Posts Tagged ‘oracle’

Acme Packet and Dell: Two Sides of the Same Coin

February 5, 2013

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?

Acme

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.

Dell

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.

I Hope I am Wrong

January 3, 2012

First entry of the New Year. Typically, these things are bouncy and optimistic. This time of year, everyone has that “clean desk” mentality. Anything is possible. Unfortunately, I am just not feeling it as the technology sector enters into 2012 In fact, I have a foreboding feeling inside.

The Potential of 2011

Way back in 2009 and 2010, when many sectors were reeling from the global downturn, the tech industry was navigating the stormy seas rather well. Yes, product revenues were down. But service revenues were holding and profits were actually increasing. By the beginning of 2011, product revenues were once again growing and it appeared the tech industry was poised for a wonderful year. But it never came to be.

  he Realities of 2011

By the time we took the Q3 2011 snapshot of the TSIA Service 50, it was clear the tech industry was not enjoying the best of years.  Every quarter, we compare service margins, product margins, and operating incomes from the same quarter the previous year. The graph below from the Q3 snapshot documents a very humdrum 2011 for the tech companies in the index.

More specifically, some of the market leaders demonstrated chinks in their financial armor:

Cisco

Cisco limped through 2011. Their own analysis in their most recent 10-Q is not very encouraging:

Gross Margin

In the first quarter of fiscal 2012, our gross margin percentage decreased by approximately 1.6 percentage points, as compared with the first quarter of fiscal 2011. Within this total gross margin change, product gross margin declined by 2.5 percentage points, while service gross margin increased by 1.5 percentage points. The decrease in our product gross margin percentage was a result of higher sales discounts and unfavorable product pricing, and product mix shifts. Partially offsetting these decreases in product gross margin were lower overall manufacturing costs, higher shipment volume, and lower amortization expense from purchased intangible assets. The increase in our service gross margin was due to increased volume, partially offset primarily by increased costs and to a lesser degree, unfavorable mix impacts.

In other words, Cisco is confirming a very troubling trend:

Product shipments are trending higher, manufacturing costs are trending lower, BUT product margins are trending lower due to increased discounting.

Oracle

Oracle ended 2011 with a financial groan, as documented in this Wall Street Journal article:

 Piper Jaffray wrote that Oracle’s Q2 results illustrate a “clearly more sluggish spending environment.” They predicted “continued unexciting growth” over the next two quarters.

The Realities of 2012

The above data is all old news. Right? It’s the New Year! Yes, it is a new year, but I do not see tech shaking this funk anytime soon. In fact, I feel it will get tougher in 2012 for the legacy providers. Even if the global economy does not falter, the financial models for tech companies will struggle in 2012. Why? Because the three most important plays in the tech company playbook don’t score easy points anymore.

Old Play #1: Next Generation Product Release

When margins start to lag, tech companies look for that next hot product release that will reinvigorate pricing points and margins. The margins on new tech products are commoditizing at alarming speeds. Look at everything from the price of an Ethernet port to the price of a tablet computer for validation of this reality.

Old Play #2: Acquire Revenue and Margin 

Legacy tech companies with lots of cash on hand love to run this play. Oracle, obviously, has been very proficient at this play as pointed out in the Wall Street article:

 But Piper Jaffray saw a silver lining in Oracle’s ability to “acquire companies with 10%-20% operating margins, strip out costs, and rapidly realize 40% operating margins for the acquisition targets”

On Oct. 24 Oracle said it would purchase cloud customer service company RightNow Technologies for $1.5 billion.

“As such, we remain optimistic about Oracle’s aggressive acquisition strategy, which we describe as an ‘earnings arbitrage’.”

Here is the rub: the up and coming stars in tech are not printing cash. Let’s say SAP decided to purchase Taleo to counter the Oracle purchase of Right Now. In their most recent 10-Q, Taleo posted a loss. What if Oracle decided to gobble up salesforce.com?  Salesforce, which has been around for over decade, continues to lose money. I am not convinced that Oracle could purchase salesforce, strip out costs, and have a new 40% margin engine. The SaaS model is simply not yet performing at that financial level.

Old Play #3: Cut Costs

Tech companies learned from the largess of the dot com era. Over the past decade, they have become masters of cost control. Which is why there is very little upside left in this play. Unless, of course, tech companies start requiring their employees to travel “cargo class” on business trips.

 

Adversity Creates Opportunity

Now that I have thoroughly depressed all of my tech industry peeps, let me offer a word of encouragement. Even though I believe 2012 will be a tough year for many tech companies, I also believe 2012 will be a year of business model innovations. I promise to carry this optimism forward in my next post by commenting on some of the wonderful bright spots I see in the industry.

Key Trends: 2011

January 5, 2011

At the beginning of 2010, I wrote an entry titled “Nine Key Trends in Technology Services” in which I predicted trends that would be impacting our industry. This is an important mental exercise I encourage every technology services leader to engage in on an annual basis. The trends in our industry are moving rapidly, and they have the potential to be very disruptive.  You and your management team need to be discussing and debating the trends that will force you to adjust your services business. Please—do not get caught flat footed here.

One Year Ago

One year ago I asked readers to vote what trends they felt would be most disruptive to technology service businesses. Readers flagged three trends as being most disruptive:

  • Cloud computing:  Impact of cloud computing on product-service revenue mix of hardware companies. I discussed this trend in the previous blog entry: Death of the 99.9999 Value Prop
  • Social Media: How strong is the preference of technology consumers to use social media platforms to resolve problems?  ? As social media applications continue to aggregate users, users are beginning to help each other. We discussed this trend of “crowdsourcing” to solve complex problems at our 2009 conference in Silicon Valley. How will technology service organizations adjust delivery practices to leverage these emerging user communities?
  • Commoditization: Hardware companies are facing continued erosion of product margins. This erosion is putting more intense pressure on service organizations to deliver both revenues and margins. This trend was discussed in Product Provider Perils.

One year later, are these trends still relevant? Are these three items impacting providers of technology services? Beyond a doubt.

Impact of Cloud Computing on Technology Services

For the past year, I have been researching, writing, and speaking on this topic. Cloud computing breaks the following aspects of technology company business models:

  • Financial Model: Healthy maintenance contract margins are rolled into monthly subscription revenues. Revenues for implementing and integrating products on the customer site potentially evaporate.
  • Service Offerings: Service offerings to keep equipment up and running on the customer site become irrelevant.
  • Partner Ecosystem: What happens when product companies offer cloud services directly? Why do they need resellers to sell and install on premise products?

Over the past year, I have watched technology companies, both large and small, gnash their teeth over these disruptions. Yet, visibility remains low. How will the dust settle on these items? Clearly, cloud computing has the potential to totally re-architect the technology marketplace.  Three years ago, could anyone have predicted that Oracle would buy Sun?

Impact of Social Media

Social Media is changing how people learn. How people gather insights. How people share insights. Crowdsourcing has become a very real alternative to traditional support models. Support organizations are struggling with how to remain the source of truth for product support when their customers have so many peer resources to leverage.

By the way, Facebook is moving into Sun’s old campus. Who would have predicted that five years ago?

Commoditization

Historically, Microsoft makes billions of dollars by selling site licenses for Microsoft Outlook.  At the end of 2010, Microsoft found itself in a losing battle as it raced to the bottom with Google to price email services for the U.S. GSA:

Google wins email contract with U.S. GSA

Deal marks significant step for search giant in Microsoft competition

$1 a mailbox anyone? By the way, long before Facebook moved into Sun’s old campus, Google had taken over Silicon Graphic’s old campus. In the 1990’s, SGI and Sun were printing cash as they provided high margin servers to enterprises. Unix servers with proprietary chips now replaced by Linux and Intel chips.

Your Input for 2011

Moving into 2011, I believe the above three trends will continue to disrupt service business models. In addition, I feel the following trends will also be disruptive:

  • New Major Markets: Like everyone, I am reading the projected economic growth statistics. Clearly, the action will be in China, India, Brazil, etc. North America and Europe are recovering, but they do not represent exciting growth for technology companies. How will service organizations successfully monetize their offerings in these new major markets?
  • Engineering the Experience: Finally, the success of technology has moved well beyond the creation of features. Features are cheap. Speeds and feeds are cheap. Customers of all types (enterprise, consumer, SMB), are looking for a successful “experience” when they attempt to leverage technology. I would strongly argue that Apple is not winning the “feature” war, they are winning the “experience” war. This requirement to deliver a successful experience to technology customers could force product companies to dramatically alter their services strategy.

Vote Now

So once again, I would like to poll the community. What trends do you feel will be most disruptive to the world of technology services? Below I have listed the five trends previously identified. Which of these trends do you personally feel will have the greatest impact on technology service organizations over the next five years? What trends will force you to rethink your offerings or your partner strategy?

Are there other trends you feel will be more impactful? Then write them in. Take a moment and voice your opinion.

Will Cloud Kill Services?

November 9, 2010

There is a debate raging in the technology industry concerning the impact of cloud computing on service activities and revenues. Back in August of 2010, the partner at A.T. Kearney who is in charge of their outsourcing practice made some provocative statements in CIO Magazine.  These are just some of observations made by Arjun Sethi:

  • In the next five years, outsourcing as we know it will have disappeared.
  • We foresee a new model wherein outsourcers will provide standardized software solutions on a per-use basis.
  • Google and Amazon will eat away a significant share of the IT outsourcing market.

Read the complete interview with Arjun for more of his perspective.

Three months later, the counter arguments are being made.  Boris Renski and Victoria Livschitz are executives at Grid Dynamics, a professional services company that specializes in cloud computing deployments and enterprise systems scalability. Boris and Victoria argue that cloud computing will not be the death of outsourcing or consulting:

  • Outsourcers generate roughly $95B a year charging customers for the support of hardware and software environments. That argument will shrink, but it will not evaporate overnight.
  • With the advent of cloud models, outsourcers are creating new revenue opportunities by differentiating themselves with specialized infrastructure offerings like IBM’s Smart Business Development and Test Cloud.
  • The emergence of cloud platforms will NOT eliminate the need for development and integration. Instead, it offers the opportunity to refocus consulting resources on solving higher level problems and build new types of applications that were previously impractical to consider.

So, the outsourcers and consultants have weighed in. What about the product companies? You know, the hardware and software providers that are making billions of dollars selling both their products and services to customers. How will cloud impact their business models? More specifically, how will cloud impact their services strategy?

The Product Company Point of View

Talking to TSIA members and analyzing industry data, TSIA has published the following point of view to its members regarding the impact of cloud computing on product companies:

  • Hardware, software and maintenance are being combined into “subscription” services. This trend will continue to accelerate over the next five years.
  • The migration to cloud consumption models is decreasing the perceived value of traditional implementation, integration, and certain classes of technical support services.
  • There is an increasing need for value added services that drive adoption and successful consumption of technology solutions value by customers.

Think about the impact these trends are having on the revenue mix of an enterprise hardware/software company. Today, these product companies make anywhere from 30% – 80% of their revenues from services. These services are mostly centered on providing initial implementation assistance and then providing a support contract. Based on TSIA benchmark data, the image below shows the revenue mix of a company selling both hardware and software as part of an enterprise solution. As can be seen, traditional support services and integration services play a vital role in the economic engine of these types of product companies.

With the advent of cloud computing, the revenue model could radically change for product companies. The image below shows a new mix modeled off of many of the SaaS providers TSIA has benchmarked.

This shift in models will force almost every product company to answer a very hard question:

Are declining service revenues acceptable in our business model?

If the answer to that question is “No”, then product companies will aggressively be entering the fray with both traditional outsourcers and consulting firms to create new value added service offerings.

With their acquisitions of large service companies, HP and Dell have already signaled they will be going toe to toe with the pure service providers.

Xerox and IBM were there long ago.

But what about the other large players?  Can Oracle or SAP survive on subscription business models with no consulting or maintenance dollars? Can Microsoft live off of lower margin subscriptions instead of high margin licenses? Every product company will need to firmly decide where they stand on the above question.  And once they do, let the market shifting games begin. The outsourcers and consulting firms may be in for interesting surprise.

 

The Q3 Services 50 Webcast

October 26, 2010

What the heck does this mean?

Join me on Thursday to find out during the Q3 TSIA Service 50 webcast:

webcasts.tsia.com/home/listing/tabid/64/listingkey/63/the_tsia_service_50_q3_2010.aspx

 

 

The Service 50: The Tech Recovery Continues

July 28, 2010

This week, TSIA has been analyzing data from our Q2 2010 snapshot of the TSIA Service 50. This is an index of fifty of the largest providers of technology services. As I pore over the data from the Q2 quarterly earnings, it is clear that the recovery for the tech industry is not just centered in a few strong performers like Xerox or Intel.  The recovery is presenting itself across the tech sector in companies both large and medium sized. Also, the Q2 numbers were better than the Q1 numbers—which shows the trending is in right direction!

On Thursday, I will be delivering my one hour dissertation on the Service 50 Q2 data. To join me, register here:

http://webcasts.tsia.com/event/809lglbhcy

To give you a glimpse of some of the analysis, below is a chart that segments the revenue trends of the companies in the Service 50. As can be seen, compared to the same quarter one year ago, companies are seeing an increase in product revenues.

Revenue Growth for S50 Companies

Historically, for technology companies, the return of product revenue growth is always news for celebration. Specifically, because tech companies operate to one clear truism:

Product Revenue = Profitability

Even services intensive tech companies like IBM, Xerox, and Oracle still operate to this unshakable truth. Yet, there is a disturbing trend that is beginning to present itself in the Service 50 data that questions this high tech truism. To learn more, join me on Thursday.

Server Sales: The Rest of the Story

May 26, 2010

This week, the Wall Street Journal reported a healthy rebound in server sales.  Total shipments in Q1 of 2010 increased 23% compared to the same quarter one year ago. This rebound in product revenues is highly aligned with the data TSIA reported from the Q1 Service 50 snapshot in our webcast back in April. Product revenues are clearly rebounding: that is the good news.

“Now”, as Paul Harvey would say, “for the rest of the story.” Server shipments increased 23% but server revenues only increased 6%. The growth rates of shipments vs. revenues is shown in the image below:

Server Sales

Now, let’s project how 2010 could play out. Let’s say the economic turnaround continues and companies keep spending on IT infrastructure. To keep it simple, let’s say server shipments continue to increase by 23% for the rest of the year. Also, let’s assume the ratio between increased shipments and increased revenues remains the same. If these trends do remain constant for the year, the gap between shipmen growth and revenue growth will continue to widen as shown in the graph below. This dynamic creates a very real “margin gap.” This means server companies like IBM, HP, Oracle, and Dell are shipping more product but bringing in less revenue. This means less product margin dollars floating around to fund things like “sales and marketing.”

The Growing Margin Gap

The economy maybe recovering, but we, in the technology industry, are not automatically heading to easier financial times.  I’m just saying: LOOK AT THE DATA. LOOK AT THE TRENDS.

“The dogma’s of the quiet past are inadequate to the stormy present. The occasion is piled high with difficulty and we must rise with the occasion. As our case is new, so we must think anew and act anew.”

Abraham Lincoln

“Cloudprem” Providers

May 4, 2010

I’m in the middle of the TSW conference here in Silicon Valley. So far, the discussions, presentations, and panels have validated several assumptions related to the impact of cloud computing on technology providers:

  • Cloud breaks existing financial models
  • Cloud is incredibly disruptive to the current go to market models of the tech industry
  • Cloud has the potential to devalue the current service offerings of product companies
  • Cloud forces technology providers to “declare” their service intentions. Will they focus on providing technology components to others that provide cloud offerings or will they begin offering value added services directly?
  • Customers under immense IT budget constraints are anxious to explore new cloud computing options.

Validation always feels good, but it is the impact of cloud I did not understand that is blowing me away right now.

(more…)

End of the Great Recession?

April 28, 2010

On Thursday, I will be reviewing the Q1 2010 financial results of the largest technology companies on the planet. Are tech revenues growing again? Are service revenues and margins still staying strong? Join me for The TSIA Service 50 webcast to find out how 2010 is shaping up for product technology companies.

To register:  http://webcasts.tsia.com/event/0u9q8m2dg5

Red Hat and Oracle: Two PE’s in a Pod

June 29, 2009

Last week, a colleague forwarded me this article on the recent financial results of open source software provider Red Hat:

“Red Hat: Bad economy is good for open source”

I’ve never really examined the business model of the open source software providers, so I decided to take a peak. We track the largest software providers in the Service 50 and we know that license revenues have been under pressure.  Is the open source model a shining star in this grey and gloomy economy? After comparing and contrasting the most recent quarterly results of both Oracle and Red Hat, I would make three key observations:

  1. Despite Red Hat’s growth in revenue, Oracle’s business model remains substantially more lucrative.
  2. Surprisingly, Red Hat’s business model is R&D intensive.
  3. When all is said and done,  Oracle and Red Hat are actually executing the same service strategy profile.

These three observations have ramifications as the software industry continues to migrate from the traditional license model represented by Oracle to evolving software consumption models like open source, subscription, and advertising based (Google).

(more…)


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