This is a guest column from my colleague Evan Frank:
This past week I attended the Software & Information Industry Association’s OnDemand Europe conference in Amsterdam. The goal of the annual SIIA event is to bring together American and European SaaS entrepreneurs, schmooze over a few days of canal tours and canapés, and hopefully let US best practices rub off on what is a much more nascent industry in Europe.
Building a SaaS business the way it's being done in the US is much more difficult in Europe.
For starters, any individual European country is too small a market to build a business with real capital markets value, especially because on-demand applications tend to be fill niche gaps in enterprise application functionality.
Second, there is a certain cultural resistance in Europe to the sales model favoured by US SaaS companies, who rely heavily on over-the-phone inside sales techniques, saving face-to-face visits for large deals only.
If you add to these barriers the challenge of multiple languages and slower acceptance of new technologies by corporations, it becomes clear that Europe has more than a few hurdles to overcome before SaaS market leaders can emerge.
Then there’s the hairy question of profitability and cash usage. Some astounding statistics were quoted at the conference, such as: the average SaaS business in the US consumes $72m of external capital prior to going public (!!).
The US market is clearly in land-grab mode, with both the public markets and private investors turning a blind eye to capital efficiency and profitability. Some companies will follow market leader Salesforce.com and succeed (see DemandTec, Salary.com, Athena Health, Vocus, among others), with huge returns to investors. But many will not, and they will have used up a lot of investment capital in the process.
Well, first, profitability does matter (kudos to Fraser Davidson from August Equity for reminding us of the most basic financial tenet: that companies are worth the sum of their future cash flows), so you better have a plan that gets you into cash-flow positive territory. Even though many of the US SaaS vendors were unprofitable when they went public, today the median company has EBITDA margins of 18%, with less than 15% of vendors still in the red, according to research by Jefferies Broadview.
And getting into profitable territory is clearly worth it. The same research shows that SaaS vendors are trading at an average of 19x forward EBITDA vs 11x forward EBITDA for traditional licence software vendors.
Second, while there are good reasons for SaaS companies to raise external capital –- annual subscription cash flows are often 1/3 or 1/5 of an equivalent up-front license -- one shouldn’t abandon the basic principles of business building when it comes to scaling across Europe. That means choosing your target countries wisely, hiring the right people, and adapting your product and sales approach to each country.
Third, while it takes perhaps more discipline and strong sales management, you can definitely sell software over the phone in Europe. We're about to announce an investment in a company that does just that, and very successfully too.
It's going to take a bit more work on our side of the pond to build big SaaS companies, but at least the Americans have shown us both how to do it and what pitfalls to avoid.