On Demand Software and Customer Relationships

Many of the software startups I talk to these days are offering a hosted or “On Demand” product.  The virtues of this approach are relatively clear, so I won’t repeat them here.  But, one aspect of the approach that doesn’t get talked about a lot is the difference in the ongoing relationship with customers.


In the traditional licensed software model, a prospective customer downloads your software, perhaps tries it (for free) for a while and ultimately buys it, at which point they become a customer.  At that point, you have basically lost connection.  You can send them emails about new releases, setup support forums etc. but in most cases you have absolutely no idea what (if anything) they are doing with the software and whether its bringing them any value.  They could be raving fans of your product, or could have abandoned it a week later.  You hope that they download regular updates, perhaps even pay for a future upgrade (if that’s your model), but that’s about it.  Given that there are 1,000 things you need to be doing as a startup founder anyway, you move on with your life until this customer needs some sort of support.


In the On Demand model, the relationship is very different  You have to bring value to your customers every day.  You know immediately (and in detail) whether customers are using the software at all – and if so, which features.  You can build a relationship.  In fact, you must build a relationship because that’s part of what they’re buying.  Its your responsibility to keep the connection. 


From, Mark Benioff, the CEO of salesforce.com:  "At Oracle, we signed a deal and we ran away as fast as we could. On demand is a marriage, traditional client-server software is a one-night stand. It's two different ideas."


Though I don’t consider this a perfect analogy, it conveys the message.  When providing On Demand software, your profits and margins don’t show up on the day that the check is written (or in GAAP terms, when the revenue is recognized), but are earned during the life of the customer.  This is both a good and bad thing.  We’ll miss the rush of that $100,000+ sale, but it in the long-term, its healthier.  


From a software startup’s perspective, the On Demand model creates some unique challenges.  Given that there is no big “upfront” license fee, the capitalization required is different (i.e. since you can’t rely on big payments, you may need outside capital until you can build a steady revenue stream).  But, this is generally more than made up for by the magic of reoccurring revenue.  Once you have a baseline of customers, and you can keep them happy, your revenue keeps growing.  You’re not starting every year (or quarter) from the ground-up.  And trust me, there is nothing like predictable, growing revenue streams.


I think On Demand software is here to stay for a while, and particularly makes sense for startups as it allows them to learn more quickly from their customers – and hopefully apply this learning more nimbly and quickly than their larger competitors.  Lets see if that actually proves out.


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