This post was originally included in our Quarterly Letter to our LPs in Q2 2013. LEC has made marketing SaaS investments in companies like Bazarvoice, Marketo, Monetate, Ensighten, Kapost, and Spredfast. Clearly we have been bullish on the marketing technology space, and in this letter, we’d like to outline some of the reasons we have been so fond of the market.
Reason #1: Marketing Departments have Budget
Selling into functional areas of enterprises can be a daunting task. When we talk to salespeople at software companies we evaluate, they relay all of the different pieces of pushback they hear from various constituencies. These excuses typically range from the concrete; “we need multiple sets of approval from management and we’re not there” to the completely intangible; “we need to figure out our strategic direction before jumping in with a new technology.” Through all the noise, however, the most common refrain within functional groups is that they simply, “don’t have the budget.”
Companies that sell into the marketing and sales departments of companies, however, don’t hear as much pushback around budget. The fact is simple, sales and marketing departments drive revenue, which for most companies is the lifeblood of their business. While other functional departments, such as HR, finance, operations, etc. are constantly looking to cut costs, marketing departments are becoming more empowered to leverage technology to drive revenue especially as it delivers a clear ROI. They therefore have budget to spend, which makes for the best type of customer. In addition, in most corporations, they need to demonstrate organizational productivity, further accelerating the need to experiment with new tools. Clearly this is not to say that marketing departments never push back on pricing, but on a relative basis we find that they are becoming much easier to sell into.
Reason #2: Marketing Tactics have become more analytical
Marketing departments have seen a significant shift during the digital age. Once stereotyped as cost centers with minimal measurability, marketing departments are leveraging technology to both enhance and demonstrate success. To that end, their appetite for products that can help generate positive ROI is large. Today, more than ever, these departments are also being judged on their effectiveness. CMO’s are empowered to make decisions, but must do so based upon concrete, data driven strategies.
As marketing departments have shifted during the digital age, they have purchased products to meet their analytical demands. Several of our companies help marketing departments meet these goals. The analytics each product offers can help to specifically drive both leads and conversions.
Reason #3: Marketing Departments have (nearly unintentionally) embraced SaaS
It is our belief that SaaS is the way in which nearly all software will be delivered in the future. In the here and now, however, the marketing departments within companies both large and small seem to be the ones that have most overwhelmingly embraced the SaaS revolution. This dynamic produces a more knowledgeable customer base and therefore a shorter sales cycle.
But why is it that this department is the one that has embraced this delivery method? In our minds the answer is simple, it comes down to greenfield sales vs. legacy displacements. As we noted above, in many functional areas, new SaaS technologies have the difficult job of displacing existing legacy application software systems. For instance, if a new vendor wanted to come in and replace a company’s legacy inventory management software system, they’d be displacing a technology that might have been used at a company for 25 years. Employees know all of the legacy system’s quirks, workarounds and troubleshooting procedures. Bringing on a new system would require a new set of education and time investment on behalf of users. In these cases, often times the old adage holds true, “if it ain’t broke, don’t fix it.” With that said, many legacy systems are in fact being disrupted by SaaS models but that is a topic for a different letter.
In the case of digital marketing, no such legacy systems exist. Due to this fact, marketers have needed to embrace new emerging SaaS tools almost out of necessity. As SaaS tools grew in the digital age, so too did data-driven marketing, and voila, in that perfect storm, SaaS was the only game in town. Because the products were so easy to set up and required minimal on-premise integrations, marketers started circumventing the IT organization, which historically had been the area that laid the red tape so many software companies met during the selling process. The inertia has continued over time, and marketers are more empowered than ever to purchase technology on their own accord.
With the aforementioned empowerment, also comes the double edged sword of rapid change. Buying cycles can be shorter, but you can also be removed more quickly. Often times marketing departments will purchase SaaS software as a trial or proof of concept, and convert to a deeper, broader deployment over time or shut the software off altogether. Because the data is hosted by the SaaS company, however, the SaaS provider itself has excellent high level data around usage and logins, that would be otherwise difficult to get if the software was installed on premise. This plays into our favor as investors, as we’re able to track these companies over time, watching smaller purchases convert to larger upsells. If there is an absence of upsell data because the company is on the earlier side, we’re able to evaluate logins, time spent in software, etc. to make a determination of how likely customers are to both renew and expand their subscription.
Reason #4: Market Dynamics and Exitability
Despite all of the positive micro-based trends above, perhaps the most important reason we like investing in the marketing software ecosystem has to do with what we term, “exitability”. Observing the private equity industry, we’ve concluded that numerous companies end up in a firm’s portfolio for years that are affectionately “the walking dead.” Often times these companies simply might not have performed to par. More frequently, however, they are companies that have revenues and are cash flow positive/breakeven yet aren’t growing and are not large enough to IPO, and have a minimal acquirer set.
The thing we like most about the marketing software sector is that historically the exit dynamics are advantageous, and have been proven out over a long time period. The chart below depicts an acquisition taxonomy of the marketing software sector:
The prior chart gives us comfort in the exitability of the companies in which we invest. There are a few particular characteristics that resonate in particular:
- Multiple Winners – Most of these sub-markets are large, and can support multiple companies with meaningful revenue streams. Given that the market is not “winner take all,” not picking the “winner” can still result in a favorable investment and enhance downside protection.
- Healthy Acquisition Multiples – Many of the companies on the list have been valued at significant multiples of revenue on exit. This shows the strategic value the acquirers have continued to place on the sector. As a reminder, in the Q412 letter we discussed in detail why strategic acquirers are able to pay these multiples for these businesses.
- Large Companies Buy v. Build – Most of the larger acquirers listed on the bottom right of the chart have made multiple acquisitions in multiple sub-sectors. Through this public data, along with our conversations with M&A folks within these organizations, we feel that there is overwhelming evidence that the big guys will continue buying in this sector.