SaaS Is the New Manufacturing
Today: Most founders and investors are attracted to SaaS. Is it the defining category in the Entrepreneurial Age?
The Agenda 👇
Turner Novak excels at marketing himself as a VC 😅
He also made me realize how much SaaS matters
Hence the question: Is SaaS the new manufacturing?
It’s about contributing to economic development
And it’s about shaping our vision of the business world
I’m not sure if you know Turner Novak. He’s a venture capitalist with Gelt VC and a respected writer on everything related to Chinese tech giants. I especially recommend his in-depth analyses of TikTok and Pinduoduo, published on his personal blog on Substack.
Turner has a funny way of marketing himself over social media. He’s created an alter ego: an insufferable VC with a distorted face who appears from time to time to display the arrogance and utter the clichés that are characteristic of that world. Have a look at this one, which is brilliant (and kind of subtle—esp. the part about where the cars should be parked 😑):
Anyway, this particular video made me realize how VC jargon has become standardized (“What’s the TAM?”, “What’s the CAC/LTV ratio?”), and how much our thinking about tech startups has been shaped by the frameworks and metrics applied to one particular segment: software as a service. I distinctly remember being a startup founder in 2010-2012 and having almost never heard of any of those concepts. From my perspective, they only emerged as the new normal shortly thereafter thanks to companies such as Facebook and individuals like Andrew Chen.
In any case, the fact that SaaS has become the benchmark for how we assess any tech startup is both bad news and good news:
It’s bad news because it creates seemingly easy-to-analyze categories in which every startup founder now thinks they have to fit. In turn, this triggers an adverse dynamic such as more and more founders focusing on the narrow segment of enterprise SaaS. Remember this critical thread about Y Combinator by an anonymous tech founder? Take it with a pinch of salt, but the point about enterprise SaaS is valid:
When I went through YC (recently), we had a “masterclass” of sorts on growth with Patrick Collison and John Collison [of Stripe]. One of the first questions they asked the group was “How many of you are consumer companies?” Like... 2 people raised their hands and everyone else laughed hysterically.
A lot of companies start out doing something else, but pivots are a fact of life in the early stages. You know what’s super easy to validate and gain traction with when you're surrounded by 200+ other early stage tech companies? Free SaaS and Dev tools. IMO YC should ban them.
Yet it’s also good news because the standardization makes it easier to educate investors outside the ‘hardcore’ VC world, thus contributing to attracting more capital into the tech space.
No wonder why the SaaS segment is the one that lends itself to investments that resemble traditional private equity more than VC. Just have a look at firms such as Vista Equity Partners, Thoma Bravo, and Constellation: true, they’re all investing in “tech” companies, but in reality only SaaS meets their bar for deploying capital—one that requires calculating future cash flows and documenting a clear path to profitability. Have a look at my Can Private Equity Firms Make Money in Tech? (Round 1):
Eventually, I’m sure, we’ll witness some kind of convergence between venture capital and more traditional private equity. While public markets run amok (again, too much money chasing too few stocks), many things are happening on private markets. In particular, the fact that SaaS revenue is easier to predict is inspiring a lot of thinking around financing such companies through debt and revenue-based securities.
Overall, the standardization of SaaS has enabled us to reach an inflection point in the current paradigm shift, whereby more capital contributes to funding more companies in the SaaS space (through both equity and debt), which in turn reach profitability faster and become even more attractive targets for profit-hungry investors. This is what has inspired Alex Danco with his Debt Is Coming thesis, which I elaborated on in my own Notes on Revenue-Based Financing (Round 1):
You can see why SaaS is the perfect solution to turn the distinctive nature of tech companies into revenue-based financing. For any good SaaS product, users are very much part of the value chain. But the design of the product as well as the various feedback loops constitute a moat that enables SaaS entrepreneurs (and their investors) to more effectively predict growth and revenue in the future, therefore turning the system into the base for raising capital from investors.
In the end, it leads me to wonder: Isn’t SaaS to the Entrepreneurial Age what manufacturing was to the Fordist Age? Let me explain.
We remember manufacturing as the dominant sector of the economy in the 20th century. Yet manufacturing never employed more than 30% of the workforce and it never represented more than 40% of the total value added as a proportion of a (developed) country’s GDP. So why was manufacturing so dominant? Two reasons, I think.
The first was related to economic development. Manufacturing was a capital-intensive industry with the highest returns on invested capital. That’s because manufacturing lends itself well to three things that make it the perfect engine for generating wealth in a given country:
Division of labor—good old Taylorism, which was first experimented with in the steel mills of the age of steel and heavy engineering and then perfected on the assembly lines of the Fordist Age.
Standardized parts—remember the “American System of Manufacturing” I wrote about yesterday?
Ease of export—there’s nothing easier to export than manufactured goods. You can serve a global market without actually deploying operations in every country!
Back then, no country could compete in the race for economic development if it lacked manufacturing champions. (Before tech startups became a viable option, the only way to compensate for a lack of manufacturing was to live off past rents and double down on financial services, as the UK did from 1986 to 2008.)
The other reason why manufacturing was so central in the Fordist age was more symbolic. Here’s what I wrote in Does Manufacturing Matter?
Manufacturing raised the bar in terms of how we treat workers. From a production perspective, the Fordist Age was about standardized parts and assembly lines. But Fordism was much more than that. It was also a social contract that said that all workers should be treated like those working in the most productive sector that was manufacturing.
Even in service sectors that didn’t generate the same returns as manufacturing, workers were supported just as well as those working in factories (albeit with notable exceptions). When that didn’t happen thanks to the market, redistribution was orchestrated from the sectors with increasing returns to scale (manufacturing) to those with diminishing returns to scale (services), by way of a higher minimum wage or public-sector jobs.
This is why, in our collective psyche, manufacturing is synonymous with overall prosperity. The manufacturing surplus made it possible to treat all workers better, leaving everyone better off as a result. As a result, as Ben Casselman once wrote, we don’t really miss manufacturing—we miss the social contract that it once brought about.
And so you don’t need a given sector to represent the majority of a country’s GDP (or the workforce, or any other indicator) for it to define a given techno-economic age. It’s enough that the sector generates the highest returns, is easy to understand from an investor’s perspective, and plants the seeds of a new social contract—just as manufacturing did in the 20th century!
I’m not saying SaaS is doing all of that in the Entrepreneurial Age. In particular, I don’t see SaaS as the ground on which a new social contract will be built. But if software is eating the world, in time every company will become a tech company—therefore we need a narrow category of what kind of tech company will dominate our collective psyche of what the business world is about.
I want to expand on this thesis in the near future, but in the meantime: what do you think?
The definitive article to understand everything about SaaS is this one by Bill Janeway (actually an extract from the latest edition of his book Doing Capitalism in the Innovation Economy): Enterprise Software: Death and Transfiguration.
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From Munich, Germany 🇩🇪
Nicolas
