing in. Fred Wilson and USV understood this well. They didn’t limit themselves to one sector but rather developed a thesis on network efforts… a factor that gives every startup leveraging them, an unassailable advantage.

So, to finish this point, startup investing is not just about great teams w/ great products in great markets… at the company level, those may be the key factors. But if you zoom out to the industry or category level, one’s thesis should present advantages. If you zoom out further, there are macroeconomic factors that come into view. Sector, technology, thematic and business model specializations can all offer investors an edge. Some short-term, others sustaining.

Whatever the case, one shouldn’t just have an edge as a picker, they should also be playing a game that’s rigged to win. In the sports industry, the most valuable hockey franchise is the New York Rangers, and they’re valued at $1.25B. The least valuable NFL franchise is the Buffalo Bills, and they’re valued at $1.5B. You need not focus on SaaS or IoTR… but what game are you playing? Why is your category giving every startup within it an edge over the rest? If you can answer these questions, you’re way ahead of most.