Will Cloud Kill Services?

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.

 

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8 Responses to “Will Cloud Kill Services?”

  1. jragsdale Says:

    Read my most recent blog post about core vs. context. What I heard at TSW is the major push toward cloud technology is because IT is either nonexistent or uncooperative in most tech companies today, and adoption of cloud solutions allows business users to avoid or at least minimize the role of IT.

    What goes missing without the more complex. service-heavy deployments is the depth of integration and customization, which impacts technology speed of consumption, value received, and ultimately satisfaction and repurchase. And satisfaction is even a bigger issue in the SaaS world, as barriers to churn are much lower than in the OnPremise world.

    In my opinion, until companies begin re-investing in IT as a competitive differentiator, the entire corporate technology infrastructure is going to be slowly dumbed down, with less innovation for all.

  2. Eric Eidson Says:

    Net neutrality is an often overlooked wildcard in the SaaS discussion. Recent Republican gains in Congress increase the likelihood that the economic model of internet bandwidth access will eventually shift toward pay-for-play, significantly impacting the RIO of adopting cloud solutions. ISP’s aren’t on the sidelines just watching this trend develop, they’re furiously lobbying to get into position to get their slice of the pie. The real question is: do SaaS adopters realize the increased risk of financial exposure that accompanies cloud solutions?

  3. J.B. Wood Says:

    These trends are present for sure, some more dangerous than others.

    As we all know, product profitability tends to decline over time. Just ask any hardware company. And today even software companies are feeling the pinch of declining product prices, low end competitors, rising cost of sales and a reduced ROI on R&D spend. But many product companies have survived this market force – even prospered. Why? For 90+% of them it is because they sold services for the product separately and they could protect their captive service business. Their service revenues and margins did not decline, even in segments where products became commodities.

    But what if the trend of bundling the services and the products into a single “subscription” continues. Which market force will win out? Will it be the forces of commoditization driven by ever lower priced competitors disrupting what will quickly look like “old school” subscription price points? Will they use price to gain share even when the bundle is both product and service? Or will the lock in factor of services rule the day?

    I believe that bundling the service and the product into a single subscription is risky for established product companies. I also dont think it is in the best interest of our customers because as soon as shrinking subscription margins threaten quarterly profits, you can be sure that service quality will be the first to go.

    So to me it is about having a crisis plan that prepares for a world where the subscription margins are zero. How will you make money then? If you arent charging separately for services or you have given that business all to your channel partners, then you better be prepared to be the low cost provider. Who wants to play that game? The vast untapped market opportunities that brought us Microsoft, Oracle, Dell and even the “new” Apple are occuring much less frequently. Tech IS maturing and the keys to building a long term company are changing. The cloud is just the latest source of fule for the fire.

  4. Andrew B Schultz Says:

    Great article. Sethi’s remarks are strictly limlited to multi-year outsourcing contracts with legions of developers. I’ve been interested in learning what people think about how the cloud is going to impact professional services firms that work in large SMB and small enterprise markets – solution providers with an offering that focuses more on a specific part of the business.

    I’ve explored the impact of the cloud on those types of professional services firms here: http://wp.me/pZlIK-pg.

    I think that it’s completely ok that the depth of integration and customization decreases with the cloud – solution providers can make up the difference when necessary, as most cloud offerings will allow further customization on the existing platform, but the investment required by the cloud is sufficiently diminished from that of an on-premise software that it’s really ok to change the way we come up with requirements and justify purchases.

    Those extra integration and customization opportunities may be the best professional services play with the cloud, but if a solution provider finds itself doing the same type of integration/customization more than a few times, they might as well turn it into a packaged app. So I do think professional services has some work to figure out how to thrive in the new cloud-based world.

  5. Thomas Lah Says:

    Andrew: Thanks for adding your thoughts to the dialogue. My feeling is that this will become a defining issue for many of the technology service providers over the next three to five years. If bread and butter implemention, integration, and support services sold to individual companies decreases, where do they make their money?

  6. Itzik Sadeh Says:

    In my view there is an important factor which was not mentioend in the article and will push in my view the cloud companies towards the services offering. This is the customer retention issue and the customer stickyiness. In the cloud apps, and specifically in the rental model of applications, the product companies will have to find ways to keep the customer loyalty, hence areas like apps intgerations (specifically with on-premise apps) will still be a major service which will be provided by the cloud product companies.

  7. Yingyu Hsieh Says:

    My company is shifting from a product provider to a cloud service provider. RD is now making product not only for external but internal IT who is hosting services. IT is the SaaS maintainers and job functions are the same and important.

  8. Update: Impact of Cloud Computing « Service Visions Says:

    […] year I wrote a blog entry titled “Will Cloud Kill Services?” This entry sparked a healthy debate from readers, which you can review. Since writing that entry it […]

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