IaaS Market—Who Wants It?
I saw this headline on Yahoo Finance, “Oracle Has Big Plans To Beat Salesforce And Amazon In A $72 Billion Market” and it got me thinking about a lot of things.
First, the market in question is Infrastructure as a Service or IaaS and I didn’t think that Salesforce was actually in the IaaS market. This shows how far we still have to go in cloud computing just to get the terms right and set the playing field.
IaaS is all about computing infrastructure — the servers, memory, disks, operating systems, middleware, databases and maybe applications — that any modern business needs to support its information processing when it chooses not to manage all this by itself. Companies subscribe to IaaS services and it’s like Walmart for conventional IT. You know this.
Second, IaaS is part of a cloud industry that also includes software as a service or SaaS — systems that are centrally managed and subscribed to and PaaS or platform as a service. PaaS is the top of the heap right now, the place you go when you don’t want to manage the gear as in IaaS but still want a robust place to design, develop and manage applications that are embedded into your business processes AND to generate those apps for multiple platforms from a single design.
Interestingly, a PaaS provider probably, but not necessarily, is an IaaS provider by the simple logic that the “P” is software and it has to live somewhere. So this brings us to the headline and article and my issues with it.
Oracle has some very nice server, storage and in-memory gear that it acquired when it bought Sun or built once it had the Sun gurus on board and working with its database mavens. It can very well supply the IaaS market — those organizations that want to run their own IT shows but not operate their own data centers. Great! Amazon is in that business. Google is in that 0business. Oracle is in that business and it is trying to be in the PaaS business with its still-being-delivered Fusion platform. Salesforce is in the PaaS business but not really in the IaaS business except by accident of circumstance noted above.
The article quotes some succulent swipes between Marc Benioff, CEO of Salesforce, and Larry Ellison, CEO of Oracle, and Marc’s former boss. The quotes are old and largely irrelevant but you have to admit, these guys sure know how to grab a headline.
How Might Lincoln React to Wall Street?
In my last piece, I discussed with Tien Tzuo, CEO of Zuora, the vagaries of the subscription services market and how Wall Street analysts have a tough time dealing with subscription metrics. But already I feel a need to go beyond the original piece to add some depth to the piece.
The nub of the story, and it is not the first time I write about Wall Street and subscription metrics, is that many of the analysts use metrics that value conventional manufacturing era companies rather than subscription companies. The businesses are different and the ways you measure them need to be different too.
Just to boil it down a little, when you sell one thing one time and collect all the money then and there instead of repeatedly selling access to a company’s products or services, the money comes in slower and it has to be accounted for differently. If you value a subscription company for what it brings in this quarter only, as you would a conventional manufacturing company, you are only looking at a small fraction of the value that the subscription company generates. So, your analysis will be flawed as a result and the advice you give from that analysis won’t be worth much.
For many years we’ve agonized over the fixation on quarterly results which the analysts pore over to get a sense of how to advise investors. The problem with this is, of course, that no matter how small the time slice you analyze this way, it is rearward looking and it cannot tell you much about the future. It’s like steering a boat by only observing its wake.
But over the weekend I ran across this article in the New York Times by a Harvard Business School professor, Nancy F. Koehn. “Lincoln’s School of Management” is part of a flood of all things Lincoln this year in which we celebrate the 150th anniversary of the Emancipation Proclamation and it’s worth reading as a buttress to Tzuo’s analysis.
Tzuo is right in claiming that the analysts have the wrong toolset for the job of analyzing subscription companies, but the issue goes deeper — all the way to asking why we measure what we measure. One of his points, which the Lincoln article seems to back up is that doing business, not turning somersaults for Wall Street, should be the main emphasis of any business. It seems like common sense and when you put it this way you wonder why so few people appreciate it.
Companies that focus on their knitting rather than the analysts in the grandstands do better for customers, employees and shareholders over the long run. That’s what the Lincoln piece is about and it’s what Tzuo has been telling anyone who would listen as he has extolled the virtues of subscriptions.
Wall St. Leaves Money on Table for Subscription Companies
Look, we know the old truism that if you don’t have customers and profits you don’t have a business, you have a hobby. But could we please get a little balance on the profit idea?
Emerging companies typically don’t declare profits because they use excess cash to fuel growth. Anything left over is plowed back into the business. If the company is public, its stock price rises not because of some magical ratio of earnings or dividends to share price, but because the money the company invests in its people, processes, technologies, research and development and products make it a more valuable entity to anyone looking at its future. The mini-computer makers were famous for this. I recall Digital rising to $199.50 per share with never a dividend. It’s a good model.
This is the basis for my argument that subscription companies are being given short shrift by Wall Street analysts because they apply metrics more in tune with the manufacturing era than the information age. You might disagree because companies like Salesforce, NetSuite and many others not yet public get plenty of attention. But that misses the mark.
Because the analysts don’t track things like unbilled deferred revenue, a measure of how much money is under contract but not yet on the books, they don’t get a realistic view of a subscription company’s health. And since the analysts influence who buys what stocks and at what price, the market pricing mechanism in the stock markets may not be giving subscription companies — or investors —a fair shake.
I caught up with Tien Tzuo last week to discuss this. Tzuo, you may recall was CMO and chief strategy officer at Salesforce before co-founding Zuora, the subscription billing and finance company. Say what you want about Tzuo but he isn’t shy when it comes to expressing his ideas about subscriptions. Last week he was seen speaking on CNBC and wrote an article for All Things D on subscriptions with NetFlix’s recent stunning 40% appreciation in the background. He believes some companies’ meteoric growth spurts are directly attributable to eschewing conventional Wall Street wisdom regarding profits and earnings. The examples he gave me say a lot.
“Salesforce vs. WebEx. For years, WebEx was on a growth path that was 6 months ahead of Salesforce’s. Then they went public, and listened to Wall Street’s insistence on earnings. Wrong move. Salesforce ignored it, overtook WebEx within 6 months after WebEx went public, and went on to soar to much greater heights.
“Successfactors vs. Taleo. Same thing, Taleo cared about earnings, SFSF went contrarian and said, ‘Hey not only are we not going to show earnings, we’re going to spend all our IPO money on growth, and show losses for years.’ SFSF started off a fraction of Taleo’s size, overtook them, and wound up with a $3.4 billion exit [SAP bought SFSF in 2012] which was almost two times greater than Taleo’s [Oracle bought Taleo for $1.9 billion in 2012].
“And finally, to bring it back to current events, Netflix. They didn’t listen to Wall Street (they never have); they knew their strategy was focusing on customers, and customers more and more want movies anywhere, on any devices, not just on DVDs, and they followed their customers’ lead. This week when the stock soared 40% higher was a big vindication for them.
Tzuo has a point and essays like his and speaking out are ways that the establishment eventually changes. Of course this isn’t a statistically valid study though I am sure such things exist but it does raise some important questions. If Wall Street is not valuing subscription companies correctly it is causing a lot of money to be left on the table.
Traditionally, it takes the establishment some time to come around on a shift this fundamental. After all, we wouldn’t want standards and controls to change so frequently that they failed in their primary mission. But at the same time, as a wise man once told me, no one should have to be hit over the head with an old tire tool to see what’s so plainly obvious.
All this affects CRM because the financial analysts have a great deal of influence. But too much influence can inhibit companies developing the next great application by preventing capital formation where it’s needed. Given how much of CRM and social are delivered as subscription applications by emerging companies today, it’s a concern. So Wall Street really does need to kick it up a notch or two.
Reading My Own Clippings
Like any sane person operating in the wilds of the Internet, I keep a weather eye out for what others might be saying about me. In other words, I have a vanity search crawling the web to find what there is to find. Just the other day, someone else’s vanity search (The Blue Ocean Strategy Institute) collided with mine to produce a virtuous result.
W. Chan Kim, a smart guy out of HBS who wrote “Blue Ocean Strategy” a few years ago, heads the Blue Ocean Strategy (BOS) Institute. If you aren’t familiar with its precepts, they are like many valuable things in life that boil down to common sense. The website offers this wisdom,
“Stop benchmarking the competition.
The more you benchmark your competitors, the more
you tend to look like them.”
Amen to that.
The point, which I borrowed from Kim and have endorsed for a long time, is that really successful companies sail out on the blue waters of the deepest ocean to find novel ideas that they turn into products and services to delight their customers and make a ton of money. After all, once you look like your competition, what do you compete on, price? Be still my heart.
I think of Apple and iPods, iMacs, iPhones, iTunes and the Apple Store when I think about Blue Ocean Strategy. I also think about Salesforce.com, the leading enterprise software vendor with a Blue Ocean Strategy to incorporate social ideas in everything it does and more. It’s also the company leading the charge on platform dominated cloud computing and you can see the results all around you though not necessarily in the financial press.
The collision I mentioned is how their vanity search found an article I wrote on Salesforce and Blue Ocean Strategy, “Salesforce Opens New Channels with Chatter,” in SearchCRM (May, 2012). They’ve posted a link from their site to this one. Not bad, I say.
On to Zuora
To show you just how long it takes to get the conventional thinkers out there to adopt a new idea, we can turn to Tien Tzuo, CEO of Zuora the billing and payments company dedicated to subscription business. You might remember Tzuo from his Salesforce days as CMO and Chief Strategy Officer. Tzuo’s recent article on All Things D was background for an interview he gave to CNBC discussing Netflix’s very good financial results.
Original AllThingsD article referenced http://allthingsd.com/20121128/wall-street-loves-workday-but-doesnt-understand-subscription-businesses/
It seems that despite all the success of cloud computing and subscription business, Wall Street still has a hard time when it comes to evaluating the success and financial soundness of subscription companies. The basic issue from what I see is the old saw, “A bird in the hand is worth two in the bush.” Wall Street analysts would rather have that bird tucked away in hand than the two or more fluttering in the bush even if they had a big net.
Perhaps that’s just human nature handed down to us from our ancestors in the savannah. Nobel laureate Daniel Kahneman tells us all about it in his recent book “Thinking Fast and Slow”. It’s part of our nature. But we also have big brains and now and then we are supposed to let those brains out for a walk, to make progress, to evaluate the safe bromides of inherited wisdom to see if they really tell us the truth about reality. On Wall Street that’s a pretty short walk.
Our big brains have come up with mathematical models and metrics that describe how subscription businesses are different and how they should therefore be evaluated. According to Tzuo’s article, there are four really important metrics, Annual Recurring Revenue (ARR), which is self evident, and
“Growth Efficiency Index (GEI – the sales and marketing expense needed to acquire new dollars of ARR), retention rate, and recurring profit margin (how much non-sales and marketing dollars are spent on servicing existing ARR)…”
But caring more about that bird in hand means not using these metrics yet and instead it awards a company like Salesforce with a PE ratio normally reserved for startups with little revenue.
But getting back to the whole Blue Ocean Strategy, it’s those companies competing in the beauty pageant punctuated by quality earnings calls and metrics from the manufacturing era (roughly steam, rails, oil and cars) that get the ink and become obsessed over by the cognoscenti of the concrete canyons on lower Manhattan.
It’s a shame, really. W. Chan Kim and Daniel Kahneman would not approve, I think.
