I’ve been thinking about the implications of this chart over the last few days:
The author, QZ’s Dan Frommer, has neatly encapsulated a growing theory among the digerati; namely, that a host of next-generation companies, offering wholly new approaches to productivity in the workplace based on cross-platform SaaS software, are slowly disrupting entrenched legacy firms like Microsoft, SAP and IBM in large enterprises. According to this argument, these quicker, nimbler competitors – best exemplified by Google, but also including firms like Amazon, Dropbox, Square, Tableau, and perhaps soon even Facebook – “grew up” on the web and often began in the consumer space with freemium models, only to pivot into the enterprise space after many of their users had already begun using their products there.
There are certain obvious caveats to QZ’s chart above. For example, email is a thoroughly commoditized product, and scales very well in a way that most categories of productivity software do not. Nevertheless, it presents some interesting questions:
- How do traditionally perpetual license-based software companies transition to a world rapidly turning to mobile and SaaS-based solutions?
- SaaS and cross-platform solutions are broadening the traditional market scope that vendors can effectively target – i.e. previously SMB-focused vendors can increasingly sell successfully into big companies as well. Do legacy “enterprise” focused companies like the ones above need to begin targeting the mid-market more aggressively? If so, how do they do that?
In some way, these are questions that tech industry icons like IBM, Microsoft, SAP and Oracle, who have built empires around providing technology solutions and services, are all grappling with today. Here are a few thoughts of my own.
First, some clarifications.
It’s wrong to look at the QZ chart above and assume that when they grow up, those startups and “mid-sized” companies will naturally keep using Gmail and Google Apps. The reason is because pressure for cost control and the complexity of needs from those business tools tend to scale in inverse proportion to one another as companies grow. (Btw, it’s worth pointing out that we don’t have a full list of who those “mid-sized” companies are, but the examples cited in Frommer’s article – Twitter, Dropbox, Airbnb and Etsy – are actually pretty small companies, at least by employee count.)
Nevertheless, it is also equally wrong to assume that everyone needs an Exchange server and Outlook when they hit some threshold number of employees. Ten years ago, that might have been more the case, but today companies have many high-quality options for hosted business email. Microsoft’s hosted option for Exchange Server is clearly still one, but it has many more strong competitors than it once did. SaaS has leveled many of the switching costs that previously allowed Microsoft to enjoy high margins.
SaaS and Mobile change pretty much everything
In the bad old days, very little ERP software resembled anything that we would call “cross-platform” today, because there was no need. Employees used company workstations and laptops with standardized OS configurations (that is to say, whatever version of Windows the company had purchased). Companies’ IT departments had to not only maintain the local hardware and network, but act as system and network admins, security experts, troubleshooters, and occasionally advise frustrated users to try rebooting their computers. These roles gave IT a huge amount of influence on enterprise technology investment decisions, which software vendors understood well.
Microsoft, in particular, had a license to print money with the integration between its monopoly operating system (Windows) and productivity software (Office suite). This is why, in Steve Ballmer’s words summarizing more of a worldview than strategy, “Nothing is more important at Microsoft than Windows.”
Flash forward to 2014: the proliferation of mobile devices means that employees are accessing company materials and communications on a multitude of different hardware and OS platforms, none of which might officially be “supported” by IT. Employees do it anyway. Pressure for BYOD becomes incredible, due to the convenience and ease of use it offers, but IT has serious and very legitimate security concerns. Cat-and-mouse games ensue.
Moreover, better connectivity and browser technology mean that more tasks can be done with cloud-hosted productivity tools, like Google Apps. Employees can access, edit, save, share and collaborate on tasks more effectively and reliably on whatever devices they’re using, anywhere, at a fraction of the costs of the company’s old intranet tool. What’s more, these solutions require a small fraction of the internal IT support the old tools did: no servers to deploy, expensive configuration and on-site support to pay for.
This new world changes not only how much of enterprise productivity tools work, but how they are bought, sold and supported too.
How vendor investments scale
No matter your model, there’s a big unavoidable difference between provisioning software services for a “mid-sized” company of 1,000 employees and one of 50,000 (Time Warner Cable), 100,000 (Amazon) or 500,000 (IBM or Siemens) employees. That said, vendors’ costs tend to scale quite differently between on-premise and SaaS software.
On-premise software entails big, obvious costs in terms of physical distribution and selling. Beyond that, depending on the product, there could be involved on-site consultancy engagements for setup, configuration and support. A single consultant or engineer seconded to a client can only do X units of work per day, so with more complex projects, the amount of increase in vendor resources required is roughly linear. Cue the same round of costs with every new software release, version or configuration.
SaaS changes almost all of this. There is still onboarding, configuration and implementation, of course (depending on the product), but this is almost always substantially less complicated than before. Thanks to multitenancy, upgrades and new versions are not generally an issue. More complex projects may sometimes require more on-site support or back end investment, but the cost curve is generally more sloped towards increasing efficiency per unit of input.
The differences in vendor investment necessary are clear. While SaaS solutions require heavy investment in infrastructure and skilled people to support it, those costs are generally more predictable, generalizable into overhead, and variable (i.e. I can more easily take a server offline than lay people off). This makes the company a lot more nimble.
The great pivot
Pivoting from mostly on-premise, perpetual license software to SaaS thus requires a major realignment in how a vendor plans resources for development, marketing/selling, support and financial measurement. The a16z blog had a terrific post about this not long ago if you’d like to read more about how, but the key points are:
- Shorter sales cycles driven by department-level buyers mean that targeted marketing – towards, say, the CMO? – is much more vital. This demands a much more nuanced understanding of a wider spectrum of business functions and their key uses cases than before.
- Accurate measurement of business results can be a much more challenging issue. Measuring results with SaaS is not like with perpetual license software for two reasons: revenue is recognized completely differently, and indicators like Customer Acquisition Costs, cash flow and churn rate are much more singularly telling than quarterly revenue. These differences can present a major problem when determining the future business prospects of a SaaS business line.
Both of these can require quite substantial reorganization of traditional roles, responsibilities and investment areas in a company transitioning to SaaS. This is exactly what has been happening at IBM for the last few years, and is the difficult path that lies ahead for Microsoft.
The (software) walls are melting
Traditionally, vendors like Microsoft, IBM and SAP built their castles selling software and services to big companies, which was a very profitable market segment to occupy. The problems they had selling into the mid-market, let alone to small businesses, were mostly ones of efficiency: generally, winning fewer, huge deals, which were seller resource intensive, trumped the alternative strategy of competing for lots of smaller opportunities. These vendors also possessed the economies of scale to provide extensive service and support. Over time, this allowed the big vendors to very effectively shut out a lot of competition from smaller competitors in this “enterprise” market.
But many of the artifacts that defined these divisions between software market segments are now beginning to melt. First, SaaS has completely disrupted the enterprise software market by offering easier, cross-platform solutions that are more flexible and at a significant cost advantage. Second, SaaS vendors’ cost structures, built around the deployment and support for a totally different product delivery model, have allowed them to meet a market whose value system for software has ineluctably changed as SaaS solutions have matured.
Thus, previously SMB-focused software vendors can sell into big company accounts with a more competitive value proposition, competitive costs and pricing, and required support capacity.
Some software vendors whose cost structures have literally been defined by SaaS include Dropbox, whose business offerings already boast over 80,000 clients. While Dropbox is still unprofitable, it’s also valued at around $10 billion, mostly because investors realize that it has focused primarily on growth thus far, not taking profits. That’s a problem that most legacy vendors probably would love to have on their hands, though it’s unclear whether their shareholders would allow them to manage it wisely.
Google is the other obvious case study here: Google Apps for Business alone is allegedly used by over 5 million businesses, and of course, you have the chart above. While Google’s cost structure, too, has been built around a cloud delivery model, the fact remains that the company’s revenues are still 90% advertising based. Google essentially subsidizes its enterprise-facing business lines (like Google Analytics), with the presumptive hope that some of them could eventually turn into profit centers too.
That business is still developing, and not yet a significant threat to the major productivity software vendors. But it is growing, and Google’s weight behind expanding it should have competitors – particularly Microsoft – concerned.
The way forward
There will always be a need (and thus a market) for specialized software services and consulting, but those services have steadily become commoditized. They will likely remain key components of any major vendor’s arsenal, but not centerpieces.
There’s a saying that “you can mine for gold, or you can sell pick axes.” This is more true for startups than major enterprise vendors who have the scale and resources to do more than one thing well at once, but broadly, it contains a lot of truth: owning the platform is much more lucrative over the long term than building on top of it. Microsoft understood this well, as Windows provided the foundation for the company’s dominance in productivity software. Apple has replicated that success with iOS running on their own mobile hardware, which acts as a wide and deep moat of competitive advantage for a long time to come.
In their own ways, both Microsoft and IBM are attacking this problem differently.
Microsoft’s new CEO famously articulated a new mission as a “productivity and platform” company, signaling a pivot away from devices and towards cross-platform solutions that kept users at the center. For a company that has been so strongly dedicated to building products on a single platform and on a proprietary hardware stack for so long, this will be a tremendous challenge – but the company’s new leadership seems to understand well that adapting to the new paradigm is less of a choice than an imperative.
IBM is doing something similar. Its software group reorganization in 2010 first signaled a reorientation towards new buyers with the Smarter Planet initiative, which markets new types of software solutions – largely SaaS-based – to non-traditional, non-IT buyers. The company’s heavy investment in cloud infrastructure, the MobileFirst group and the innovative Bluemix platform have led to strong growth in Big Blue’s cloud and mobile revenues, and put it on a very sound trajectory.
That said, firms like Microsoft and IBM face a huge challenge in adapting their legacy organizational cost structures to a new market where they face “native” competitors. Those smaller competitors have built their whole organizations, not just their technology, around SaaS markets and very specific groups of buyers within companies. Adapting incumbent cost structures within large organizations to completely new markets, with new sets of buyers, is an incredibly difficult – and sometimes painful – task.
The most effective way for big companies to make a major pivot into a new market like this is often to found a specific unit focused on that market and to give it considerable autonomy. (Clayton Christensen gives some famous examples of this in the Innovator’s Dilemma.) Inevitable organizational pressures – which are usually particularly pronounced in large corporations – combined with managers’ incentives and fear of failure are powerful handicaps when companies attempt to enter a new market value system. Everything about the business needs to be re-invented, from operations, development, marketing and sales down to financial guidelines and the target cost structure. Otherwise, you have a square peg and a round hole problem.
“The New [Insert Company Name Here]”
It’s abundantly clear that Microsoft’s productivity offerings, particularly Office 365, Azure and their sweep of consumer web services (ex. Bing) are the future of the company’s growth, and all of these need to be utterly cross-platform. While Apple has the luxury of building on top of its own hardware/OS platform, Microsoft has lost that advantage and is extremely unlikely to ever get it back. Fortunately for them, Apple has never shown a strong interest in enterprise productivity tools.
Unfortunately (for Microsoft), IBM has. The recent IBM-Apple partnership complements each company’s strengths: IBM’s deep reach into enterprise buyers and ranks of sellers, channel partners and service offerings, and Apple’s strong device and platform appeal. IBM’s strategy of building its future business around mobile and cloud infrastructure, application development and SaaS-based departmental offerings provides a possible long-term foundation for enterprise use of Apple’s hardware and OS. Along the way, a new route suddenly opens up for IBM’s software solutions business too.
But competition from SaaS enterprise market “natives” will persist, and how well legacy players – IBM, Microsoft, SAP and others – can adapt will largely determine their success. You can have an army of sellers, but market fit and pricing based on competitive cost structures will often win. You can talk about the “new [company name]” ad infinitum – but the real test will be whether that new organization operates, moves and speaks differently. If not, then not much has really changed.