The cloud startup endgame: Lock you in early

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Credit: Nina J. G. via Flickr

If you're not paying for it, you're probably the product.

blog post from Andreessen Horowitz Partners Scott Kupor and Preethi Kasireddy breaks out the economics of how venture capitalists like themselves justify their investments in software-as-a-service companies -- and it's enough to give any prospective SaaS adoptee pause before taking the plunge. 

The blog entry, titled "Understanding SaaS: Why the Pundits Have It Wrong," takes aim at those skeptics who wonder why venture capital firms like Andreessen Horowitz are pouring so much money into enterprise startups like Box and Slack that are spending a ton of money on sales and marketing -- in the case of Box, it spends more just on sales and marketing than it earns in revenue. (It's worth a read for some of the inside-baseball stuff around the market, even if a lot of it's going to be obvious to anyone who's been watching the enterprise software market for a while.) 

But the section called "So why would any rational person ever invest in a SaaS company?" is extremely revealing as to how these software industry power brokers -- and thus the companies they advise -- view the end customer. It's not necessarily all that charitable.

The question is answered in the first sentence:

"Because once a SaaS company has generated enough cash from its installed customer base to cover the cost of acquiring new customers, those customers stay for a long time."

And why, exactly, is that? 

"These businesses are inherently sticky because the customer has essentially outsourced running its software to the vendor, making them very predictable to model and more likely to yield high cash flows."

Reading between the lines, the investors are saying that SaaS vendors are willing to spend a lot of money on marketing, or lose a lot of money on price breaks and other incentives, to get you as a customer, because once you're in their world, the pain of switching away will become too much to bear. 

That pain only gets compounded, as the authors note, when you consider that a lot of IT spending has moved out of the IT department. This adds to the total number of seats in an organization using any given vendor, as platforms like Box and Salesforce diversify their offerings to appeal to a wider range of business segments. This gets compounded when you add in the "me-too" factor where departmental users in, say, marketing, see their colleagues in sales reaping the benefits of a SaaS application and turn to their manager to get it deployed for themselves as well -- often without IT intervention. These kind of scattershot deployments can lead to out-of-control licensing costs and overspending.

This trend may be empowering to departmental users, but it also makes it a tremendously uphill battle for a CIO to declare an app as unsupported, let alone to try to replace it. 

In short, SaaS companies are willing to give you essentially whatever you'd like, as long as you don't mind the fact that these vendors have every incentive to to turn the crank and gradually inflate their prices as they squeeze out their competition. All that matters is that you don't leave until the comfort trap is sprung. As the old adage goes, if you're not paying for a service, you're probably the product. 

Lock-in is nothing new if you've been around the block a few times. Microsoft, for example, has a long history of selling multi-year contracts for on-premises products, which cover upgrades and make license compliance easier. It's possible to keep using the software without renewing the contract, but it's more complicated -- and often, companies not only renew, but add new products to the same contracts. Now, Microsoft is using this powerful tool to move customers to its cloud services, or at least offer them the option.

Just because SaaS is a new software delivery mechanism, and just because they offer new ways to do business, it doesn't mean that these vendors aren't still businesses themselves.

Update: In an e-mail, Andreessen Horowitz's Scott Kupor -- coauthor of the original piece -- expands on his thoughts around cloud lock-in: 

"I agree lock-in is not a new issue, but there is real value-add here in the SaaS context since there is a broad base of users and we actually know whether customers are using the product! So, I think this is a less nefarious form of lock-in than existed in the perpetual license days where many products ended up as shelfware."

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