7 minute read 24 Apr 2017
Man walking tight rope

How to transition to the SaaS business model

By Barak Ravid

EY Global Technology, Media & Entertainment, Telecommunications Leader for Strategy and Transactions, Ernst & Young LLP

Energized by all things at the intersection of technology and strategy. Passionate about the strength of diverse and inclusive teams. Love sailing, soccer and snowboarding. Father of three girls.

7 minute read 24 Apr 2017

We at EY-Parthenon have seen a wide range of SaaS transition strategies and have found three key principles that contribute to success.

The last decade has seen software buyers express ever-increasing preference for purchasing software as a service (SaaS). Most new entrants in the software space have been SaaS-native, but what about the thousands of software vendors that started out with traditional licensing models? How can they transition to SaaS? Where on the transition spectrum should they aim to be?

Think of the move from perpetual licensing to a SaaS business model as a wide chasm between present and future. To cross it, companies must rethink the way they do business.

Companies that have contemplated the crossing understand that there are a myriad of challenges and risks in making the transition, from operational to financial to technical. We at EY-Parthenon have seen a wide range of SaaS transition strategies and have found that the following principles contribute to business model transition success:

  1. Set the right SaaS strategy
  2. Expect more than a pricing change, expect a business transformation
  3. Follow lessons learned from companies that have already begun the transformation

With the expectation of higher SaaS penetration across the entire IT ecosystem, vendors in all software stacks are planning their transitions. Successful vendors will prepare their companies to offer SaaS even if there is not yet overwhelming demand from their customers. In the diagram below, we’ve grouped an example set of companies by the percentage of revenues that are derived from SaaS. Note that many companies still left of the chasm are already preparing their companies for SaaS.

Figure 1: Percent of SaaS (2016) vs revenue growth (2015-16) by total revenue, enterprise software providers

Consolidation opportunities

All SaaS strategies are not created equal

In most business transformations, companies want to act as quickly as possible. With the SaaS business model transition, however, there can be valid reasons for a more measured approach. Companies evaluating SaaS transition strategies must consider the customer and competitive dynamics of their market and determine what the right speed and degree of change is for their business.

On the far right end of the spectrum, companies are becoming SaaS-only businesses. This means that existing products will no longer be sold as perpetual licenses and all new products will be rolled out in SaaS forms only.

On the far left end of the spectrum, companies are ready to offer SaaS but still emphasize the sale of perpetual licenses. In this approach, companies can offer customers a choice among a full range of consumption models and use pricing incentives to steer customers toward the perpetual model. Companies may choose this approach if the existing customer base is largely satisfied with the traditional licensing model and competitive conditions are not driving a rapid shift to SaaS.

Companies choosing this strategy still need to “cross the chasm” as they need to be ready to accelerate the transition to SaaS on short notice if needed. Based on our experiences at EY, most companies choose one of the middle options as a starting point.

Whichever SaaS road is taken, companies need to think through the details of SaaS offering that they plan to extend to their customers. When designing the SaaS strategy, vendors must ask which business challenges will be addressed given the range of benefits that customers may expect. To start, vendors should ask themselves the following questions:

  • How is the SKU defined? What is the licensing unit? Does the SKU include product, maintenance and professional services?
  • Is there a minimum dollar amount? Minimum time commitment? Minimum usage baseline?
  • Is the customer allowed to scale up or scale down?
  • Can the license be used across on-prem and off-prem/hosted deployment models?
  • What is the price point? What is the crossover point in terms of years when comparing SaaS with perpetual pricing? What are the billing cycles?
  • Is there an upgrade path from existing licensing models?
  • How can customers be incentivized to commit to multiyear periods? To renew?
  • How will volume discounts work? What options will be provided for customers who want enterprise license agreements (ELAs)?

Companies should think through the answers to these questions, and others, with the customer value proposition in mind.

Expect more than a pricing change, expect a business transformation

Many companies underestimate the degree of business transformation required to achieve the SaaS model while others have a full appreciation and are hesitant to dive in. In either case, the right next step is to understand the operational requirements of crossing the chasm and to assemble a team that can transform the organization.

That team will need to rethink how to operate each function including sales and enablement, product engineering and customer support, finance and accounting, and IT. M&A activity will also need to be thought through carefully whether the reason is as an add-on to a current software vendor business or the company is seeking SaaS-by-acquisition. Bottom line, the SaaS business model brings its own challenges.

Lessons learned to enable the transformation

Those considering the transition now can benefit from the lessons learned by those who have executed the crossing before them. The following are some of the lessons we’ve observed over the past few years:

  • Do not expect to be revenue-neutral during the transformation

    The most common question we encounter when speaking with executives about the SaaS transition is, “How can we make this change revenue neutral?” In all likelihood, you won’t. Crossing the chasm is a fundamental move from up-front to ratable revenue recognition for some or all sales. Attempts to bypass the transitional revenue impacts by phasing or altering the offering are likely to undermine the success of the transition. If employees do not believe their company is committed, the organization will not change.

  • Prepare for a transformation period of more than a year

    The time from ideation to execution for SaaS transition has fallen since the trailblazers began this journey, but the depth and breadth of organizational transformation required means that effective transition will not happen overnight. We have observed that it takes most companies at least a year from strategy commitment to SaaS product in-market.

  • Create a cross-functional program management office (PMO)

    The SaaS PMO should determine, plan for and execute against the SaaS strategy. This team should include representation from sales, pricing, product management, R&D/engineering, IT, finance, legal and other functions, and it should be empowered with decision rights required to enact change. Staff the SaaS PMO with dedicated leaders who will evangelize the vision of the SaaS transition. The team should be accountable for meeting interim deadlines specified by the CEO.

  • Create a customer advisory board

    Feedback from customers on the offering structure, flexibility, features and pricing will be invaluable in the transition. Formally gathering input from a set of key customers will ensure alignment with customer needs. In addition, this customer advisory board can be used to test messaging and determine the timing and level of detail for public announcements made throughout the transition.

  • Communicate. Communicate. Communicate.

    Though it may seem obvious to some, we cannot understate the importance of communication during this transition. A rigorous change management program including stakeholder analysis and effective communication will enable your customers, employees and investors to journey across the chasm with you. Without their support and enthusiasm, the likelihood of a successful transformation is small.

In closing

What was once a trend of the future is now the reality of today. Software companies should ask themselves if they are in the right position to compete in a SaaS-driven environment. For those peeking over the chasm, now is the time to define your SaaS strategy and begin the journey.

  • Show article references#Hide article references

    1. Adobe’s stock price grew at a CAGR of 29% from December 30, 2011, to December 30, 2016. The NASDAQ composite price increased at a CAGR of 16% during that same period. Adobe made the transition to the SaaS business model between 2011 and 2015.
    2. EY-Parthenon’s 2016 Survey of CIOs.
    3. Global technology M&A report, Issue 34, EYGM Limited, February 2017.

Summary

Software vendors using traditional licensing models need to transition to software as a service (SaaS) since increasingly this is the preference for software buyers. However, there are a myriad of challenges and risks in making the transition, from operational to financial to technical. EY-Parthenon has seen a wide range of SaaS transition strategies and have found that specific management principles contribute to business model transition success.

About this article

By Barak Ravid

EY Global Technology, Media & Entertainment, Telecommunications Leader for Strategy and Transactions, Ernst & Young LLP

Energized by all things at the intersection of technology and strategy. Passionate about the strength of diverse and inclusive teams. Love sailing, soccer and snowboarding. Father of three girls.