Posts Tagged ‘salesforce’

Double Click on the SaaS Business Model

April 17, 2013

Current Wisdom

Yesterday, my colleague Maria Manning Chapman forwarded me an article from Tien Tzuo, a former marketing executive at

Wall Street Loves Workday, but Doesn’t Understand Subscription Businesses

I strongly agree with his title but vehemently disagree with the content in his article. Mr. Tzuo makes a compelling argument for why it is justified for SaaS based companies such as Workday to receive such outrageous valuations.  The crux of his argument rests on the importance of “deferred’ or “unearned” revenues. Currently, is sitting on top of over three billion dollars in deferred revenues. In their last annual report, Workday stated they have almost $300M in unearned revenues. To date, investors are clearly bought into the importance of these deferred revenues. The table below stacks Workday next to Oracle. As can be seen, Oracle out strips Workday in all key financial metrics except one: deferred revenues. Clearly Mr. Tzuo is on to something.



Fly in the Ointment

As Mr. Tzuo correctly points out, stock price of any company is a function of FUTURE potential, not past results. When a company has so much deferred revenue already on the books, the future looks very bright indeed. But, what if in the future, a company does not make any profit with these currently deferred revenues?  What in the future all of that deferred revenue and additional booked revenue barely pays the bills for running the company? Would investors still be so excited about the future of the company?

Theory of SaaS Profitability

SaaS companies are running to a pretty straight forward business model. They build platforms. As more customers get on those platforms, revenues will eventually outpace expenses and the business will generate profits. The image below documents the theory. All SaaS companies are navigating how to maximize upfront investment costs to propel them over to profitability.

SaaS Theory

The Realities of SaaS Profitability

The challenge with the theory of SaaS profitability is that is has been under accounting four critical factors:

  1. The increasing costs to support and serve customers
  2. The increasing costs of acquiring new customers
  3. The downward pressure on subscription pricing (as markets become competitive)
  4. The percentage of deferred revenue that becomes bad debt

Each one of these factors deserves a TSIA research paper in itself, so I will not elaborate further on them in this blog entry. I will only state that these factors are proving significant and they are resulting in SaaS business models that look more like the model below. This graph is the one you will clearly see reflected in the public data of companies like salesforce and Workday.

SaaS Reality

In reality, I am a massive fan of subscription based models for technology. Our last book, Consumption Economics, makes the case for why the entire technology industry will be moving to this model. However, I am gravely concerned that both investors and technology executives are unclear concerning the factors that will ultimately drive sustainable and profitable business models in this new world. A large chunk of deferred revenue, alone, will not guarantee profitability.


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 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 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, 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.

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:



The Cloud 20

September 28, 2010

The impact of cloud computing on technology services is a area TSIA continues to study with great interest.

I’ve just completed a review of the financial performance of companies in The TSIA Cloud 20. This is an index of twenty of the largest cloud computing players. In March, when we took the last snapshot of The Cloud 20, I made three observations:

  • •Cloud computing revenues are less than 5% of total technology solution revenues.
  • •Currently, SaaS models are at least 50% less profitable than the traditional enterprise software business model.
  • •YET: “Cloud 20” revenues grew 3% last year while “Service 50” revenues shrank 8%.

After reviewing the current data, there are three new ratios I have observed:

  • •49%
  • •80/20
  • •2X

To find out more about these three ratios, join me for the Cloud 20 webcast this Thursday: