The million dollar addiction

How can you transition enterprise on-premise applications vendors to a cloud play. Here is one suggestion.

My good friend Vinnie Mirchandani and I are on a roll at the moment. On some topics we are in agreement, on others were not. Those debates are out there in the public domain and that's all goodness. One upon which we can agree is what I am terming the million dollar addiction by enterprise companies. This is especially apropos in the context of recent management changes at SAP which I have documented to near death.

In this post, VInnie says:

Part of the challenge in these vendors (SAP, IBM, Oracle, Verizon etc) is they cannot let go of older revenue. So their field keeps being incented to sell what they are comfortable with, and innovation product groups get lip service and no real power...

...It takes an Apple (and historically Intel) to actively develop and launch new products, and not worry about cannibalizing older revenues. Often, older product revenues continue to flourish as the innovation halo from newer products gives customers more confidence even about the older. But the only way to find out is to give customers the choice of newer technology. Too many vendors are afraid to give their customers that choice.

On the surface, Vinnie is correct. In a video conversation with Jon Reed, (check the time stamp at 15:30, runs about a minute), I posed the question: "If you're a salesperson looking at the choice between a $10 million deal and a $50/seat/month deal, which are you going to go with?" The response is obvious and yet wholly indicative of the structural problems enterprise vendors face.

But I think that at one level, Vinnie's argument is off in the sense that when Apple and Intel make new products they're usually looking at low hundreds of dollar price points. Enterprise players are looking at many hundreds of thousands or millions of dollars. The price point differential is huge. From a purely financial standpoint, the perceived impact of cannibalization is terrifying. But is it?

Vinnie frequently bemoans the levels of GS&A that get expended keeping those old products in the sales cycle. On the other hand I vividly remember Bob Evans (formerly at Info Week now part of SAP's global communications) noting that one analysis of Oracle's results would suggest the only way it makes money is through maintenance:

...the fact of the matter seems to be that Oracle has developed a maintenance business whose 22% annual fees not only provide all of the company's profits but also cover enormous losses stemming from all other parts of Oracle's business

When you balance the S&M effort to gain new sales needed to feed the maintenance machine you quickly arrive at a similar conclusion. The same is broadly true of other enterprise vendors. It is the classic vicious and addictive cycle that forces vendors to become increasingly dependent upon ever weakening net new sales, when measured in real terms. And just as those solutions mature, it is natural for management to allocate less not more to the research and development effort. Viewed in those terms, the eventual demise is almost a self evident prophecy. Is there an escape route?

When we look at the business model development of the SaaS/cloud vendors, they have to run much faster to achieve a given level of sales because their price points are typically lower. That's not universally true. Workday is an exception where they have firmly positioned themselves as premium, enterprise providers offering a highly differentiated solution. But generally, my observation is on the money.

So while VInnie might bemoan the amounts enterprise on-prem vendors spend keeping the sales machine ticking along, it pales into insignificance when compared to what the SaaS/cloud providers have to do. Check Salesforce.com financials. They routinely spend 50% plus of revenue on operational sales and marketing alone. By comparison, SAP spends roughly 20% of total revenue on sales and marketing (PDF.)

Salesforce spends extra on S&M at the cost of sales line level but that is typically around 4% of revenue. That's a part of what it costs to keep existing users.

That leads to one of the most interesting FUD issues I see in the market: don't buy from a SaaS player, they don't make any money. My answer is simple - watch what happens when a SaaS player takes its foot off the marketing gas. The revenue still keep coming in and profits skyrocket. The market knows that.

Curiously, I think the on-prem vendors trying to transition to SaaS/cloud could do exactly the same. But they will only do so when they finally wake up and realise that those $50/user/month deals are actually worth a fortune and that their customers are not hanging around to wait for them to work it out.

Siemens is the classic case. Arguably SAP's most important customer and partner it is also a Salesforce shop. It is also a NetSuite shop. It is also a SuccessFactors shop. What would SAP give to kick all those tiddlers out of its most valued customer? It wont happen until SAP (but I could say the same for others) is prepared to give up the mega deals in favor of much larger user deals and recalibrate its revenue expectations.

The old excuse given for not taking this action is that the market will crucify them. Which would the market prefer? A predictable, growing and continuing revenue stream or a decaying company with lumpy sales based upon perceived premium value that eventually gets commoditized?

What is so different about the behemoths that somehow their revenue model is sacrosanct (to management) when Salesforce has a market cap equivalent to double that of SAP and Oracle when measured against revenue? As Vinnie observes, existing customers are not going away and will not sacrifice the core platforms any time soon.

I believe the get out of jail will only come when these companies are prepared to let go of the past and ring fence their new development into autonomous units. That's effectively what Workday has done. Old PeopleSoft leadership with a new vision, a new team and a fresh start unencumbered by the need to satisfy Wall Street. Does anyone see that company struggling? Far from it. But to take that step you have to be prepared to stop drinking from the million dollar bucket. It's drying up anyway.

Endnote: Just to throw a spanner in the works. SAP powers Apple's AppStore, currently transacting $1.4bn a quarter. Will Apple give that up any time soon? Nah - didn't think so.

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