Q&A: Yunqi Partners’ Yipin Ng

Q: There was a lot of hype around SaaS before COVID-19. What has changed since then?

A: COVID-19 has acted as an accelerator, essentially speeding up SaaS adoption – just look at the popularity of Zoom. It helps that the Chinese government and various state-owned enterprises are also pushing for more digitization and then quantitative easing has boosted public market valuations in the SaaS space, which has filtered through to private markets. Previously, a price-to-sales (P/S) ratio of 10 was standard. Now, in the US public markets, it’s 20-30, and for market leaders like Snowflake, it is around 100. Private markets generally follow public markets with a 30-50% discount, so the P/S ratio is around 15. However, clear market leaders, such as [cloud database provider] PingCap, are fully priced to the public markets. PingCap’s P/S is 100.

Q: How do you define a market leader?

A: Snowflake’s NDR [net dollar retention] rate is 150%. That means even if the company does not bring in any new customers, it can still maintain annual revenue growth of 50%. To be considered a market leader, you need to generate similar statistics. Moreover, the technical barriers to entry should be high, making it difficult for new market entrants.

Q: Do you see more investors entering the space?

A: Zoom and the Snowflake IPO last year drove a lot of interest and investment into the SaaS space. Generalist and consumer Internet funds in China have started to participate as well, but it is a complex space that requires a deep understanding of what enterprises need. I expect the market to cool off slightly this year as the hot money chases other hot trends like domestic consumer brands. At the same time, we are seeing increased participation from pre-IPO or hedge fund-like investors, such as DST Global, Coatue Management, Tiger Global Management, which used to focus more on the consumer internet side. But they are established SaaS investors because they understand the history of the industry in the US.

Q: What is the difference between enterprise software and SaaS?

A: Enterprise software is software sold to the customers as a product, and before the emergence of the internet, it was known as client-server architecture. Many enterprise software products also allow customization. SaaS is more standardized, generally cloud-based, and offered as a service to the customers. Hence there is the concept of recurring revenues in SaaS. SAP is a classic enterprise software provider. It specializes in ERP [enterprise resource planning] software which can be implemented on a project basis across multiple phases over several years, with input from consulting firms and professional developers. SAP’s customers are mostly large corporates; small companies cannot afford this kind of service. It requires a huge amount of work for SAP to develop new products, because after more than 30 years of customer accumulation, every new product must be backwards compatible. With legacy systems, it’s extremely hard to shift to SaaS.

Q: Where do start-ups fit into this?

A: Start-ups provide a cloud environment that enterprise software cannot. It is a huge disadvantage for SAP, not being cloud-native. When you develop enterprise software in a client-server environment, you consider computing power, memory space, and speed. Based on that, you calculate the scalability of your software. In a cloud environment, these factors don’t matter – you have as much computing power and memory as you want. There is no way a start-up can beat Oracle in client-server databases, but a cloud-native database is different. The first company to develop a cloud-based database was Google.

Q: Do large corporates prefer customized software over SaaS?

A: Many large corporates in China are starting to embrace cloud computing and the idea of SaaS. They still need customized enterprise software, so we are seeing many successful SaaS-customization hybrid models. SaaS is based on general modules that can be used anywhere, but you can add specific features to meet the needs of individual customers. Our investments include Kujiale, Sobot, and Xiaoyang, which run software platforms for home design, customer service, and education, respectively. They all started in standardized products and then introduced customization.

Q: Some start-ups move in the opposite direction, from customization to standardization. Which way is better?

A: SaaS is a relatively new business model, and some companies have done customized projects for years. It’s hard for them to reinvent themselves. Their systems are based on a client-server architecture, which must be rewritten. We see more successful transitions from standardization to customization rather than the opposite direction. It tends to be young start-ups with brand new technology infrastructure.

Q: What about concerns that small companies would rather use pirated software than pay for SaaS solutions?

A: SaaS can leverage the advantages of cloud computing to provide better services. Pirated software is generally still at the PC level. For example, we are early investors in Kujiale. They offer an online computer-aided design platform for interior designers to render designs. With PC software, this may take several hours; with cloud computing, Kujiale can do it in a matter of seconds. Other advantages include cross-platform capabilities (the software works on mobile devices and PCs), regularly updated content such as a furniture database, and the ability to easily share and edit the output via the internet.

Q: It is also argued that small companies need orders to survive, not software…

A: There is another model in China called SaaS + transaction. Two of our portfolio companies, Baibu and Chubby Bear, trading platforms for fabrics and renovation materials, are in this category. In addition to a SaaS offering, they run marketplaces through which customers can source products on the platform. Because it is B2B and businesses are regular buyers, transactions are recurring in nature and you can calculate ARR [annual recurring revenue] and NDR like in SaaS. But it goes deeper than that. Baibu and Chubby Bear also help companies improve productivity. For example, Baibu’s cloud factory consolidates the capacity of many small textile operators, making it easier to handle orders of scale, while its digitalization solution boosts fabrication efficiency.

Q: Are there areas in which China SaaS has an edge over the global competition?

A: There has been a significant development in that China’s software start-ups are not just focusing on import replacement in the domestic market, they are also developing global ambitions. Our internet environment is complex, our user base is large, and the likes of Baidu, Alibaba, Tencent, ByteDance, and Meituan are demanding customers, constantly pushing against the far reaches of technology and doing so before their international peers. A software developer working in this environment may see problems before others, and have the chance to invent solutions before others. Another key factor is 5G, which China is implementing faster than many other countries. Chinese cities are densely populated, so the economic benefits of 5G base station construction are higher than in the US. I would not be surprised if China found the killer app for 5G before the US.

Q: Are there any early examples?

A: We already see some China SaaS players becoming international companies. I think there is a lot of promise in the SaaS + infrastructure space, which others may know as artificial intelligence software or opensource software. PingCap, as an open-source cloud-native database provider, is an example of the kind of company that can do well.

Q: It seems everything is labeled as SaaS to boost valuations. What are you looking for in a real SaaS business?

A: There are many metrics that you can look at to determine if the business model qualifies as SaaS. First, does the business generate recurring revenue? If a company provides a lot of customized software or sells hardware services, its gross margins and recurring revenue will be lower. That is not to say enterprise software is a bad business; it’s just the valuation model is different.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Technology
• Early-stage
• GPs
• China
• enterprise software
• Yunqi Partners