Is it possible to build a scalable and successful SaaS business in govtech? I find myself going back to this question often. By no means am I saying non-SaaS businesses in govtech are no good, it’s simply a thought exercise for SaaS companies. Let’s start with a few definitions:
SaaS (Software as a Service) — Software licensed on a subscription basis. Revenue recognized over the life of the contract. Primary revenue source is the software, not implementation fees, maintenance fees, or consulting fees.
Scalable — Acquire more than 1,000 paying public sector customers.
Successful — An actual path to profitability.
Let’s break down some of the fundamental elements of a scalable and successful SaaS company:
1. Customer Acquisition: It turns out selling software to the public sector isn’t an easy task for all of the reasons highlighted in this post. A lot of companies forget (conveniently) that customer acquisition isn’t just the sales team. It’s marketing, sales, legal, procurement, and customer onboard. It’s every cost to actually get the paying customer into the product. The govtech market has so much opportunity because the relatively low utilization of SaaS products. That also means the customer acquisition costs reflect the primitive state of the market. From a practical standpoint, if you have a 15% conversion rate from prospect to customer, every penny spent on the 85% you lose, gets amortized over the 15% you won. Given SaaS revenue is recognized over the life of the contract, SaaS companies are unprofitable for the first 12–24 months of every contract. Where any govtech company falls on that spectrum is of course related to pricing.
2. Pricing: The good news for govtech is that more outside capital is coming into the space. More companies are getting funded and more products are getting built. However, like most industries where capital is flowing, it enables companies to aggressively (read low) price as a means for acquiring customers versus pricing for value or pricing for profitability. More products at lower prices might be good for adoption of SaaS at an industry level , but it’s generally not a good recipe for individual companies. Low pricing might help a company become scalable (1,000+ customers) but it might come at the cost of being successful (profitable).
3. Product Utilization: For most industries, active use metrics (DAU, WAU, MAU) are probably the best indicator of happy customers. Particularly, active and consistent use over time. This may not actually be true in govtech. My own theory for the space is that product value is derived from high magnitude use versus high frequency use. Government budgets are designed around episodic, high magnitude use cases, often called projects. That results in a demand for project specific software needs, that may or may not provide value post project. If this is true, customer acquisition cost will be higher and retention is less predictable. There are certainly exceptions to this rule, public safety tech is an example.
4. Retention: Finally, the ultimate success (profitability) factor, retention. SaaS companies subsidize customer acquisition, by delivering and recognizing value over time. They are designed to be unprofitable for a certain period of time. SaaS companies are built on two key assumptions; high retention rates and a decline in the cost to service customers. Do these two assumptions really hold true in govtech? Time will tell I suppose.
I think these are fundamental challenges in the govtech space. Observationally, there are more companies and products than ever in the space. Pricing seems to reflect the increased competition plus a desire of companies to stay under procurement thresholds. However, I’m not convinced that cost of services models have proportionality decreased to match lower pricing. This may not create short term issues, but certainly will create longer term issues in the space. There are of course many alternatives (less customers, higher price, hybrid delivery models, etc..) to pure SaaS. I continue to be bullish on the long term prospects of the space, but also cautiously optimistic that the current companies can figure out the right equation.
This article was originally posted on the blog Better Planning.