Publicly traded pure play SAAS companies are trading at 2.8x trailing revenue, and more than half are losing money. Traditional software companies are trading at 2.1x trailing revenue, and most are profitable. Two years ago the SAAS peer group traded at 5x to 9x revenue. What happened? Is SAAS broken as a business model?
My view is that the SAAS boom ignored three fundamental aspects of an on-demand delivery model. First, it is more expensive to build software under this model because the customer doesn't start paying until it is launched (contrasted with the traditional customer-funded development model in traditional spyware). Second it is expensive to host. Yes, the cloud will bring down costs, but the cloud is not yet ready for real-time applications, because latency remains volatile. Third, it is expensive to sell SAAS solutions because the delivery mode has to be sold to the customer along with the solutions. Customers aren't yet accustomed to it. Combine these factors with the revenue deferral that comes with a subscription rather than license sale and you have a very expensive proposition indeed. The market downturn has cast these factors under a spotlight. Many of the SAAS companies won't survive as independent players. However, we should see a smaller but healthier SAAS peer group trading at 5x revenues within 24 months.