One of my current areas of focus is in SaaS Product & Solutions Engineering for ISVs and Enterprises and I attended the SaaScon 2008 conference in Santa Clara. Attended the first day and I found the session by Bruce Richardson, Chief Research Officer, AMR Research titled Balancing Customer Acquisition Costs and Elusive Profitability. He presented data that showed that high percentage ( I think 40%) of cost for SaaS companies like RighNow, Taleo and NetSuite is sales & marketing costs or customer acquisition costs.
This seems to be in line with another article I came across from the blog Unreasonable men (with interesting follow-up posts at SmoothSpan by Bob Warfield and another at SaaSBlogs by Sinclair Schuller). The high cost of customer acquisition combined with the long customer ramp to profitability (SaaS companies requiring a critical mass of users and sustainable growth to attain profitability) are two key factors that will remain a challenge to emerging SaaS companies.
This might be an opportunity for global SaaS companies from countried such as India, China and Asia in general to leverage their lower cost of operations to deliver world class SaaS solutions to US customers. This could pose a challenge to US based SaaS companies. One example of an India company emerging into the SaaS space is Zoho that has launched a suite of SaaS solutions including CRM, Recruiting, Invoicing, Conferencing and many other business solutions. Zoho seems to be gaining quite a bit of attention in the market and I am guessing that their cost structure for both customer acquisition as well as R&D is significantly lower than the likes of US companies.
One of the ways US based SaaS companies can address such a threat from foreign competitors will be to consider offshore BPO and R&D setups of their own or through partners in order to reduce their onsite costs. It is not only about the cost but also about scalability. Being able to extend the respective services into platform and/or marketplace channels for their vertical or horizontal markets. The other aspect is to be able to expand the SaaS solution to emerging global markets rapidly. Thus having operations in one or more of emerging markets such as China & India can be instrumental in capturing the high volume sales required to realize the true business potential of the SaaS business model.
It will be interested in hearing thoughts from people in SaaS companies on this.
Vivek Wadhwa, in a recent Business Week article titled “Why Small Tech Companies Aren’t Outsourcing“, points out that contrary to what you might think, only 15% of the total outsourcing is done by technology companies. Being in the Silicon Valley this is a bit hard to digest knowing that most of the product companies around here seem to be doing some level of outsourcing and quite a number of them a significant amount. Nevertheless it is indeed a recognized fact that product development companies have been slow to get on the offshore outsourcing bandwagon.
Wadhwa presents as evidence research by Professor Amar Bhide who queried 106 companies and found 45% of them did some work offshore and just 15% core product development offshore. Availability of highly skilled talent in relative abundance at a lower cost the primary reason for going offshore. Communication, integration of components, lack of enough skilled talent to meet demand, IP protection and offshore productivity are the key hurdles he cites in preventing companies going offshore.
But if I were building a new technology, I wouldn’t trust an outside team to innovate for me. Outsourcing testing and support is one thing, but when you’re starting up, all you have is an idea. You learn as you go and can never predict what will captivate the market (see BusinessWeek.com, 5/4/06, “”Countdown to Product Launch (Part I)”"). You simply can’t outsource your success to others who don’t have as much skin in the game as you do. Bottom line: Entrepreneurship and innovation is alive and kicking in the tech world. It won’t be outsourced. It is one of America’s greatest strengths and will help the country keep its edge in a globalized economy.
Another article by Andrew Gelina on Redmond Developer titled “Best Practices for Dev Outsourcing” warns against fixed time/fixed bid projects. His argument is as follows:
If the agreement is truly a fixed bid arrangement and the client won’t approve any overages, the outsourcing firm has to make some hard choices. As the end of the project approaches and it becomes apparent that it’ll require more effort than was estimated, the vendor is pressured to pull his high-priced “rock stars” off the project and assign more junior staff to keep the project profitable. In the end, the fixed bid isn’t such a bargain after all.
Personally I have been involved with two clients who came with product concepts and we were able to deliver products to their respective markets in a timely and cost effective manner. They key aspects why they chose us were due to our skills in technologies pertinent to those products as well as our ability to propose a turnkey fixed-bid pricing model for these engagements. As in any decision to select a partner you have to weigh your options to find the right offshore partner and the right engagement model.
You can read the press articles about the two projects by following the URLs given above. These are examples of how small tech companies and startups can indeed get new innovative products and solutions to market successfully by leveraging the advantages of offshore outsourcing.
Couple of recent deals announced, one I mentioned earlier by Nokia Siemens and another by Rockwell Collins to open an outsourced offshore design center illustrate the growth in R&D outsourcing.
The current (June 2007) issues of R&D Magazine has a cover story (R&D Outsourcing Becomes More Strategic) that describes the result of a May 2007 survey on R&D outsoucing. The report quotes several other studies and the number of firms conducting some R&D outsoucing varied from 30% to 65%. Interestingly 51% of respondents stated that the main reason for outsourcing R&D was that the external organization had more expertise while cost was 4th behind manpower shortage and workload!
An analysis and 50 year outlook on R&D outsourcing by the Delta Scan forum produced by the Institute for the Future, a Silicon Valley think-tank, states that the traditional large organizations such as Bell Labs or Xerox PARC have become less competitive versus companies like Cisco that either outsource or acquire innovation. They predict that there is going to be a major shift in the geography of R&D in the future.
Over the next 20 years, the geography of R&D may shift again – from regional clusters in the developed world to global networks with large outsourced operations in the developing world. India and China, in particular, will provide large pools of highly skilled workers at 25% to 50% of the cost of their counterparts in the West and Japan. The Indian government estimates that outsourced R&D in India currently generates about $1 billion annually; this is projected to rise to $11 billion by 2008, mostly in software. China’s manufacturing capacity gives it a natural advantage in computer hardware R&D. Both nations also have the long-term potential for large-scale work in pharmaceuticals and biotechnology.
However the studies state that quality and concerns over IP protection are still key impediments preventing organizations from using outsourcing for breakthrough innovations. Will R&D outsourcing really parallel the offshoring of manufacturing in the 1990s and of routine services in 2000 and later as Delta Scan suggests? Not likely. Once the offshore geographic locations start becoming strategic R&D outsourcing locations, very soon innovation will be driven from these locations which can be major threat to the existing R&D clusters.
History shows that regional R&D clusters like Silicon Valley and Boston attracted top talent from around the world. However in the flat world, will there still be regional innovation clusters?
Edit: There is a very interesting article on the future of Silicon Valley that discusses innovation clusters and SV in particular and their future by Dave Llorito. I thought it a pertinent addition to this post.