A Recession-Proof Corner of the Tech Sector ('Entrepreneur Journeys' Book Excerpt)

by: Sramana Mitra

An excerpt from the new book Entrepreneur Journeys, Vol. I by Sramana Mitra, reprinted with permission of the author and publisher:

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With another US recession on the horizon in 2008, corporations will likely rein in information technology spending. But one class of software maker – Software-as-a-Service companies – managed to thrive during the 2000-2002 downturn and should continue to be recession-proof.

Indeed, SaaS companies such as Salesforce.com (NYSE:CRM) have been reshaping the IT sector for the past decade, offering corporations low-cost Internet-based business process software. And unlike software giants such as Microsoft (NASDAQ:MSFT) and Oracle (NYSE:ORCL), SaaS companies have also been successful selling to the growing and lucrative small- and medium-sized business market (SME).

While some tech pundits believe Google (NASDAQ:GOOG), which gets a lot of buzz for its online software products, will become the vendor of choice for SaaS, I think companies like Salesforce.com, Qualys, Taleo (NASDAQ:TLEO), and SuccessFactors (NYSE:SFSF) that specialize in software for specific business processes will prevail.

Take Concur Technologies (NASDAQ:CNQR). This Redmond, Washington-based SaaS company saw revenues jump 33% to $129 million in fiscal 2007, and it expects revenues to climb to $200 million in fiscal 2008. Concur's growth reflects the need for its niche products – employee expense management and vendor payment software. "We help companies enforce travel policies throughout the organization, and during a recession, organizations can control costs using our system," says Concur Chief Executive Steve Singh. "Large chunks of employee travel budget can be reduced, and Concur makes sure that the budget is adhered to."

Another attractive element: Concur charges on a per user basis rather than the hundreds of thousands, or millions, of dollars typically charged for software deployments at companies. Concur is also able to keep its own business costs down by closing most deals over the phone rather than traveling to clients' offices.

Overall, the SaaS business model is the key to the industry's success and its ability to weather recessions. During downturns, businesses typically cut large-scale capital expenses, but they don't do away with services that manage vital functions, such as payroll, travel, communications and sales.

While Concur sells to large corporations, such as Texas Instruments (NASDAQ:TXN), JC Penney (NYSE:JCP) and Airbus, it also focuses heavily on the large SME market. There are 25 million SMEs in the US that spend close to $500 billion on IT services. This means that Concur, which has 6,200 customers so far, has a lot of room to grow.

Intuit (NASDAQ:INTU), for example, has been particularly successful in penetrating the SME market by creating a very simple product and offering good customer support. (Microsoft unsuccessfully attempted to buy Intuit in 1994, with the single objective of entering the SME segment via Intuit's killer app – small business accounting software.)

Other companies, such as ADP and Paychex (NASDAQ:PAYX), have also been successful selling payroll processing services to SMEs. 

SaaS is also popular on Wall Street these days. Companies such as Concur and Salesforce.com haven't missed earnings estimates, mainly because they have predictable revenue streams. So as long as metrics like new customer growth and churn rates are monitored, SaaS stocks can be extremely comfortable investments. Other public SaaS companies that have done well include Omniture (OMTR), Taleo, SuccessFactors and NetSuite (NYSE:N), which was founded by Oracle's Larry Ellison and went public at the end of 2007.

There are also numerous private companies gathering momentum, each specializing in a particular business process. Be it Payroll Processing or Talent Management, they are quickly proving to be strong performers through boom or bust.