At AFMSI, SSPA, and TPSA, we started ringing the warning bell back in September of last year that services margin dollars will become a critical commodity for product companies in 2009. That reality is now here as we look at the recent results of several historically product-centric companies. The force and suddenness of this trend is astounding. But before we look at the fresh data, let’s review the warning system that correctly went off
Back in September of 2008, I wrote a post titled PS in a Downturn in which I warned services organizations will be asked to deliver more with the same or less resources:
Finally, if the downturn persists, PS may be asked to actually find new sources of revenues for the company. Building off of the request for account expansion, PS may be pressed to aggressively identify new service practices and offerings that can keep the top line growing as product revenues weather the slump. So stop hiring and increase profitability, and increase revenues all at the same time.How hard can it be?
This warning was based on a combination of personal experience working with product companies under product revenue duress and analyzing the financial data of product companies post 2001 downturn. Then, on February 2nd of this year I wrote a post titled Health Check: Technology Services in which I reviewed the current trends emerging from our analysis of fifty of the largest providers of technology services:
If capital spend is tightening, services revenue streams become more important. Also, customers seem more inclined to invest in optimizing existing infrastructure than buying new products—this equates to more services spend, not product spend. This creates a dynamic we call the “services buffer.” This is the financial buffer services revenues and margins create for product companies when product revenues are flat or declining. Every indicator we see tells us this buffer will be critical to the profitability of many product companies in 2009.
This warning was based on the projecting forward from the data trends of 2008. It was clear from this data services margin dollars would become very important to product companies in 2009. Now, we are in to 2009 and the reality is upon us. We can see the growing importance of services revenues and margins in three historically product–centric companies: EMC, HP, VMware
At the end of January, EMC released their results for 2008. If we drill into Q4 of 2008, we can tease out two following facts which were not highlighted in the earnings press release. Product revenues grew 1% while services revenues grew 14%. Services margin dollars became 34% of total margin dollars (up from 28% the year before). The numbers are shown below with the additional calculations provided by me in yellow:
On February 18th, HP released their results for Q1 2009. We can see from this data that product revenues across the board decreased from 7%-19% while services revenues increased by 116% with the acquisition of EDS. More importantly services now represented 36% of the $3.1B in operating income dollars reported below.
Finally, VMware reported earnings on Feb 25th, showing product revenues did grow 11% but services revenues grew 55%! This disparity in product and services revenue growth for all three companies is shown in the graph below.
I wrote about the importance of “the services buffer” when capital spending is under pressure. These three companies are leveraging that buffer.