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Summary:

When a web application gets popular enough, features matter less and the underlying ecosystem matters more. There’s a tipping point at which network effects outstrip software features. When that happens, users get the benefits of additional functionality — and the risk of new kinds of lock-in. […]

When a web application gets popular enough, features matter less and the underlying ecosystem matters more. There’s a tipping point at which network effects outstrip software features. When that happens, users get the benefits of additional functionality — and the risk of new kinds of lock-in. Salesforce.com, for example, started as a replacement for in-house software. Now it’s a software ecosystem complete with a programming language, developer conferences, and a marketplace for third-party developers. That makes Salesforce a lot harder to leave than if it were just a bundle of software features.

Freshbooks, whose SaaS-based billing tool tracks time and expenses and sends invoices to customers via email or post, is at that tipping point. It’s grown to 900,000 subscribers using a mix of free and paid offerings. Now that there are so many users, subscribers often wind up sending bills to one another. So the company made it possible to send those invoices within the system directly, bypassing external email. Today, Freshbooks revealed that 20 percent of its subscribers had adopted this new capability — taking Freshbooks from software tool to SaaS ecosystem. Software as a Network

Is this how freemium pays off? In “Free,” Chris Anderson speculates that information-based businesses won’t make money from what they do, but rather because of what they do. Here, Freshbooks may not make money from every subscriber — but it can offer compelling new features because of them.

Once a SaaS provider hits a certain size, secondary business models based on network and ecosystem effects can eclipse the initial business. This makes the economics of running a SaaS provider a bit strange: Too much focus on short-term revenues may undermine long-term success, because free helps reach critical mass, where new models can emerge. At the same time, network effects may make it hard to launch a new SaaS offering, since early players can erect significant barriers to entry.

For SaaS customers, this portends a new kind of lock-in. SaaS promised us freedom from the proprietary formats and costly, custom deployment efforts of enterprise software, but network effects can constrain subscriber choice and make it hard to leave. If you want access to Salesforce’s ecosystem, you have to use Salesforce.

Freshbooks CEO Mike McDerment, understandably, maintains that network effects are more about added benefits to end users than about lock-in: “If you can add a feature that’s not possible without a network, and there’s sufficient value offered by that network, then it’s worth it to stay on the network.”

  1. [...] This article on GigaOM really caught my attention because it’s dear to the hearts of the team I work with.  Creating feature after feature may not be what’s needed to grow — but rather create one or two compelling reasons to be on the platform, and then use that network effect to create additional features that benefit large numbers of users. [...]

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  2. PayPal has inexplicably refrained from building out its invoicing capabilities. It’s already way bigger than FreshBooks.

    And Malcolm is either dead wrong or doesn’t understand the argument (not sure which is worse).

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  3. Alistair
    I think the value of a platform is undeniable. In addition to providing B2B kind of functionality between tenants, the SaaS vendor can also eventually provide value added analytics, collaboration functionality. I had written in my post http://www.prudentcloud.com/saas/value-added-saas-12062008/ about some of the features we were able to provide to expand our offerings at my previous employer.

    I see this eventually moving into co-operative consortiums of SaaS vendors/platforms.

    Subraya Mallya

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  4. It is obvious that the SaaS will gain traction in near future. Salesforce.com and others have shown the benefits of not using in house applications and relying on using applications hosted and supported by a third party over internet, whose job is the application service itself.

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  5. We at ExpertCEO use Freshbooks for our billing. The thing that has impressed me the most about the firm is the quality of their customer service. Every time you call, you’re immediately connected to a real person, and that person invariably knows the intimate details of the product and how to solve your problem or answer your question. In the long run, that type of service is integral to any company’s success.

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  6. Alistair – great post. Another interesting notion is the focus a lot of these successes have. They start with a narrow but deep focus on one domain, with Freshbooks its invoicing, with Basecamp its inter-company project collaboration, with SurveyMonkey its dead simple survey creation and mgmt. It makes me wonder just how “in the know” some of the folks still straight-arming SaaS really are. Take the recent Gartner survey as an example; the audience for this survey is Gartner clients, which are primarily going to be CIO’s of large enterprises. I would be willing to bet that at least 50% of the SaaS applications running in their enterprise they don’t even know about! I am not saying this is a good thing, but for sure a lot of the success of SaaS is the ease at which you can get it up and running and adding value to your organization. And holistically speaking, we can’t lose sight of that.

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  7. Hi.. Your post got me thinking… What is more valuable for a software company (like facebook or flickr). 1,000 paying users or 100,000 non-paying users? What are your thoughts? View my blog post here: http://www.purlem.com/blog/?p=57

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