SaaS as One Answer
As I wrote in the previous post, Attacking and defending software vendor maintenance fees, I think this situation is unsustainable in terms of the economics. I also listed several possible market responses to this situation, including the rise of software-as-a-service providers to provide a low-cost alternative.
Then today, I received a confirmation: Chris Kanaracus at Computerworld emailed me the latest missive from Marc Benioff, CEO of Salesforce.com. It's supposedly an email to his management team, but Chris received it from Benioff's PR group, so the audience is clearly the general public.
Benioff writes,
It's time for The End of Maintenance. Every year, companies spend billions on maintenance fees and get relatively little in return. Maintenance fees cover updates that are mostly patches and fixes, but they stop far short of the kind of innovation every that enterprise needs to survive. Companies pay to keep the past working and they end up doubling down on technology that can never keep up with their needs. The fees that companies pay have actually been rising, from something like 17% a few years ago to numbers more like 22% today. Every four or five years, companies are paying for their software all over again.Benioff is right to take this approach. A large part of the so-called investment that traditional on-premise software vendors, such as SAP and Oracle, make in product development does not go toward new products or new functionality. Rather it goes into porting and regression testing every product change against myriad combinations of databases, versions, server and desktop OS releases, middleware, third-party products, and other platform components. SaaS vendors avoid many of these costs as they write to a single platform: their own. Therefore, they ought to be able to deliver the same functionality for lower cost. In other words, they have a natural cost advantage that they can exploit in competing with traditional on-premise software vendors.
And this does not take into consideration the fact that SAP and Oracle are realizing gross margins somewhere in the neighborhood of 90% on their software maintenance revenue. It would seem that beating these guys on the basis of price should be a pretty easy target.
Disruption of a low-cost strategy
As industries mature, the basis of competition generally moves to price. In fact, there are really only two strategic alternatives for a business: low-cost leader and differentiation (everything else). For example, in retailing, Wal-Mart competes as the low-cost leader. Wal-Mart's entire business model is designed to give it a cost-advantage, resulting in its ability to be the low-cost leader.
Nordstrom, on the other hand, competes on the basis of being different, mainly on the basis of customer service. Nordstrom's entire operation is organized to give excellent customer service.
Today, nearly all of the traditional software vendors compete on the basis of their products being better, and therefore commanding a higher price--either the initial license fee, or more commonly, high annual maintenance fees. But these days it is difficult to differentiate SAP, Oracle, or other vendors on the basis of functionality. In many ERP vendor selections, the leading enterprise software products can check all the boxes—so where is the differentiation?
Perhaps the large vendors think they can be the Nordstrom of enterprise software. If so, they should learn from Nordstrom, as it is difficult to find any buyer that would describe the customer service experience of enterprise software vendors to be "excellent."
So, the time may be right--especially in light of current economic conditions--for some vendors, especially the SaaS providers, to come out and use their inherent cost advantage to compete on price.
If Marc Benioff wants to take the lead, more power to him.
Side note: as I'm writing this, I see Dennis Howlett is making a similar point, about open source business apps gaining ground due to their lower cost. "Low-cost leader" may not sound like the place where enterprise software providers would want to be. But there's nothing special about business applications: as the industry matures, cost must become a dominant element of competition.
Update, Apr. 29. Read Vinnie Mirchandani's post on the same theme today: What Cloud vendors can learn from Southwest Airlines.
And, Dennis Howlett points out that open source CRM SaaS provider SugarCRM just announced a price cut yesterday. It's a long post, worth reading, as Dennis goes into the economic advantage that SugarCRM is enjoying. This very much confirms my point that we may very well be entering into a phase where some enterprise software providers can succeed with a low-cost-leader strategy. Read: Sugar CRM reduces prices across the board, looking for broad adoption.
Now Vinnie points out that SAP has announced a postponement of its maintenance price hike. Maybe SAP is finally seeing that raising maintenance fees is an untenable position, especially in this economy.
And be sure to read the comments on this post, as there is much good discussion.
Related posts
Attacking and defending software vendor maintenance fees
Infor's opportunity: value in maintenance and support
Open source ERP and CRM carry strong ROI
Computer Economics: The Business Case for Software as a Service
16 comments:
Frank - the tyranny of maintenance fees has long been a sore spot for users, and yet they keep on paying (and asking for surprisingly little in return). And they are not immune from economic hard times, something we highlighted to clients months ago. However, SaaS and open source have yet to prove they are cheaper alternatives (again, something we highlighted in 2007). For all the hand waving, why has no one, Salesforce included, sponsored in independent ROI and TCO analysis. The short answer is simple - add up the costs of CRM or mySQL or pick your favorite product, and the 5 year TCO is surprisingly close to that of the other guys.
If open source was a more attractive business model, why are the open source companies unable to reach profitability? Similarly, if the SaaS model is so much better, why can't Salesforce produce more than $60M on a $1 billion in revenue? Customer churn indicates user sat is not optimal. These business models need greater scrutiny, or better management, or both.
SaaS is an interesting model (although I think the Price of Risk is seldom properly factored in) and yes ERP is yet another software sector moving to commoditisation where the main differentiator is price.
BUT maintenance charges should be viewed as an investment in the future viability of the product. You want to keep your vendor alive just as a farmer wants to keep his donkey alive. When a new opsys comes out in five years time you want the vendor to still be around to port your product to it.
Sure SaaS may short-circuit that argument, if SaaS models do prove to be viable in the long term and more attractive overall - as Andrew says that is yet to be proven.
If the farmer needs 95% gross margins to keep his donkey going, I am leaving software and going into that LOB:)
seriously I am amazed at the sympathy the sw industry gets when its customers are hurting and barely making 30, 40% gross margins, if that.
But this should be not about beggar my neighbor. This should be about value for money. Maintenance should not be an entitlement - 17, 22 % guaranteed each year. It should ebb and flow with customer needs and vendor product delivery...some customers wll gladly pay 22%, others it is closer to 5% because all they want is bug fixes...let the market drive the pricing not the expectation of locked-in guaranteed amounts each year
SFdC could turn the profitability screw very quickly by hammering down its GSA numbers which are among the highest in the industry. It is on a land grab, ergo not showing a huge profit. For now. Price pressure will hit these guys as well -- check what Sugar did today and my remark that it is cash flow neutral.
While I've some sympathy with Vinnie's argument, there are two points to consider:
1) if the customers are making 40% gross, how much would they make
without the software? A lot less, or they wouldn't be using it!
2) if we let the market drive the pricing then we know it will only be driven one way - down.
Culturally we usually believe this is a good thing, and we all love lower prices. But this can be a very short-term view and when we apply it to a long-term strategic business decision it loses some resonance.
Which is why I think The IT Skeptic has nailed it again here. Drive the prices down too far and your business investment in the product
will suffer.
Paul, the flaw with your argument is 90 to 95% of every dollar that goes to your software vendor is not going into product innovation. So how much more could they under-deliver - another 1 or 2% - wow, let's do cartwheels!!
The goal here is to remove huge SG&A inefficiencies - 30 to 60% in every software dollar, and yes balance the margin sharing between investor and buyer. Instead of rewarding only investors, how about also a buyer dividend?
Vinnie,
I'm sure your stats are right ... I'm going by the SAP annual report 2008.
Revenue:
Support 4.2bn euros
Software 3.6bn euros
Prof services 3bn euros
Costs:
Software services 1.7bn euros
Prof services 2.3bn euros
R&D 1.6bn euros
SG&A 3.1bn euros
So how do we spin the figures? With your point that <10% revenue goes into R&D? Or we could say that there's >50% margin on Software. How about the fact that 27% of the revenue is used in SG&A to yield 16% increase in sales?
A personal favourite is that software sales, not support, cover all SG&A with 64% of Support profit going into R&D !
I'm all for SAP reducing inefficiencies where they can, but let's not get too hung up on the stats - they are open to interpretation.
I think the real issue still comes down to how the business perceives the value it is getting from support, and that's something which SAP aims to make clear by using the SUGEN KPIs.
I don't see a problem with vendors wanting a steady revenue, just like customers want steady expenses. Stability is good for vendor and customer alike. But how the vendor goes about actually achieving that might leave something to be desired.
Sure the big enterprise vendors are making hay while the sun shines, before more flexible technology rolls in. And the mega deals are done and dusted meaning new licence windfall income has diminished. Adding to this is license discounting, which means the maintenance charge as a percentage might be bigger yet the absolute amount might be the same. So maybe the change from 17 to 22% is to offset the discount effect. Yeah I'm being to nice.
The vendors would do well to re-brand part of their maintence revenue. If a mobile phone company can give away phones at the start of a contract, I don't see why enterprise software vendors can't do something similar. This way they would never need to quote maintenance in terms of a % of initial sale price. And we wouldn't be having this discussion.
Has anyone got any data on license revenue trend over the past few years?
Matthew makes a good point. There is no clear connection between the vendor's cost of delivering maintenance services and the initial license fee amount. So, why do almost all vendors base maintenance fees on initial license fees? Because that's how it's always been done.
A more rational approach would based maintenance fees on some simple driver, such as number of users times maintenance cost for each module. The maintenance fee per module could vary based on the volatility of changes (e.g. payroll modules would carry higher maintenance charges, as they have more regulatory changes).
Matthew also points out that initial license fees are often heavily discounted, which in effect lowers the cost of maintenance. (This is true and is another reason that there is great variation between customers in what they pay for maintenance--another sign that the current system is not rational.) Therefore, it is even more imperative for buyers to negotiate strongly on initial license fees. As software maintenance rates increase, the impact on total cost becomes even greater.
Paul, the problem is the industry has gotten addicted to low R&D investment, and in the crunch of last 12 months, now every dollar is being scrutinized - annual maintenance was often a cursory review and renewal. Now when a CIO looks at the maintenance budget line items he/she is asking - calculate cost per support call, how was vendor performance on those support calls asking what did we get (and importantly use) in new features etc etc. If I had that dollar to spend on other items would ROI be better - and the answers are eye-opening. Then they get the unsympathetic sw salesperson who spins "the value of that maintenance" and it annoys the CIO even more. The scrunity and increased expectations of value should have started 5-7 years ago...
On the SUGEN KPIs, I have predicted that they will show even 17% is too high given how much of routine queries are being handled by SDN, how much SAP has moved to cheaper locations, how reluctantly companies have benefited from new features in ECC 6.0 etc
Not just picking on SAP...overall value from sw and hw maintenance has been low. Like the extended warranties we get on our home gadgets and the runaround we get when we do file a warranty claim.
My two central points in these discussions have been:
1. SAP haven’t made a good job of defending themselves and
2. People are not putting maintenance costs in any business context.
Now SAP has come back with it’s SUGEN KPI offering and engaging the user community - which I’m pleased to see happening as it addresses both points.
Some companies with a very expensive upfront license cost may well find themselves on a lower percentage than a company with a smaller installation cost.
Normalised out, I guess where they fit on the bell curve will depend on how well they can negotiate ... and rather than everyone knowing where they are with a fixed percentage it will be down to individual bargaining again.
The only way to build long term value of a software business is to charge maintenance with recurring revenue. Cost of sales and Marketing runs very high, and since clients are demanding custom scripted demos and much work from a very expensive software sales team. Buy software from a brochure and specs, do you own mods and support and the vendors could easily drop their prices. Hard to make much money in professional services, it's a necessary evil. So pay the maintenance and smile, its what keeps the Vendors in Business. Period. - Scott LaFata - Managing Director of MyVision3 and former Chairman of MetaVision, Inc.
Scott, this point comes up again and again. The issue is not that customers should pay maintenance. It is that the value they receive from some vendors is too low at the price they are paying. It's not whether maintenance should be paid...it's how much.
As Vinnie and others point out in the comments, 80-95% gross margin on maintenance is simply outrageous.
Having just completed a 6-month ERP comparison/search, followed by a 9-month Oracle implementation, I can offer this: right now Oracle can charge these high prices because many customers don't really have another choice. Functionality-wise they do, but after factoring in the long-term viability of the vendor, and the availability of support personnel, and the quality of available "partners" for implementation, the list gets very small. The quality of the software itself is not very high, comparatively speaking. I really think that in the near future, someone will offer an ERP with modern development tools and techniques, which does not require an army of consultants to configure, maintain, and continually fix. Once that system gets enough user-base behind it, it will be easy for them to beat the big vendors on price. And even easier to beat them on quality.
Robb, great feedback. Thanks. Your experience confirms my thought. That the enterprise software market is ripe for disruption.
For us, the cost of license/maintenance fees, even at 22%, is negligible next to the potential cost of the consulting support. In just over one quarter, a single consultant can charge as much as our entire annual maintenance fee.
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