Porter’s Five Forces – Analyzing Industry Attractiveness

To assess the attractiveness of the SaaS market, the following section provides a Porter’s Five Forces-analysis to identify the conditions for profitability. Output from the analysis is primarily based on findings from a MarketLine report published in 2020, studying the Global cloud-computing market and US Software market.

4.4.1 The Power of Buyers

The buyers of SaaS vary in size, from individual customers to multinational corporations and government agencies. In this instance, the larger buyers with great financial muscle exert more buyer power. Business buyers come from a wide range of industries, including but not restricted to banking, retail, logistics, telecommunications, and healthcare. Buyers tend to be reliant on particular providers as software is often industry-specific and requires users to be trained, which leads to high switching costs. However, buyers are often large companies that require multi-user licenses across their entire business, resulting in stronger bargaining power.

16,10%

14,40%

3,90%

2,70%

62,90%

Revenue distribution in SaaS market by vendor as of 2019

Microsoft Salesforce IBM Oracle Other

57 As previously discussed, the software-as-a-service business model allows buyers pay through regular subscription, or as and when they use the software which is hosted and managed remotely by the SaaS provider and can be accessed via the internet. This model requires lower upfront costs and tends to be more accessible, subsequently increasing buyer power. Contracts are also often offered in a pay-as-you-go format, charging buyers according to their usage. Many SaaS providers avoid long-term contracts and allow customers to terminate their custom with no extra costs or fees, reducing the switching costs for buyers if they want to change providers (MarketLine, 2020).

Ultimately, customers enjoy a reasonable degree of buyer power; yet this could depreciate if players devise ways to lock buyers in with longer term contracts.

Major market players are switching to SaaS business models at a rapid rate due to the transition towards cloud computing and open-source software. Business in the 21^st century places great emphasis on data. Large companies, from Coca Cola to Netflix, are big users of cloud technology, which SaaS is part of. In a 2018 report published by Cisco, it is predicted that by 2021, 94% of workloads and compute instances will be processed by cloud data centers. Cloud computing has therefore become indispensable for large companies’ operations reducing buyer power somewhat.

The services offered by the players are often undifferentiated, which has resulted in a high degree of price competitiveness, illustrating the power that buyers hold. Leading players wish to differentiate themselves in terms of customer relations and are likely to create more complex features for their customers, which may in time weaken buyer power.

Overall, buyer power in the SaaS industry is assessed as being moderate.

4.4.2 The Power of Suppliers

The SaaS market requires employees with specific and adaptable knowledge, as well as the most up-to-date hardware devices. Skilled programmers are key for success in this market, forcing players to rely on the continued services of highly qualified and usually well-paid employees, which results in high switching costs. Large players often have the economic means and reputation to attract these individuals to join their organization which places them at an advantage over smaller players. Microsoft’s Developer employment rates in the US and Canada in 2019 were 96,33% and 95,4% respectively; therefore, there are good job prospects, a large available

58 workforce and strong competition among employees to develop innovative technologies and get noticed by employers which reduces their power to some extent.

While the suppliers in this market are individual employees, they do possess power in terms of their highly specific knowledge. As such, employment retention is important, as switching costs are abnormally high, particularly in the case of the loss of a skilled employee who understands the criteria of the role. Additionally, the various computer programming languages serve to distribute the workforce into their areas of expertise, leading to reduced concentration of potential suppliers and therefore increasing supplier power.

Inputs such as hardware components are often purchased from sole suppliers. Such suppliers are often large companies who offer differentiated products, resulting in significant supplier power.

IBM is an example of a player backwards integrating as it produces its own hardware and software capabilities, which reduces its reliance on external suppliers, but backwards integration with regards to hardware is rare amongst most major firms. Forward integration from suppliers has been historically rare, as software production entails a highly complicated process with large amounts of proprietary knowledge, which directly weakens supplier power. However, Microsoft is a key example of forward integration as it has moved strongly into the cloud computing market with its Azure cloud platform and continues to invest in delivering advanced software to consumers, such as Office 365 which is its main SaaS product offering. This allows Microsoft Office software to be used by buyers through the cloud.

Overall supplier power in this market is assessed as being strong.

4.4.3 Threats of New Entrants

The global SaaS market has experienced double-digit growth in recent years, which is particularly attractive to new entrants. Entry on a small scale is possible within this industry, and a wide range of smaller cloud computing companies has been able to offer innovative and niche solutions for specific industries, which has made them an appealing alternative in comparison with larger players. Such industries include healthcare and finance which can provide lucrative opportunities if players are able to develop systems which adhere to regulations. However, large companies in

59 this industry tend to have greater financial strength, allowing them to develop storage and processing that can offer more services.

Cloud computing is a hi-tech, highly specialized industry. To offer the services that clients demand in a reliable manner, scale and a great deal of expertise is required. Large companies that can offer the scale that major clients need tend to stifle competition as buyer choice is limited. The strength of these incumbents also prevents new entrants, except for those with strong financial muscle which may look to diversify further into this space, such as Apple and Alibaba.

The population of internet users has been consistently growing over the last 20 years, reaching a significant proportion of the total North American population. For SaaS providers, the enormous scope of potential consumers, alongside the seamless online distribution network, serves as a key attraction for market entry. Increasing numbers of devices with a broadband connection means that software can be purchased, delivered, and updated without the need for physical media or conventional distribution channels, such as CDs, allowing software to spread rapidly.

The markets in which SaaS operate are often subject to technological advancements, changing industry standards and varying customer needs and requirements. The success of a company is highly dependent on its ability to anticipate and act accordingly to these changes. Therefore, large companies often look to acquire the intellectual property of smaller, more innovative players.

Mergers and acquisitions demonstrate how industry leaders are leveraging their economic strength to acquire smaller players who hold valuable technological knowledge, a trend which is expected to become increasingly prevalent within the industry. However, because large players have the ability to attract highly skilled individuals, they may instead choose to use their own in-house talent to create innovative solutions.

New entrants are likely to be more dynamic and may be able to offer rapid progression and share capital. The software market is subject to technological advances, developing standards, and changing customer needs and preferences. The success of a company is highly dependent on its ability to anticipate and adapt to such changes. Large companies are therefore increasingly concerned with acquisitions to obtain the proprietary technology of smaller, innovative firms.

While there is concern regarding large companies attempting to create an oligopoly, it does display

60 the opportunities for new entrants to successfully enter the market. The position of incumbents may be strengthened by knowledge of their customers' business needs and associated long term relationships, their ownership of key intellectual property, and potentially high switching costs for buyers in certain sectors.

Overall, the threat of new entrants is strong.

4.4.4 The Threats of Substitutes

A relevant alternative to the Software-as-a-service model would be to use traditional internal IT systems and install and run software applications and save data locally. If a company is experiencing economic difficulty, some companies may choose to rely on existing IT systems rather than switching to unfamiliar and potentially/seemingly risky solutions. However, cloud solutions offered by industry players often provide businesses with a variety of key advantages which traditional systems cannot. Over time, cloud computing can help avoid a large amount of capital expenditure on hardware and upgrades and can improve cost efficiency by closely matching the cost of individual cloud environments. Additionally, major aspects of capital expenditure are taken on by the vendor in terms of servers, storage, cooling equipment and back-up systems, avoiding further expenditure. Despite this, SaaS firms have recently been criticized for their high costs. However, the costs for cloud computing services are significantly cheaper for large firms than storing the data with traditional IT systems due to the capital expenditure.

The main advantages of running a traditional IT infrastructure locally, revolve around security and privacy. The fact that public cloud services hold buyer data within shared centers, could frighten some organizations. However, offerings that involve private cloud and hybrid cloud services are likely to reduce the effect of these concerns and therefore the potential for substitutes.

Nevertheless, buyers that operate in industries with a strong regulatory environment may not wish to use cloud services if private data is not stored in local data centers. However, players have recently looked to alleviate such security concerns and cloud computing is not considered to be as risky as it once was. For large firms with vast amounts of data to store, cloud computing is seemingly becoming the only practical solution moving forward.

Overall, there is a weak threat of substitutes in this industry.

61 4.4.5 Rivalry Among Existing Competitors

Despite the presence of smaller companies that aim to meet niche aims and deliver innovative solutions, the industry is heading towards consolidation. The leading players globally include Microsoft, Oracle, Salesforce, and Adobe, meaning that rivalry is intense (Statista, 2021). Since international expansion can be relatively fast due to distribution over internet, competition over profit margins is likely to increase rivalry. Advances in technology mean that new products are continually introduced to the market, enhancing rivalry, and affording new entrants the possibility of gaining market share.

Larger players often utilize their ability to acquire and merge with smaller firms in a bid to obtain innovative solutions that they can implement within their services. Although this tactic may help to reduce the threat of rivalry within the industry, the process may in fact positively impact smaller players who have the ability make financial gains by merging or selling their company. Large players are now attempting to differentiate themselves through several initiatives in an effort to boost their competitive edge. Companies such as Microsoft offer a variety of services and products including hardware and software, which serves to ease rivalry as it is not solely reliant on the revenues generated from this industry.

The OECD held consultations on changes to the international tax regime, particularly in terms of transfer pricing and internet-based companies. As such, measures have been agreed to update international tax rules and reduce the opportunity for multinational companies to implement tax avoidance strategies. SaaS companies that have taken the advantage of the “nation-less” aspect of the origin of SaaS distribution may see an increase in their effective tax rates, which would serve to increase rivalry further.

Overall, there is a strong degree of rivalry in the SaaS industry.