An interesting question about Force.com model

Posted: February 7, 2008 in CRM

There’s a comment by Raj Gupta to another column "Salesforce.com goes on tour" that bears looking into.  It reads in full:

"Perhaps this question is more for Salesforce.com, but what is the difference between a developer and user in this model of pay per login.

Is "developer" the person (or company) that uses the force.com platform to develop an application and "user" is the person who uses it — in which case the user cost ($0.99 per login with caveats) is like a royalty paid to Salesforce for an appliation developed by a 3rd party using force.com platform — or is it something completely different.

That’s a good question.  My understanding, based on briefings and informal conversations with Salesforce staff is this.  Gupta’s summation is accurate — the organization that develops the application using Force.com pays no fee to Salesforce for use of the tools, hosting environment and all the rest of the technology supplied — AKA ‘The stack’.  You get it when you sign up for a developer edition account, which is free. 

The application’s user would incur a fee from Salesforce for using the application.  Customers who already have Enterprise or Unlimited Edition can also develop, but the cost of development is bundled in (or is free) with their CRM subscription. The only cost to developers is if they choose to deploy the application on the Appexchange. There is a cost for the validation of the application. There may be separate costs if they go down the OEM route too, but that is separate discussion.

There is a charge for application use.  In this case, an occasional user would pay a buck but in more high use cases there would be a monthly fee of $50 (last time I checked) per month for the user.

There is a real cost associated with hosting a user regardless of who writes the code.  If you think not, ask yourself how any SaaS provider can afford to build a data center and supply it with consummable services like power, security and smart people.  Does it cost $50 per month per user?  No.  I know this because that would mean this is a breakeven proposition and who goes into business to break even?  I bet fully loaded the cost of supporting a seat is less than $10 per month.

So there’s a profit motive involved, that’s no surprise.  I fully expect the cost per seat-month to go down over time.  Right now, I think the pricing is based more on the comparison cost for an internal IT department to host a user and I suspect many CIOs see this as a good deal.  Go out a few years and there will be competition for hosting like this and prices will fall but that’s still far off.

Users have to expect this kind of pricing — which I view as reasonable.  After all, as Salesforce gets deeper into the platform business, its main source of revenue will be from selling generic seat hosting.  Most financial analysts and investors already know this.

Keep in mind that this mechanism also applies to the ISV market too.  That means that a potential $50 charge will be augmented by another charge by an ISV for a custom application, unless other arrangements are made.

Some models to consider —

1.  Salesforce invoices the end user for hosting services as well as the ISV’s application and then pays the ISV for the application use minus billing and processing fees.  They’ve already experimented with this model and I think one of the reasons that Tien Tzuo, former Chief Strategy Officer at Salesforce, left to start an on-demand billing company is that everyone is discovering how Balkanized and hard the billing function is.  There’s money to be made in billing and savvy people are backing start-ups in the space.  As Mike Braun, CEO of Intacct told me recently (see posting The diaspora) as on-demand software companies become more and more like other utilities billing will be the critical application for them.  A billing system lets you take a relatively generic service and package and price it in almost limitless ways.  Volume pricing comes to mind when I think about it.  It takes high speed computing, analytics and good reporting, as well as a lot of business rules to make it all happen.

But I digress.

2.  You could see another model in which a development company sells licenses to an application, just like conventional software today, but where the hosting company still charges monthly for basic service.  To me this looks a lot like cable TV today with basic and premium services.  The differentiator or enabler here will be the billing system.  On balance and depending on pricing, this could be a good deal to the enterprise customer because it reduces the capital expenditure needed to support IT and turns it into a line item expense.  I don’t know what the tax implications might be though.

There are probably other models too that are waiting to be born and whether or not they are will depend on the applications built, the economics of being an ISV in this new world, and numerous other factors.  It’s a wait-and-see game but it’s also a good reason to follow markets and individual companies. 

It’s also insights like this that drive investors’ calculations.

So, what did you think?

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