Domain Knowledge Drives SaaS Unicorns

We’ve looked at a number of Unicorn companies so far: Tableau, FireEye, RightNow, Palo Alto Networks,Kayak, SuccessFactors, and Marketo. Today’s featured company is ServiceNow.

Fred Luddy, the founder, was a classic nerd. After meandering his way through various companies as a programmer, he ended up as the CTO of Peregrine Corporation that built software for the help desk and service desk markets. Peregrine acquired numerous companies and eventually grew to $500 million in revenues, but filed for bankruptcy due to accounting irregularities in 2003.

Fred, however, developed domain experience with the IT service desk market through that process. He decided to start a SaaS company in that space.

I would like to tell you I had a brilliant business plan which I executed perfectly, but nothing could be farther from the truth. I just knew that the Internet delivery of applications was very simple to use and was going to be a huge wave. Salesforce.com was becoming very popular, and things like myYahoo! and iGoogle were starting to appear.

Internet deployments were obviously a wonderful way to do business and a great enabler for a significantly larger group of people than client server software had been. When I started ServiceNow I had no idea what area we would attack. I clearly wanted to do something involving forms-based workflows. It turns out the whole service desk area was a wide-open opportunity for us given our Internet posture and delivery model.

There are a set of practices called Information Technology Infrastructure Library (ITIL) which have four disciplines: incident, problem, change, and configuration management. Incident means something is broken and needs to be fixed immediately. Let’s say your laptop won’t boot up. The problem is, why did the laptop break? A change is how you fix the particular piece of technology so that the incident does not ever happen again. Those are the core disciplines of how most large IT organizations approach problems in this day and age.

Fred had 12 customers during production, which was in the beginning of 2005. It took him 18 months and he had no employees. In July 2005, he decided to turn this into a real company. He wanted to generate revenue, hired five people, and raised a venture capital round of $2.5 million from JMI.

Initially, he started charging $25 per seat and the 12 customers paid up.

Our very first contract was with a company called WageWorks in San Francisco. It was for $2,600 a year. It took only three months to generate real revenue, so we were ecstatic.

Unfortunately, we didn’t have a grand plan or scheme. We worked hard, but I think a lot of it has to do with luck. We first sold to WageWorks, and the guy who bought us there went to work at Edmunds.com. He recommended Edmunds.com buy our product, and they bought at $35,000 a year. It just started to proliferate and spider out from there. We had more and more customers at increasingly higher price points.

At first we thought we would serve the mid-market, but we quickly found out that we were far more appealing to the global 2000. They have large IT organizations and a lot of employees who are the customers of that IT organization. We wasted a full year on the mid-market. We really thought we were going after a certain market.

The first year ServiceNow did $850,000. The second year they were at $5 million, and in the third year they were at $13 million. They finished the fourth year at $28 million. In 2010, its fifth year, ServiceNow was about a $45-million-a-year recurring revenue company with 350 enterprise customers.

Fred, however, had a very big vision for the scope of what ServiceNow was to address. In our 2010 interview, he outlined that vision:

The service desk market is $1.2 billion to $2 billion a year. However, we have a much broader vision. Based on our customer feedback, we believe that there is a need for enterprise resource planning (ERP) for IT. If you look at most large IT organizations, they will have 40 to 50 different processes to manage their operational areas, their application development area, their application portfolio, and demand management. We believe that should all be offered under a single portfolio. We can offer all of that, not just the service desk.

Application portfolio management, performance management, capacity planning, budgeting, and financial aspect cost management can all be done in a single system of records. Upper management in the IT organization as well as the people turning the wrenches at the lower levels should all have an idea of what should be done, when it should be done, who it should be done by, who approved it to be done, how much it will cost, and what risks are associated with doing it. Even though we are in the service desk market, which is a $1.2 billion to $2 billion marketplace, we really believe that our approachable marketplace is probably a lot closer to $4 billion to $6 billion a year.

A lot of water has passed under the proverbial bridge since then.

In June 2012, ServiceNow went public at a market cap of $2.17 billion, raising $210 million.

Two years later, market cap shot up to over $8 billion.

Fred Luddy was in his mid-forties when he started ServiceNow. While we hear a lot of complaints about age-bias in Silicon Valley, he did not seem to have had any difficulty raising money from top VCs including Sequoia Capital and Greylock Partners. With only about $7.5 million of funding, Fred was able to deliver spectacular results. From there on, the company was able to raise a total of ~$84 million. Some of the founders and employees were even able to cash out prior to the IPO with the additional capital influx.

I come back to first principle, as I analyze these success stories. Domain Knowledge. Execution. Paying Customers. Show ’em the money!

That, it seems to me, is the long and short of it.