Monday, July 27, 2009

M&A in a SaaS world

People often casually talk about mergers and acquisitions in the SaaS space. Some say this space is "ripe" for M&A. There is already enough statistical evidence that M&A has more chances of failure than success. SaaS company acquirers should take this data point even more seriously.

There may be several reasons to acquire a company in the SaaS space e.g. to buy your way into a market, buy innovation through acquisitions etc. But the most critical part is the post-acquisition integration. Since SaaS is still an evolving space there are no clear SaaS platform leaders. In fact there are hardly any SaaS platforms in the market.

Without a standardization or maturity in the SaaS platform market, every SaaS vendor has a purpose built platform for their product. This applies to any company out there including, SuccessFactors, NetSuite, Concur etc. Imagine integrating the platforms of these companies if they were to merge. It is a non-trivial problem and should be a huge consideration for the acquirer for one simple reason - margins.

The margins for a SaaS company is very heavily dependent on how scalable their SaaS platform is. By scalability I don't mean only technical scalability. It is also the cost of scaling. If the cost of scaling is high then the business is not scalable. I can easily imagine a cost-of-scaling metric that will eventually be used to value a SaaS business just as customer acquistion cost and customer churn numbers are key metrics used to measure a business like Netflix.

Integration becomes a challenge with highly custom platforms and without integration the benefits of economies of scale become a dream. I don't think there is a realization of this fact in the industry. So I think major M&A activity in the SaaS space is nowhere near. And the ones that do get acquired by bigger players like PayCycle by Intuit, will forever remain independent operations without ever achieving the benefits of economies of scale.