SaaS revenues thrive but fail to drive profits

To look at its revenue figures from the past two years, one might think that was operating in an entirely different economy to the rest of the IT industry. As businesses have sought ways to increase sales without capital expenditure, the company’s web-based customer relationship management application has been in high demand.

And the growth keeps on coming. In April 2010, the company revealed a 24% year-on-year increase in revenues to $377 million for its most recent quarter. saw growth in all locations, although North America remains by far its largest market, raking in $260 million.

“Our success this quarter demonstrates the massive shift we see globally in cloud computing,” said CEO Marc Benioff in a conference call with investment analysts. “Businesses of every type are increasingly looking to the cloud to solve their challenges, and they’re starting to look at the cloud in a whole new way.”

But’s profitability, its Achilles heel, actually fell year-on-year. Despite adding 4,800 customer during the quarter, the company saw net income drop 3.8% to just $17.7 million. The company attributed this decline to growing operational cost and its $142 million acquisition of crowdsourced business database provider Jigsaw. at least has its rapid growth to justify its weak profit. A similar story unfolded for Descartes Systems, which sells on-demand logistics management tools. It grew revenues by more than 22% year-on-year to $21.3 million in the first quarter of its financial year. But net income at the Canadian vendor was down to $0.2 million from $2.2 million in the year-ago quarter.

Descartes explained that this was the result of two acquisitions it made during the quarter: a $40.9 million deal for trade management solutions firm Porthus and the $6 million purchase of communications start-up Imanet.
“Our first quarter has historically been our most seasonally challenging quarter, and this year the challenges were heightened by severe currency fluctuations and the Icelandic volcanic activity, which adversely impacted European air shipment volumes,” said Stephanie Ratza, Descartes’ chief financial officer.

Other SaaS providers do not have the excuse of such rapid growth. NetSuite, which sells on-demand finance and accounting applications, was founded a year before, and in the past decade has preached a similar message. But despite considerable press and analyst attention, NetSuite’s growth has been much more sedate.

That wasn’t much changed in the first quarter of 2010. The company reported a 6% increase in revenue to $43.9 million and enjoyed, it said, the highest number of bookings per quarter in its history. “These results show NetSuite’s strong momentum in delivering solutions that meet customer requirements to run complex, mission-critical business processes in the cloud,” said the company’s CEO, Zach Nelson.

Unfortunately for NetSuite, this momentum did not carry over into the business’s net income, as the company widened its overall loss from $3.9 million to $6.6 million. Still, the company has ambition. In May it announced a partnership with IBM to integrate its application with on-premise enterprise resource planning applications, signalling a desire to attract larger customers than those in its mid-size heartland.

Profitability was a little better for Concur Technologies, which sells both on-premise and hosted versions of its expense claim and invoice management software, but it still grew much more slowly than revenue. During the second quarter of the financial year, the company reported a 17% lift in sales to $72.8 million, while net income was up only slightly from $6.7 million to $6.8 million.

“We see a variety of opportunities to continue to grow our business substantively over the next five years,” commented Concur CEO Steve Singh. “These include growing our customer base in the markets we currently serve, geographic expansion and addressing the emerging business sector.”

Another SaaS company to have exhibited the trend was SuccessFactors, whose roots are in the human capital management market but which now describes its on-demand tool as “business execution software”.

In its first fiscal quarter of 2010, SuccessFactors grew sales by 24% to $48.1 million. CEO Lars Dalgaard revealed that this was driven in part by a customer win he described as “the world’s largest planned use of cloud computing solutions in a single enterprise”. Interestingly, the last company to make this claim was also in the HCM space: in 2008 Workday announced a 200,000-seat contract with global electronics distributer Flextronics.

But like many of its peers, SuccessFactors has yet to turn its escalating revenues into profit. In this most recent quarter, the company lost $4.7 million. This was, to be fair, an improvement on its $5.7 million loss in the sane quarter of last year.

The CEOs of these companies would doubtless argue that their investors will receive greater returns when the market matures and growth becomes less explosive. But the phenomenon is one that appears to blight SaaS providers whatever their level of growth. It may therefore be an unintended consequence of the shift to cloud computing that the IT companies are a less profitable investment than in the past. This arguably calls into question the pace of innovation that such vendors can afford to fund.

Peter Done

Peter Done is managing director of Peninsula Business Services, the personnel and employment law consultancy he set up having already built a successful betting shop business.

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