Watering Down SaaS ARR

  • Investors typically value software product companies at 6x revenue or more. (With bigger multiples for faster license growth.) That’s because a software product company with a well-executed multi-tenant architecture and ruthlessly efficient onboarding can add new corporate customers (logos) with very little incremental effort or cost. Once the company passes break-even, each additional customer is nearly pure profit. [See All of the profits are in the nth copy.] Customers don’t care how hard we work, or how big our development is, but whether the application already does what they need. And they will renew (over and over again) as long as they’re happy.
product vs service economics
  • Software services companies (aka consultancies aka outsourced development aka staff augmentation aka nearshoring aka custom application builders) are typically valued at 1x annual revenue. Ultimately, clients pay them for hours/days/weeks worked: for effort expended rather than value delivered. Clients are always evaluating whether their uniquely bespoke software needs can be built elsewhere (internally or externally) faster for less money. Services firms have to keep their technical staff busy to stay profitable.
  • Many (likely most) of our biggest clients’ special requests or custom work is of little use to the rest of our customer base. We tell ourselves endless lies stories about market leadership and early adopters and how “everyone will eventually need that,” but it’s mostly not true. I like to ask this retrospectively: “Of the 7 things that we built for HugeCorp last year, how many are being used in production by 3 or more other customers?”
  • This plays havoc with product planning and roadmaps. Inevitably, some of what MassiveCo wants will need changes deep in our application architecture. Or creation of new permissions. Or adding new APIs. Or white-labeling interfaces. Or retuning our query optimizer.
    When we signed the contract, we imagined setting aside some generic development resources or field engineering time, but these requests need specific people on specific teams who are our experts in those specific technical areas. And we can’t reserve 20% of every architect or designer just in case Behemoth Inc might need them in Q3. Instead, we assign our best people to work on our most strategic problems… and are (inevitably) surprised when we pull them off innovation for one-off contractually obligated projects.
  • Big customers learn to view us as a services firm, not a software product company. They increasingly want their own version, codeline, dedicated development team. They expect us to jump on command (since they’ve prepaid for our attention). Their shopping lists have items quite far from our core application or competence.
  • Since custom development and staff augmentation are mostly about cost, we’re always in competition with pure services firms who are hungry for business or willing to charge less. The pressure is on deadlines, delivery dates, more accurate work estimates. Customer specs may be unclear, or incomplete, or non-sensical, or flat out fail to fix the problem they have. But there’s intense pressure to deliver exactly what the customer wants, on their schedule, even if we take quality shortcuts or subvert our core product or build what we know is worthless. “We have to hit these dates, or they may cancel the rest of our services work.” Success generates even more exotic projects; failure costs us service renewals.
  • Product strategy slowly erodes. As more of the development calendar is allocated to delivering what Colossal Ltd and Mammoth Inc want, the remainder goes toward ‘keeping the lights on’ and quality escalations and chasing the competition. Why put together a great strategy that we won’t execute? Disenchantment leads to learned helplessness leads to engineering/product staff turnover.

Sound Byte

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Rich Mironov

Tech start-up veteran, smokejumper CPO/product management VP, writer, coach for product leaders, analogy wrangler, product camp founder.