Friday, February 29, 2008

The RaaS Revolution

For all of us tech geeks, the past decade or so has brought about the evolution of an important enhancement to the software business – Software as a Service (SaaS.) Essentially, SaaS means that customers (as explained by Wikipedia) ‘do not pay for owning the software itself, but rather for using it.’ In other words, although the end user may not pay $100,000 to own the software, they will pay the software provider $1,000 a month to utilize the software.

This is a win-win scenario – it means that the end user makes a smaller commitment (often on a monthly, or quarterly basis) – so there is flexibility in case it doesn’t work out – which is often an enormous hurdle in the purchasing process; the software provider is servicing the account, so the end user has an ‘on call’ service center to help them with any issues; and it works in the favor of the software provider because the client is paying them on an ongoing basis, which helps the company to establish a more long term business model.

SaaS may have taken some time to evolve, because this is not the way people were used to paying for things, but we do believe it’s here to stay. As we said in a blog earlier this week: If you show people a more reasonable way to do something that they’re already doing, you can, over time, shift their behavior.

We believe that this model can be (and is being) effectively replicated in the investment research world – or, more specifically, how institutional investors pay for research.

“Just Because It’s Always Been Done That Way Doesn’t Make It Right”

Research has traditionally been provided to portfolio managers and investors as an ‘add on’ to a trade. More or less, a ‘pay-for-play’ for ideas, where a sales trader calls with a great idea, and the PM appreciates the idea, so he kicks a few hundred thousand shares to the trader to execute, and those commission dollars (or pennies, really, as the case may be) cover the expense of the idea.

However, as commissions shrink, this model faces a serious threat. If commission compression means that there are less commission dollars to put toward research (to cover the overhead of having a research desk at all) – then research becomes a cost that cannot be covered or justified by the firm. The only way a firm can then justify the research is on volume rather than pricing. However, to be dependent on volume alone because commissions are almost completely compressed is an extremely risky business model, because it means there is no ‘cushion’ built in to pricing that helps you weather dips in your volume.

RaaS: Creating the Category

Research-as-a-Service, we believe, is the future of the research business, in the same way that SaaS is the future for software. Providing access to analysts as well as research, on a limited distribution basis; a payment schedule and commitment period that is comfortable for the end user, but provides a steady income stream for the provider; encouraging provider-customer interaction and feedback – are the key components to an ongoingly successful business model in the RaaS category.