Why Your SaaS Startup Will Probably Fail

Let’s be clear. I’m not saying that you, specifically, don’t have a great idea. I’m not saying that you couldn’t create some great software with a killer UX...

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Let’s be clear. I’m not saying that you, specifically, don’t have a great idea. I’m not saying that you couldn’t create some great software with a killer UX that solves a problem for users. I’m not saying that you couldn’t turn that software into a viable, profitable business and achieve the growth and market penetration necessary to make it a commercial success. I’m not saying that you won’t attract the attention of VCs, investors, and the market at large and take your SaaS start-up to a successful exit. I’m just saying that it’s not very likely. Statistically, that is.

There are many reasons why SaaS start-ups fail. The most common and frequently cited among them are a poor product/market fit, a failing business model, cash-flow problems, and poor management. These are all very important factors to get right in any startup and failure to do so can certainly be catastrophic for your business, but another factor which we should not overlook is competition. It’s tempting to look at the growth rates in the SaaS market and think that there is more than enough business to go around but the fact of the matter is that the SaaS market in 2015 is crowded.

Your Children Aren’t Special

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Whether you’re in collaboration, email marketing, HR, CRM, file sharing, project management, or pretty much any other product category within the SaaS industry, you can be sure that there a plenty of other products just like yours. If there aren’t, congratulations – you’re first the market and you’re competitors won’t be long about showing up, so get moving and take as much of that market as you possibly can. You will need to figure out very quickly what your unique differentiator is, not just in your opinion but in your potential customer’s opinion, and do everything you can to make that USP difficult for your competitors to replicate.

And no, being SaaS isn’t enough to differentiate anymore. SaaS has become the norm for B2B software and is replacing legacy on-premise software left, right, and center. And if being SaaS isn’t enough to make you stand out from the crowd, then you’ll need to find something else, particularly if you’re entering into one of those product categories like file sharing, CRM, or collaboration where there are monsters like Microsoft, Salesforce, and Oracle just waiting to chew you up and spit you out. Not to put too fine a point on it, but in the words of the legendary comedian Bill Hicks “Your children (SaaS start-ups in this case) aren’t special. I know YOU think they’re special. I’m aware of that. I’m just trying to tell you they’re not.” In case you hadn’t noticed, I am being slightly facetious. There are, of course, lots of examples of SaaS start-ups that have been wildly successful and have proven themselves to be very special indeed. My point is that the special ones few and far between.

So why is the SaaS Market so Competitive?

The classic framework in corporate strategy for looking at the level of competition in a given industry is Michael Porter’s Five Forces model. The model, as illustrated in the diagram below, looks at the five forces that shape industry competition: threat of new entrants, threat of substitute products or services, bargaining power of suppliers, bargaining power of buyers, and rivalry among existing competitors. Although the model is limited by the fact that it is static in nature and doesn’t take account of changes over time, it is still useful as a lens to take a snapshot of a broad industry over time and to shape our thoughts about what drives competition in that industry.

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Threat of New Entrants

The threat of new entrants in the SaaS industry is relatively high. Barriers to entry are low when it comes to entering the SaaS market, even if there are many barriers to gaining a foothold and remaining in the market long-term. The availability of cheap IaaS and PaaS from providers like AWS, Azure and others takes away a lot of the large upfront costs that used to block small players from entering the traditional software industry – the various inputs required in order to get started are ubiquitous and a SaaS company can get off the ground quite quickly. That and the fact that SaaS is seen as a very trendy industry to be involved in will see a lot of new entrants looking to take a share of the SaaS pie.

Bargaining Power of Suppliers

The bargaining power of suppliers is limited in SaaS. There is any number of infrastructure and platform providers that SaaS companies can use to develop their applications and the commoditised nature of storage, compute, database, and other services has led to costs plummeting in recent years. Scale is not of importance to the likes of AWS, with virtually no minimum commit and a pay-per-use model as you scale. Furthermore, it is relatively easy for a SaaS provider with the requisite technical ability to containerize their application and switch providers if necessary. Finally, supplier costs are a small proportion of the costs faced by SaaS companies, and of the overall revenue opportunity, so the influence of suppliers is relatively low.

Bargaining Power of Buyers

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This force is one which drives a significant amount of the competition in the SaaS market. SaaS could almost be a case study in how to hand over as much power as possible to the buyer/user. The first key factor is the level of information available to the buyer. Free trials are pretty much standard practice in SaaS so buyers can do a deep dive on any application before committing to a purchase. Monthly rolling contracts without any long-term commitment are also common in the SaaS model so buyers can, at least contractually, switch to an alternative provider at any time. Product differentiation tends to be quite low given the relative ease of replicating features although brand loyalty can be strong in certain product categories, like CRM and storage, where very strong brands have emerged. Fundamentally though, the focus of SaaS companies on customer success and doing everything in their power to drive long-term value of the customer is a sure sign that buyer power is very high.

Threat of Substitutes

The key substitute for SaaS is traditional, on-premise IT. And given that demand for SaaS applications is expected to be five times that of on-premise applications by 2018, it is safe to say that SaaS is winning that battle. To put it another way, a contributor to “Onpremscribe.com” doing a Porter’s Five Forces analysis of the traditional IT industry would list SaaS as the number one threat to that industry when it comes to substitutes. It’s more scared of you than you are of it, guys. Factors which may keep customers away from SaaS, or see some moving back to the traditional model, like security concerns or connectivity and bandwidth limitations, are quickly disappearing so it’s not the substitutes but your fellow SaaS rivals that you need to worry about.

Rivalry Among Existing Competitors

As Jason Lemkin puts it, “competition-to-the-almost-death seems the norm in SaaS”. There is fierce rivalry among the big players like Microsoft and Google, SAP and Salesforce, that rears it head in price wars and battles for large accounts. There is also bitter competition among the up-and-coming SaaS companies all trying to carve out a space for themselves in an ever more crowded market. This is reflected in the constant battle to differentiate, to keep customer acquisition costs under control, and to keep customers once they sign up – not to mention the key indicator of a market in which competition is very high which is the downward trajectory of prices over time.

So, if you’re thinking about a SaaS startup, do think carefully about how you plan to be the one that’s good enough and differentiated enough to make it. And please don’t take these words of caution as discouragement, if anything you should see them as extra motivation. If you are someone who takes pleasure in proving the naysayers wrong then by all means print this article out, put it on your wall, and throw darts at it. I look forward to hearing the stories of the special SaaS startups that defy the odds and prove me wrong.

by Michael Cullen @michaelcullen87

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