Zoho and the Bottom of the Software Pyramid

Last week Sridhar Vembu the CEO of Adventnet, makers of the Zoho suite of software, was featured on the Economist’s Face Value. This may seem like a big deal for the CEO of $60 M company (The Indian CEO featured before Sridhar was TCS’s Ramadorai). But you have to hand it to the Economist. For a magazine that covers politics, economics and business, it has the pulse of the software industry. What Zoho is attempting to do can be game-changing for business software.

I saw the article coincidentally when I was looking at a Zoho product after a long time. A friend in New Bombay who co-owns a fledgling, but growing business was looking for a CRM solution. I was spending the weekend with him so he and I got on the internet and started checking things out. He was already being pitched by salesforce.com. Apparently, salesforce.com has a center in India that calls out to trial users in India. He was getting ready to get salesforce.com for the low, low price of $9 per user (limited time offer) before I suggested that he have a look at 37signals and Zoho. I had never tried them but knew that they both had something on CRM.

The 37signals product, Highrise, is somewhat different from your classical CRM so that didn’t work for my friend. But he loved Zoho – especially, the price – free for up to 3 users, $12 per user after for a full-featured CRM product. I tried out the product myself and I was very impressed by it. CRM software functionality is not rocket science. It’s been done many times before. But Zoho had managed to improve on it considerably. For example the one feature that totally wowed me was how you could convert a list of contacts or leads into a Zoho spreadsheet (nice cross-integration, guys), edit it and then save it back to the CRM database. Very cool.

Back to the topic at hand. The Face Value story was about how Sridhar and Zoho were creating a new disruptive model in software based upon a dramatically lower cost of operations. Not just lower cost Indian engineers, though that probably doesn’t hurt.

If Mr Vembu still expects to make money, it is because of his firm’s frugal ways. This has little to do with low Indian wages: these are rising quickly, and most Western software firms also do much development in India. More importantly, he says, Zoho’s software and data centres are built for efficiency. The firm spends a pittance on marketing. And it uses free technology developed by others wherever possible. Its subscribers can, for instance, use Google’s authentication service to sign on to Zoho.

And further,

But Mr Vembu is unfazed: “We’ve heard this before from the likes of Digital Equipment and Sun Microsystems. But look what Dell did to them.”

So while the SaaS model upends the high cost licensed software model, Zoho aims to become the cost leader amongst the SaaS business software vendors. And do what Dell did to the PC industry a decade ago.

But there are some crucial differences. The PC and hardware business is a variable cost business. Lower costs translate into a pricing advantage that leads to more sales and better margins. On the other hand, software, especially in the SaaS model, is largely a fixed cost business. Lower fixed costs don’t automatically turn into a pricing advantage and more sales.

According to the Face Value article, Zoho has wired its business so that a variety of costs are lower:

1. Fixed costs – use of open source, engineering and most of the company is in India. Almost no Marketing costs. Just word-of-mouth.
2. Variable costs – data center efficiencies. Minimal Sales costs. Service costs are presumably India based.

This is a comprehensive, across-the-board cost advantage. But what we must note is that while some things have a lower cost at presumably no trade-off, having lower Marketing, Sales and Service costs than say salesforce.com is a strategic bet. The bet is that sales can scale without them.

Does this comprehensive cost advantage automatically translate into success in the market? Not necessarily. If the lower costs enable Zoho to offer a somewhat lower price, say 15% lower, it may not matter to the customer. The design and quality of the software may matter more. Part of what makes one software product better than another is simply feature coverage, which is more a function of cumulative investment in engineering rather than this year’s fixed cost, giving incumbents the advantage. The other part of it is just how it is designed. “Code is poetry”, as wordpress.org says. Lower costs make no difference whatsoever in this regard.

In my opinion, lower costs are only part of the story here. The big bet that Zoho is making here is that there is a lot of room at the “bottom of the pyramid”. My quick assessment is that a Zoho CRM subscription is between 4 to 5 times cheaper than salesforce.com (ignoring their limited time offer). That is not a measly 15% less. That is 75 to 80% less!

At these prices, they don’t have to fight salesforce.com for customers. They are going after an entirely different market. A market that includes my friend in New Bombay and his Indian startup. Or a Chinese toy manufacturer. Or a small business in the US. You get the picture.

I’ll leave you with an excerpt from my post Go South, Young Man from two years ago.

I think the bottom of the global pyramid in SaaS (borrowing heavily from Prof. C. K. Prahlad) is a great opportunity for Indian tech startups. India abounds in technical talent but is stymied because it can’t develop cutting edge software for developed markets. Indian technologists aren’t deeply knowledgeable about business practices there and thus lose out. My contention is – forget developed markets. Go for the bottom of the pyramid. There are thousands of businesses – small and large – in China and India that need the same software that is being served up by today’s SaaS providers in the US. While these companies are trapped in their first world pricing traps, Indian companies can create similar SaaS products and target the South. These products, at first will be similar, but will eventually diverge as the needs and price points take them in a different direction from their US competitors. And that is good. It creates entry barriers for when the SaaS companies from the North wake up and realize the potential in the South.

[Update: General Electric is going with Zoho on thousands of its desktops. Clearly targeting the bottom of the pyramid does not preclude a smart player at the top of the pyramid (and they don’t go any higher in the pyramid than GE). Well done Zoho!]