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We’re seeing a lot of gloom and doom in the SaaS space and the techworld in general as valuation multiples have compressed and late-stage funding has become more challenging. However, there still exists tremendous opportunity to build large, valuable companies in the SaaS space.
How can an entrepreneur do this? Build a “system of record.”
A system of record (SOR) is software that serves as the backbone for a particular business process. By definition, it’s very sticky and hard to rip out for many reasons. And these software solutions have moved beyond the standard questions buyers ask about ROI – they have become a class of software that is a required purchase for a given business process.
A number of companies have built highly successful systems of record: Salesforce in the sales function, Intuit in finance, Workday in human resources, and vertically oriented companies such as Guidewire and Veeva in insurance and life sciences respectively. What stands out about these companies is how valuable they each are and how low their annual gross churn is.
Once someone buys and implements a system of record (assuming it works as advertised), it’s never coming out.
Are you on path to building a system of record? Here are the seven questions to ask:
1. Does your software run a mission-critical business process?
Systems of record are typically the backbone of core business processes — processes that will not run if the system of record goes down or gets ripped out. The more your system is at the heart and soul of how a company makes money, the more valuable your system of record will be.
2. Does your software store proprietary business data?
The power of systems of record is that they are the ultimate source and therefore “record” of critical business data. Your general ledger is stored in Quickbooks or Oracle Financials. Your pipeline data is in Salesforce. And your compensation and payroll information is in Workday. Once you are the “store” for critical business data, other applications, by definition, have to integrate into you in order for their solutions to work. Historical SOR companies, like SAP, kept their solutions closed and forced third-party vendors to spend millions of dollars for customer integrations to access the SAP data. Salesforce has taken a more modern approach by having an open API and an entire ecosystem of third-party application providers.
3. Do large portions of the employee population interact with your software on a daily or weekly basis?
The engagement and usage of your solution is a measure of how integrated your solution is into the workflow of rank and file employees. Analytics solutions are great, but if only a small set of data scientists use them, then they are easily replaced. Conversely, large numbers of employees use travel and expense reporting on a weekly basis, and so replacing such solutions would mean retraining huge numbers of people.
4. Is your company the system of truth? Do the outputs from your solution — your reports or insights — form the foundation for important business decisions?
The most valuable SaaS companies have evolved from being systems of record to being systems of truth. The data the executive team looks at for human resources discussions comes from the HRM system, and the data for discussions about customer service operations comes from the CRM system. The goal of any company aspiring to be an SOR should be that the exec team or the owner of a business is using its screens on a regular basis.
5. Does your software codify solutions that are “inside the heads of human beings?”
The more your system requires and benefits from human input of some kind, the harder it is for the next player to take over and replicate what you have. The process of implementing a system of record is a forcing function to take this undocumented knowledge that is spread out inside a company and structure it in a repeatable way in a software solution. Systems of record become the place where rules for how a company operates get codified. This is why systems of records can be so time consuming to implement – this information is sitting inside the heads of a disparate group of people and needs to be extracted and parameterized.
6. Does your software “learn” and improve over time?
Learning can be algorithmically triggered — e.g., your software leverages machine learning to improve the output over time. In addition, learning can come from feedback loops built into business processes (our forecasting approach needs tweaking based on our recent performance, so let’s update the core methodology in the forecasting solution). In this way, systems of record incorporate years of learning within a corporate function or workflow. This is a powerful reason why systems of record are so valuable.
7. Does your solution have negligible “gross” churn rates?
By definition, systems of record that work and are successfully implemented should never be ripped out unless the company goes away or gets acquired. Enterprise-focused companies have gross retention rates above 90% and the best are over 95% (not including upsells). The company where I led sales and marketing, Trilogy, is still collecting annual maintenance from clients we sold in 1995!
This is not necessarily a comprehensive list, but hopefully it provides some directional guidance on what it means to build a system of record.
Many of the examples I’ve given are enterprise-focused companies. But these same concepts apply whether you are selling to large companies or SMBs, whether your solution is horizontal or is specific to one vertical, and whether you are serving a broad function or a narrow one.
Building a system of record is not the only way to build a billion-dollar SaaS company, but it is surely the most reliable way to get there.
Ajay Agarwal is managing director and leader of the Bay Area offices for Bain Capital Ventures, where he focuses on early-stage application software and SaaS investing.
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