Unsustainable Competitive Advantage

This week, I read a scathing article on the demise of Michael Porter’s consulting firm:

What Killed Michael Porter’s Monitor Group? The One Force That Really Matters

If you are in management, you will find this article fascinating. If you are in the habit of using expensive “strategy” consultants, you will find this article both fascinating and discomforting.

Beyond its general insights, this article contains a timely message for technology companies. Michael Porter has argued for years that companies should identify “sustainable competitive advantages” that are hard to replicate. These advantages translate to higher company profits. As this article highlights, in reality, THERE ARE NO LONG TERM SUSTAINABLE COMPETIVE ADVANTAGES. Unless a company has an unfair advantage through government regulation or some other market anomaly, ALL CAPABILITIES can eventually be replicated.

The technology industry has enjoyed very high margins and profits over the past forty years. In mature industries, best in class companies can be expected to generate an operating income of  8% to 15%. In tech, companies are expected to generate operating incomes above 20%. Today, there are tech companies generating operating incomes well north of 30%.

Past success has made tech executives believe their high margin business models should be the perpetual norm.  I would argue these business models are a function of unsustainable competitive advantage.  These business models are a result of consumption models that require customers to make massive up front commitments to technology—and then make it very difficult for customers to change their mind if they are not satisfied with their decision. This approach to technology consumption is not sustainable. Business customers are rapidly exploring new “pay as you go” models designed to match value received with the price paid. In other words, the tech industry is gravitating to more normal market dynamics between buyer and seller.

Our last book, Consumption Economics, has become one of the top five sellers on Amazon in the category of high tech investment:

Amazon Best Sellers

This book defines how tech business models will need to rapidly change as the tech market matures. Many in the industry have read the book. Some readers believe the book is an accurate portrayal of how the tech industry will change. Some readers are convinced their high margin business models will not be changing anytime soon. For all past and future readers of the book, I would repeat these words:   THERE ARE NO LONG TERM SUSTAINABLE COMPETIVE ADVANTAGES.   The consumption models in tech are changing. Get ready.

Industrialized Services

There is a concerted effort in the technology industry to provide professional service offerings that are fixed cost, low risk, and high value. These offers are sometimes called “packages”, “productized solutions”, or “industrialized services.” Regardless of the title, these types of service offerings have the same key attributes:

• They are well defined and highly engineered to reduce delivery risk
• They leverage delivery tools and methodologies to reduce the amount of hours required to deliver
• They are designed to be highly repeatable from customer to customer

As more PS organizations swing the pendulum of their services from “custom and labor intensive” to “engineered and optimized,” TSIA is hearing a common service business challenge: What are the organizational capabilities required to successfully build and deploy industrialized service offerings?

Build it and They May Not Come

The concept of codifying PS expertise into delivery methodologies and tools to reduce both risk and delivery effort is by no means new or revolutionary. However, the successful execution of this concept continues to elude most PS organizations.  Why? I would argue there are three key reasons:

1. The service organizations define and develop service offerings based on their strengths—not their customer needs.
2. Service organizations attempt to market these offerings on features and not business value.
3. Even if the service organization has defined compelling offerings that could deliver business value to customers, the services organization fails in executing the services consistently on a global basis.

These failures occur because the service organization does not have the required organizational capabilities to truly execute industrialized services.

 

Organizational Capabilities Required to Execute Industrialized Services

Before a service organization jumps on the “engineered” or “industrialized” services party train, TSIA recommends the organization assess the effectiveness of the following organizational capabilities:

1. Value Proposition: The ability to engineer service offerings that deliver valuable customer benefits and clear points of competitive differentiation.
2. Value Based Pricing: The ability to set prices for fixed priced service offerings that are based on the value proposition of the solution.
3. Solution Components: The understanding of what assets truly reduce engagement effort and risk.
4. Service Development Life Cycle: A mature and effective service development life cycle for professional services offerings.
5. IP Asset Reuse: The ability to maximize the reuse of all relevant existing services assets in service engagements.
6. Field Enablement: The processes and programs to enable regional services staff to delivery target offerings.

These are not the only organizational capabilities required to drive the market success of industrialized offerings, but these are table stakes. If your company has poorly defined processes or weak skills in one of these categories, your ability to drive industrialized services will be hampered.

TSIA has observed that PS organizations that pursue industrialized offerings can quickly create datasheets describing the offerings. However, without the organizational capabilities described above firmly in place, the offerings never reach their theoretical potential.

Acme Packet and Dell: Two Sides of the Same Coin

There were two events that happened this week in the technology industry that speaks volumes to how the financial models in the industry will be shifting dramatically over the next few years.

First of all, Oracle made a surprise acquisition of Acme Packet. Acme Packet is a classic hardware company selling to telecom carriers. Acme currently makes almost 80% of their revenue on selling high margin hardware. They wrap high margin support services around that around to generate a 80% gross margin business. Beautiful. Isn’t this the business model that any hardware company would envy?

The problem is that Acme’s is spending over 34% of their revenues on sales and marketing. The industry that they are in is hyper competitive. The stock has been going nowhere. The future prospects of Acme Packet as an independent hardware company banking on high margin product sales to drive growth and profits seems to be limited. Oracle is looking to broaden into the world of networking and they saw a unique opportunity to buy their way in. If Acme saw a future of high growth and high profits as an independent company pushing hardware, they would not have sold.

Next, news broke that Dell plans to go private. Last year, Dell made 80% of its revenue from selling products. Their revenue mix looks very similar to Acme Packets. However, Dell products are becoming more and more commoditized. Gross margin on products is running around 20% for Dell. This is my intuition, but I believe Michael Dell is clear that the future of a company making the vast majority of revenue selling hardware is challenged at best. Dell must reengineer the economic gears. And this will be painful. Better to go through this pain as a private company.

Acme Packet selling to Oracle and Dell going private are really two sides of the same coin. An economic engine based on the vast majority of revenues coming from hardware is under very real duress. Companies in this model need to make bold moves to move off of this model.

This is only the beginning. The historical tech business models are about to be turned upside down. The Dell and the Acme Packet business models were forged in the tech industry over twenty years ago. Personally, I believe product intensive business models are no longer the path to growth and profits. Keep watching the news—this is not the end of interesting headlines.

Service Capabilities Heatmap

A new tradition.

TSIA defines organizational capabilities as “the ability to perform actions that achieve desired results.” TSIA maps the capabilities required by all service organizations into the following eight categories:

1. Strategy and Planning
2. Offer Development
3. Sales and Marketing
4. Talent Management
5. Service Operations
6. Partner Management
7. Technology Infrastructure
8. Performance Management

In each one of these categories, there are capabilities that a service organization must master to scale and optimize their business.

In the first ten months of 2012, TSIA received over seven hundred inquiries from member companies. Also, TSIA has been surveying member companies regarding the service capabilities they are most interested in improving. Mining that data, there are clear patterns regarding the service capabilities that member companies are
working to establish or refresh.

This month I published a Service Capabilities Heatmap.

These are the top ten service capabilities we sell TSIA members working to optimize as they enter 2013:

1. Sales Coverage: We effectively align sales resources and channels with the market to cost-effectively sell our service offerings.
2. Pricing Strategy: We actively manage pricing based on a strong understanding of demand, competitive factors, and business objectives.
3. Customer Analytics: We have the data streams and expertise to monitor how customers are using our technology and then develop services that are proven to increase adoption of our technology.
4. Proactive Channel Management: We effectively analyze the cost and quality of all customer interaction channels (phone, email, self-service, chat, online communities, social media) and then influence channel choice, moving customers toward more efficient and less expensive channels.
5. Services Enablement (issue avoidance): Data and experiences from service engagements effectively influences product development priorities to reduce the cost of implementation and support efforts.
6. Realtime Dashboards: We leverage enterprise class systems to provide realtime data on critical service performance metrics.
7. Organizational Structure: We have implemented an effective services organizational structure that optimizes the parameters of service costs, service revenue growth, and customer experience.
8. Asset Reuse: We maximize the reuse of all relevant existing services assets in new service engagements.
9. Resource Optimization: Across geographic boundaries, we optimize the mix of resources to services delivery to ensure service success and margin performance.
10. Managed Service Offering: We have multi-year, annuity based service offerings that help our customers operate and optimize our technology solutions.

For the complete report on 2013 Service Capabilities, send me an email at thomas@tsia.com and I will forward it on to you.

Eleven Things I Learned

On the last day of the recent TSW conference, I summarized the key insights I was taking away from my converesations with attendees over the three days. To watch this presentation, visit:

http://vimeo.com/52654677

Below are the insights I cover in the video.

1. Managed Services

• Growing, profitable, but don’t call it Managed Services.
• Limit liability? Org structure? Rev Rec? Comp Models? Financial Model?

 

2. Margin Box

• Fixation on achieving certain margin targets for embedded service business lines. This means we walk away from customer opportunities because they don’t meet a specific target. We could be boxing ourselves in.
• What matters: Total margin dollars (rev * margin) not margin %

3. Service Controlled R&D

•  Service executive is given control of 5% to 15% of the product R&D budget. Focus those resources on capabilities that help customers realize value.

4. Solution Managers

• Not product managers. Not service marketing managers. They are comped on the growth of both product and service revenues.

5. “On site is Insight”

• Quote from Bill McDermott during his keynote. Why he believes service capabilities are so critical for product companies.

 

6. Success Science

• You understand what makes your best customers your best customers.
• Best customers = spend lots with you because they are being successful
• Do you have a cohesive vision throughout the entire company concerning what makes your best customers your best customers?

7. Place Big Bets

• Ex: Stand up a business consulting capability
• Ex: Stand up a hosted version of your product for a customer
• Ex: Aggressive reskilling program for services (technical to business)

8. Remove the Complexity of Services

• For your customers
• More importantly: for your sales force
• Complexity look like: stove piped service capabilities, overlapping offers, death by a thousand packages

9. Starting up SaaS

• 2 years to profitability
• Amount you spend on sales and marketing impacts time to profitability
• Design of the platform can dramatically impact time to profitability

 

10. Financial Model of Your Company

1. Has to change
2. Transition as quick as possible to the best model possible
3. New model will not be throwing off 25 to 40 points of profit

11. Disenfranchising your team

• Be savvy about orchestrating change
• You have to bring the company along with you (R&D, Sales, Finance)
• Don’t sacrifice your best people in this process

The Service 50 Snapshot

The first quarter of this year was rather flat for the fifty technology companies TSIA tracks in the TSIA Service 50. This Thursday I will be reviewing how these companies performed in Q2. Did the bumpy ride continue? Tune in and see how your company performance compares to the broader industry. Also, hear TSIA’s perspective on the key trends that will be impacting the performance of technology solution providers throughout the remainder of the year.

Register for the TSIA Service 50 Webcast

 

 

So what is “Premium Support” in the world of cloud computing?

Amazon.com has become a substantial player in the world of cloud computing. Amazon (yes, the online book seller) provides cloud offerings to host web services, storage, and computing cycles for companies of all sizes.

Recently, Amazon announced new pricing related to their support services:

• Amazon Web Services Announces Price Cuts On Premium Support, Free Basic Support For All

When you read the article, it sure feels like a race to the bottom for what cloud computing companies plan to charge for support services. However, the technology industry currently has a model where significant revenues are achieved by providing value added support services to customers. In the TSIA Service 50 data, we know that enterprise software companies, on average, receive over 60% of their revenues from services. Hardware companies receive over 30% of their revenue from services. If cloud computing companies are going to give “premium” service away for free, will these service revenues simply evaporate in the world of cloud computing?

What Amazon Does Offer

Before we say goodbye to all those lovely service revenues, we need to pause. Julia Stegman is TSIA’s VP of Research in the area of Service Revenue Generation. She lives and dies around the best practices for attaching and renewing service contracts to product customers. And she is convinced, more than ever, that attaching value added services will continue to be the lifeblood of economic health for technology companies.

After reading Amazon’s announcement, Julia tried to contact Amazon by phone to ask questions about their new support service offerings.  She summarized the following experience:

• There’s no phone number on their website
• You have to enter an account number to receive the phone number
• Even a “sales question” doesn’t have a phone number — you fill out a web form and it gets routed to someone

Frustrated with the lack of response, she read the information provided by Amazon on their web site regarding their premium support offering deliverables: http://aws.amazon.com/premiumsupport/

After reading the document, she sent me the following summary observations:

The Basic Level Support

• Customer service/billing questions   (that’s a cost of doing business)
• Support forums     (power users do the work + 1:Many creates scale)
• White papers, best practice guides    (1:Many creates scale)
• Access to Technical Support appears very limited.
• Seems you are invited to place a case JUST to resolve an error message through their proactive monitoring capabilities.

Support for Health Checks  

• “Health Checks monitors the health and status of AWS Services and the status of these checks are displayed within the AWS Management Console.
• When a check does not pass, customers will be given the option to open a high priority ticket with Technical Support for assistance.”

Developer Level

• Email only and local business hours with 12 hr response time   (industry average is 4 hours)

Business Level

• Where the deliverables start looking like traditional tech companies with access to Technical Spt via phone, chat & email 24X7.
• 1-hr response.

Best Practice Guidance

• Offered via white papers at the Basic Level and via the Technical Spt team on the “pay for” service levels.

Premium is not Premium

At the beginning of this year, TSIA began benchmarking the service revenue generation practices of technology companies. Part of this benchmarking includes data related to what hardware and software companies provide in level 1 (basic) and level 2 fee based support contracts. The graphs below from Julia compare industry averages to the Amazon offerings.

As you can clearly see, Amazon “free support” and “premium support” look nothing like the basic and premium support offerings of enterprise class technology companies. This is truly an apples and oranges comparison. Enterprise class technology companies are providing a host of capabilities that Amazon is clearly not putting on the table.

Perception Becomes Reality

Even though the support offerings of cloud based providers like Amazon do not look anything like support offerings of enterprise technology providers, TSIA is cautioning all of its members to track these industry comparisons. As more customers move IT infrastructure to the cloud, their service expectations are being reset by the Amazon’s of the world. And what service capabilities they value are being reset. Enterprise technology companies will need to be expert at defining and defending the value proposition of their services. That is, if they want to maintain those services based revenue streams!

A New Record by the TSIA Service 50

I just completed analyzing the quarterly results for the companies in the TSIA Service 50 index. To my surprise, the companies in the index set a new five year record (in a good way) on one of the key financial metrics we track. Join me this Thursday to find out what record was broken:

REGISTER for The TSIA Service 50 Webcast

 

TSIA Point of View: Should Cost Pricing

This week we received an inquiry from one of our members:

We are seeing a new approach to negotiation of pricing for some of our services – what is being called “Clean Sheet” or “Should Cost” analysis. In a nutshell, the customer does their own in-house assessment of what they believe a service (such as training) costs a supplier to deliver. The customer also does their own assessment of supplier overhead and margin, and presents a “should cost” price to the supplier. The supplier can either accept the proposed price, or refuse – in the latter case the supplier is then expected to reveal their cost structure to the customer for negotiation.

 This approach has been applied in other industries, such as the commodity auto parts supply business, for some time, but this year is the first time we are seeing it being applied to technology services. This could turn service pricing on its head if it became a widely adopted model among consumers of technology services.

 Is TSIA seeing this trend emerge more broadly in the technology services industry?

I strongly agree with the observation that “should cost” pricing could turn service pricing on its head. Also, I believe that any technology service that is commoditizing and can be sourced from multiple providers is susceptible to this pricing approach from customers. For example: you want to provide Microsoft Office training, or you have a managed service to maintain a customer’s server environment. Clearly, outsourcing vendors that are providing generic IT services have been faced with ”should cost” by customers that want to secure the best deal possible.

However, I am not hearing from our members that customers are using a “should cost” model for technology services they view are unique. I think this is true because “should cost” pricing requires the buyer to understand the creation process of the provider, as discussed in an article on this topic from GBM Consulting:

Initiating should cost analysis requires that the company have a good understanding of the manufacturing processes used to produce the item that they are buying.  Because should cost analysis is typically applied to specialized and unique parts, this is a reasonable assumption.  When a company designs a part or assembly for a car or airplane they typically specify much of the manufacturing process or at the very least they specify the characteristics of the part that define the process.  Based on those specifications, engineers can determine the manufacturing process steps what a reasonable amount of accuracy

For example, if a customer wanted to use “should cost” pricing to determine how much they should pay for technical training on your product, these are the relevant questions to ask:

• Are your customer’s experts at creating technical trainings materials?
• Do they know how long it takes for your specific product?
• Do they have accurate market data on how much experienced technical trainer’s cost?
• Does your customer know how much time is required to develop competent technical trainers?

All of these variables factor in to the final price for your education services. All of these variables make “should cost” pricing more challenging to apply.

 

The TSIA POV (point of view) on “should cost” pricing:

TSIA does believe that many technology market segments are commoditizing. Especially at the product level. With this in mind, it is even more imperative that technology companies are able to defend the unique value  they are delivering through service interactions. And remember, value typically equals margin. For this reason, TSIA has the following POV regarding “should cost” pricing for service offerings:

• Technology companies should resist “should cost” pricing for any unique services.
• Intense effort should be applied to educate both your own sales force and the customer on why a “should cost” model is not applicable to specific services.
• Once a “should cost” pricing model is applied to a service offering, that offering will be relegated to a “cost plus” pricing model.
• Cost plus pricing models that are totally transparent to the customer will yield very thin margins.
• Once a “should cost” pricing model is applied to a service offering, TSIA recommends a company divests itself of that commodity service.

Why Partner Enablement is Broken

This past week eChannelLine announced the arrival of an annual study titled “State of Partnering.” The study is conducted by PartnerPath, a boutique consulting firm that focuses on partner strategy and channel enablement.

The eChannelLine article highlighted several key observations from the annual study. What caught my attention were the responses from the product vendors (or OEMs). Product vendors had the following rankings for what they want from their service delivery partners:

• First and foremost: “Doing effective pre-sales discovery”
• Next most important: “Selling value to LOB decision makers”
• Other important capabilities: “Selling and marketing an annuity-based service” and “Developing a vertical solution”
• Dead Last:  “Enhancing post-sales professional services delivery”

Beth Vanni, a Vice President at PartnerPath, provided the following observation to eChannelLine: “Only 30% of vendors plan to offer professional services training with partners.”

So it appears that vendors (or OEMs) are looking for service partners that can pull through products. How the partners actually implement and support the products are of little concern to the OEM. Sure, the OEM will provide the partner with technical training on the product. But training on delivering services—well, the partner can figure that part out on their own.

When OEMs made their money on large upfront product transactions, this focus on product pull through made sense. However, this traditional approach to poor partner enablement is incredibly dated and running out of economic gas.  Moving forward, OEMs will obtain revenue from customers actually consuming product features and capabilities. To make sure customers can consume, partners will need to be adept at enabling customers. To enable customers, OEMs will need to invest in enabling partners to deliver effective services.

The success models for the OEM/Service Partner relationship is changing—right before our eyes. For more thoughts on this topic of the OEM/Service Partner handshake, refer to my previous blog entries:

Understanding Partner Needs

Who REALLY Owns Partner Success?

Managing the Mix: Changing the Partner Management Dialogue

The Common and the Missing in Partner Enablement Practices