6 minute read 31 Aug 2023
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Cutting costs in the cloud: six strategies for SaaS companies

Authors
Jeff Vogel

EY-Parthenon Americas Software Strategy Group Leader

Advisor to top PE firms and software companies. Provides guidance for driving value across product, technology and R&D strategy. Navigates the software economy.

Michael Stricklen

Managing Director, EY-Parthenon Software Strategy Group, Ernst & Young LLP

Technology executive focused on enhancing the humanity of software and its development. Father, sailor, he/him/his.

Ajay Khandelwal

EY-Parthenon Managing Director, Software Strategy Group, Ernst & Young LLP

Thrilled to help organizations on their journey to acquire, improve and grow software and software-enabled businesses.

6 minute read 31 Aug 2023
Related topics TMT Strategy by EY-Parthenon
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SaaS companies are urgently seeking to control cloud hosting costs, but navigating the complex landscape of cloud expenditures is no simple task.

In brief

  • Rapidly increasing cloud hosting costs and a slowdown in growth have prompted software vendors to prioritize cloud hosting optimization.
  • Many SaaS companies are struggling to effectively assess and improve cloud hosting costs.
  • Evaluating cloud architectures, hosting infrastructure and processes is crucial in identifying areas for margin improvement and implementing solutions.

In the fast-paced world of Software as a Service (SaaS) companies, skyrocketing cloud hosting costs have become a major concern. Over the past decade, many businesses have moved their workloads to the cloud to capitalize on its advantages, such as elasticity, scalability and global deployment capabilities. However, this shift has come with a hefty price tag, exacerbated by the increasing demand for innovation and the need to deliver innovative technologies, like Machine Learning (ML) and Artificial Intelligence (AI).

The financial strain

For a typical SaaS company, cloud hosting costs usually account for 6%-12% of SaaS revenue and constitute a sizable portion of their cost of goods sold (COGS)¹. To ensure financial sustainability and continued growth in this competitive market, addressing and optimizing cloud expenses have become critical priorities for SaaS companies.

Taking control of cloud hosting costs: challenges and solutions

Cloud cost management is a multifaceted challenge for SaaS companies, demanding a broad and in-depth understanding of the factors driving these costs. From the deployment architecture to the culture among engineering teams, from pricing strategies to the choice of technologies, every facet contributes to the overall cloud expenses. To confront these challenges head-on, software leaders can take six immediate actions, including:

  • 1. Formalize an agile cloud cost governance program

    Challenge: Absence of a cloud cost governance program.

    Based on our experience, many organizations are grappling with implementing a cost governance program. The governance program may need to balance SaaS companies’ inherent business speed and agility and the need for financial discipline. It can enable rapid innovation and responsiveness to market demands while ensuring prudent fiscal management and cost optimization.

    Solution: Formalize an agile cloud cost governance program.

    Integrating cost monitoring and governance into operational processes ensures transparent visibility and accountability in cost allocation. Agile cost governance facilitates continuous monitoring and analysis of cloud expenses, enabling prudent fiscal management and cost enhancement without burdening engineers and product leaders.

  • 2. Foster cloud transparency

    Challenge: Lack of cost-aware product and engineering culture.

    Engineers and product managers approaching cloud resources with an "all you can eat" and "free infrastructure" mindset can lead to inefficient resource usage and increased costs. This mindset may result in overprovisioning and underutilization of resources, driving up expenses for the organization.

    Solution: Foster cloud transparency.

    By integrating cost discussions into regular product delivery processes, leaders can proactively manage cloud expenses and ensure that teams are aware of the fiscal impact of their activities. Creating a cost-aware culture empowers engineers to make informed decisions that contribute to cost enhancement.

  • 3. Align pricing models with customer usage

    Challenge: Inefficient use of discounting and pricing.

    Cloud providers often offer various discounting options and pricing models that can help reduce costs for long-term commitments or high-volume usage. However, if these options are not effectively utilized, organizations may miss potential cost savings. One common issue is failing to leverage available discount programs. Cloud providers offer discounts for reserved instances, spot instances or volume commitments, which can significantly reduce overall cloud hosting costs.

    A related challenge is the improper selection of pricing models based on workload and usage patterns. Cloud providers offer different pricing models, such as pay-as-you-go, tiered pricing or usage-based pricing. Understanding the specific needs and usage patterns of the business is essential for selecting the most cost-effective pricing model.

    Solution: Align pricing models with customer usage.

    Evaluating unit economics allows companies to offer fair and transparent pricing aligned with actual customer usage. By understanding customer needs and usage patterns, SaaS businesses can enhance their pricing strategies.

  • 4. Emphasize cost considerations in decision-making

    Challenge: Suboptimal technology choices.

    The modern landscape of cloud service providers allows many choices for making technology decisions. Regarding computing options, organizations can choose from a variety of serverless alternatives. Storage choices can range from block to object storage, with the opportunity to manage relational database services or self-managed databases. However, architects and engineers have traditionally focused on these choices’ functional and nonfunctional characteristics, overlooking the runtime cost implications.

    Solution: Emphasize cost considerations in decision-making.

    When making technology decisions for cloud solutions, it is essential to prioritize cost considerations alongside functional and nonfunctional characteristics. This approach likely ensures that technology choices are both effective and cost-efficient in the cloud environment.

  • 5. Educate customers about resource consumption

    Challenge: Lack of controls in SaaS resource consumption.

    SaaS companies may need to prioritize customer awareness regarding resource utilization, such as storage and computing, to avoid potential financial risks associated with a "free-for-all" approach. For example, a CPM or “cost per thousand” SaaS application that measures the effectiveness of digital advertising allows its customers to upload historical data and perform reporting and analytics. If customers have no limitations on storage and computing, they can overuse these resources, impacting the margin profile. Transparency is important. SaaS companies may need to communicate the associated cost before providing customers with access to resources. A lack of transparency can lead to customers unknowingly consuming excessive resources, resulting in unexpectedly high bills and financial challenges.

    Solution: Educate customers about resource consumption.

    To address this issue, SaaS companies should proactively educate and inform their customers about resource usage and its corresponding costs. This can likely be achieved through clear documentation, communication channels and user-friendly dashboards providing real-time resource consumption visibility.

  • 6. Optimize deployment architecture

    Challenge: Expensive deployment architecture.

    In the SaaS landscape, some applications are designed with a deployment architecture that enables hosting multiple customers within a shared infrastructure environment, known as multitenancy. A well-designed, multitenant solution should offer cost-efficiency as one of its key benefits. By leveraging multitenancy, SaaS companies can reduce infrastructure costs as the same resources serve multiple customers.

    Similarly, selecting the right instance size and region reduces idle workload. However, it is essential to note that designing and implementing an effective multitenant architecture requires careful consideration and expertise. Proper isolation of customer data, efficient resource allocation and robust security measures may need to be in place to ensure data privacy and maintain the integrity of each customer’s environment.

    Solution: Optimize deployment architecture.

    Well-designed, multitenant solutions can significantly reduce infrastructure costs by enabling shared resources for multiple customers. SaaS companies must carefully assess their software architecture for cloud readiness and identify the right workloads for cloud migration to maximize performance and cost-efficiency.

With extensive experience in assessing hundreds of software companies each year, the EY-Parthenon Software Strategy Group assists private equity operating teams in tackling cloud hosting cost challenges for their portfolio companies. Our knowledge of cloud hosting cost governance, SaaS architecture and cloud suitability assessment enables us to help provide valuable insights and solutions to develop cost-effective cloud expense strategies for our portfolio companies.

Conclusion

Effectively managing cloud hosting costs requires attention to various components, including networking costs, backup storage and deployment architecture. A comprehensive approach to cloud cost management emphasizes monitoring, education and adoption of a cost-aware culture. By taking these proactive measures, SaaS companies can enhance their cloud expenses, make accurate cost predictions, and achieve significant savings while ensuring financial sustainability and continued growth.

Ioannis Wallingford, Harrison Cohn and Patrick Daly of Ernst & Young LLP also contributed to this article.

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Summary

As companies focus on the bottom line, several strategies can help to improve cloud hosting cost profiles. Companies often struggle with how best to improve hosting COGS and knowing the order in which they should proceed. Reach out to find out how we can help.

About this article

Authors
Jeff Vogel

EY-Parthenon Americas Software Strategy Group Leader

Advisor to top PE firms and software companies. Provides guidance for driving value across product, technology and R&D strategy. Navigates the software economy.

Michael Stricklen

Managing Director, EY-Parthenon Software Strategy Group, Ernst & Young LLP

Technology executive focused on enhancing the humanity of software and its development. Father, sailor, he/him/his.

Ajay Khandelwal

EY-Parthenon Managing Director, Software Strategy Group, Ernst & Young LLP

Thrilled to help organizations on their journey to acquire, improve and grow software and software-enabled businesses.

Related topics TMT Strategy by EY-Parthenon
Upvote