Category Archives: Software Ecosystem

The App Economy – How should we view app monetization?

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The blogosphere is all about apps and how different ecosystems compete for the eyeballs of these and the money of course. You might still remember the the news when a far app pulled as much as $10,000/day in revenue but since then there is tens of similar applications on the marketplace. This started a trend where people left their well-paid jobs to chase their dream of creating apps and living a life without pressures. The growth of app economy is one of the most promising trends, but people/organizations that want to make real money of it, need to include some risk management into it as well. The app industry has become similar to film industry where relatively few people make money and the ones that make, are hugely successful like Angry Birds phenomenon from Finland.

One might of course ask oneself is whether this is a shift in our society and how work is performed. according to Erik Brynjolfsson (director of the M.I.T. Center of digital business), “technology is always destroying jobs and always creating jobs, but in recent years the destruction has been happening faster than the creation”. There is no question that technology is creating new jobs and apps can be part of this opportunity as can be seen in many of the reports that have studied this trend towards “app economy”.

What I have not seen many discussions around is how the app economy is linked with the enterprise software business. I have researched around this and identified the “dimensions” that are typically linked to the app business, but not that much is said how established software vendors should view this space and how these vendors can make a entry to the app space in a way that makes sense and where there is also a sustainable economical model.

So, the question that we should ask ourselves is how much of the app business is truly geared towards the consumer business and how much of this will gradually move into enterprise business? Should software vendors keep the app business in their plans when building enterprise solutions specifically using the cloud? If they should keep this in mind, what kind of pricing should the ISV use? Maybe free as the real money comes from the enterprise solution and not the app that accesses it? As you can see, it is not that clear and my own experience when working with both small and large enterprises, the app business hardly ever comes up in discussions. I am convinced that this will change and it will change very quickly. One of the drivers will be Windows 8 and Windows Phone 8 developers that will create solutions that will be based on app technology and not on traditional desktop app architectural model even if these will be able to run in Windows 8 Pro environment.

Another valid question that we need to ask ourselves is whether app economy should be see purely from mobile app development perspective or should we view it from a perspective where the device is just the means to get to what you want and the backend (typically the cloud) is the one that provides the services and brokers the interaction between different services. Shouldn’t we in fact be talking about services economy instead where organizations build apps to consume and combine information from different sources using different SOA interfaces that organizations/developers have exposed to the world. Isn’t this what we have always dreamt about?

NokiaExpressI downloaded today a Windows Phone 8 app (Nokia Xpress) to my shiny Nokia Lumia 920 and this app really demonstrates where things are going. After having installed the app, it asked me whether it can use location information (which most apps want to use), but what really made me to think about the future of apps is that developers really have to think “outside the box” on when developing apps. The thing with this Nokia Xpress app is that it enables users to store and read articles on your phone (locally) so when you travel, you do not have to use expensive data roaming. I know.. there are many of these apps from before, but what this app has specifically thought of is to really monitory and minimize data usage and provide a combination of technology such as Microsoft SkyDrive technology to store videos and images without having to use the data plan. Why is this relevant to me? Just this week, my son’s data plan was going over the limit and I found out that it was all about video streaming and 2 gig data plan does not cope well with this.

The topic of “app economy” is very interesting to me as researcher, but also as practitioner. A recent paper written by Dr. Michael Mandel and Judith Scherer (commission by CTIA (The Wireless Association) and Application Developers Alliance provides an interesting view on the app economy. According to Mandel, the entire “App Economy” was coming to use in early 2009 and was popularized by a cover story run by BusinessWeek in November 2009.

The way that Dr. Michael Mandel describes App Economy in his February 2012 report resonates well with what I have educated my customers in respect to ecosystems:

“ App Economy is a collection of interlocking innovative ecosystems”. Each ecosystem consists of a core company, which creates and maintains a platform and an app marketplace, plus a small and large companies that produce apps and/or mobile devices  for that platform. Businesses can belong to multiple ecosystems and usually do”.

There is no question in my mind that this topic is relevant to anybody that works in the software industry and it is fascinating to see how this evolves with time and what kind of new companies will rise to take advantage of this.

If you work in the Microsoft ecosystem, I highly encourage you to read the article “Microsoft’s cloud vision: Why Azure is the linchpin of the firm’s new devices and services strategy”. Another great article from Information-Management.com that predicts Enterprise Apps to go mobile big time and that money apps will move to the cloud. The article lists quite a few things that are very interesting and I encourage you to read that article as well.

Stay tuned for more, there will be more to come on my research on different topics and this app economy being one of them!

A tale of “me too” kind of innovation: RIM to launch music service for BlackBerry

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It is sad to read about Research in Motion (RIM) attempt to become hip again. I have been a client for RIM for the past few years for one reason: AT&T provides me with an unlimited data plan (worldwide) and that is hard to beat. I have not been able to switch to any other phones as I really need my phone when globetrotting and I am reluctant to spend hundreds of dollars each month for roaming.

As a Blackberry user, I would have appreciated RIM to focus on getting a real phone on the market that is competitive and I can still keep my unlimited data plan but I guess nothing lasts forever and I need to move on and change to a new operating system and vendor and deal with the roaming. I can’t be left behind in innovation and usability and when you look at the current smart phone market, it is growing and advancing with huge steps every month. My current phone (BlackBerry Torch) has a lackluster touch screen that does not react to my fingers the way one would expect. I have also had to rebuild the phone at least 10 times from scratch due to applications that have broken the phone. One would think that cannot be possible, but it is and I have seen it many times. I even had to buy a software tool to “self-manage” the rebuilding as AT&T refuses to rebuild the phone and forces you to buy the phone again if the warranty is over. Not something I enjoy doing. Once returning from Europe I put my phone on and it went dead and by discussing with AT&T service they said to buy it again.

The latest attempt from RIM was to publish BBM Music store that enables BlackBerry users to stream 50 songs using BlackBerry Messenger. Why on earth would I want to do that and wasn’t this something that Nokia already failed in and decided to kill? If I were RIM, I would focus purely on getting new phones on the market and focusing on the youth as they are the ones that either make the platform or break it. Another group are the developers that now are at crossroads as they have to decide what to do to a dying operating system as RIM is moving to the new QNX operating system that they acquired by RIM.

My personal opinion is that RIM needs to focus on having applications that support music services such as Spotify, Rhapsody etc. and forget about things that are outside their own core competence areas. This tale is also something that the software/IT industry keeps seeing all over again: once you are the top dog, you will eventually come down due to many reasons. We have seen this happen with IBM, Nokia and many other players. We need to remember to reinvent ourselves on regular basis and keep working in a humble way. Becoming arrogant and believing in something that is not true anymore can be lethal in the long run. When somebody becomes market leader, it always causes people/employees to think that this stays status quo even in the future. This never happens.

Where does this leave me as a smart phone user? In my mind there are only three players left in the smart phone field: Windows Phone 7 from Microsoft, Android from Google and iPhone from Apple. With these three choices the follow-up decision is to select the hardware manufacturer and that is where the race is going on with Nokia, HTC, Samsung, Dell etc. on the WP7 field and obviously the same thing with Google Android devices but with iPhone with only one manufacturer being Apple.

Life at Apple after Steve Jobs?

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I can’t believe how many announcements we are getting from the large IT players: First Google buying Motorola, then HP deciding to kill its HP TouchPad.  I just read news from Wall Street Journal that he is resigning as CEO of Apple and taking the role of Chairman of the Board if the board accepts that. I am sure that will happen. According to CNN, Steve Jobs sent a letter of resignation to the Apple’s board with following statement:

“I have always said if there ever came a day when I could no longer meet my duties and expectations as Apple’s CEO, I would be the first to let you know. Unfortunately, that day has come,” wrote Jobs, who has been on medical leave since January. Cook has been filling in as the company’s leader.

The question that everyone will now have is what Apple will be when Steve Jobs no longer runs the day-to-day business. Some might say that nothing and Tim Cook that will take the CEO role will be doing what he was doing before. However, there is no question in my mind that Steve Jobs is and has been the visionary for the company and there will be a change at least in the long term.

When I look back at very successful software/hardware companies, there has always been a strong leader with almost ruthless and dedicated desire to win the game. Look at Apple and what happened to the company when Steve left long time ago: it was almost bankrupted. There are several books that tell this story such as “The Second Coming of Steve Jobs” by Alan Deutschman.

I am listening to CNBC when writing this blog entry and according to the analysts; Steve Jobs was never the one that has executed on operational level that has been Tim Cook.  The question that I have is whether Apple will be coming with new things as they have with Apple iPhone, iPad etc. According to the CNBC, the stock has lost 5% of its value afterhours.

Tim Cook isn’t Steve Jobs and the other way around. The question that the CNBC is asking whether Tim Cook is the right guy to lead: he came from an IBM operational role to help Apple to run operations smoothly. Only time will tell how Apple will continue on its path and the market is in shock as this could be the end where Steve Jobs and his presentations are over.

What is this going to do for the mobility and tablet market? The questions that the market will have is whether Apple will be able to continue on its iPhone and iPad success or will the market become suspicious whether the ecosystem and the devices will be able to compete. I do not like to speculate specifically as this has probably to do with Jobs illness, but this could be a major break for the competitors to gain some momentum at least on the long term. The market will be in disarray for a while even if CNBC says that Steve Jobs has mapped the devices/software and strategy for years to come. However, when you look at the current mobility and tablet market, it is in flux and any player can take over in matter of months. Just look at Android and how it is taking market share from Apple iPhone and others.

I expect there to be more announcements in the mobility/tablet market during the fall. No question about it.

Cloud ISV: make sure you understand your ecosystem play – example of Intuit and Microsoft collaboration on software platforms to create a foundation for solution developers

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I have written several times in my blogs about ecosystems and the role that ecosystems play. I recently run into an interesting article in the Redmond ChannelPartner with the header “Intuit Extends Cloud Pact with Microsoft”. As I am working with Microsoft ecosystem every single working day, I became interested what the article was all about. Intuit has been building a Partner Platform (IPP) that was reported by Mary-Jo Foley already back in January 2010. I am a longtime QuickBooks Online user so I have a pretty good picture of Intuit’s SaaS delivery model at least from 2003. I believe Intuit was one of the first software companies to introduce a full-blown accounting solution for the SMB market and my company still uses it every single day.

In January 2010 Jeffrey Schwartz reported that Microsoft and Intuit stroke a cloud pact for small business where Windows Azure would be the preferred PaaS platform for Intuit and Intuit App Center.  This value proposition is obviously good for ISVs that can build solutions to the waste QuickBooks ecosystem with integration not only to QuickBooks data but also between QuickBook applications.

The idea behind this Intuit Partner Platform (IPP) is to help developers to build and deploy SaaS applications that are integrated with QuickBooks data and also to give huge exposure for the ISV on the marketplace that Intuit provides for its partners. This marketplace (Intuit App Center) has thousands of applications that can be used with QuickBooks and other QuickBooks third-party solutions.

Let’s look closer to why Intuit and Microsoft need each other. I read an interesting blog entry from Phil Wainewright that includes very interesting remarks about software platform that happens to be the topic of my Ph.D. dissertation (Evaluation of a Product Platform Strategy for Analytical Application Software). The blog entry from Wainewright includes following picture:

 

You can read more about this topic and download Wainewright’s report “Redefining Software Platforms – How PaaS changes the game for ISVs) for Intuit” and this can be found by following this link.

When you review the picture above in more detail, you will find interesting and relevant information how Windows Azure and Intuit IPP platform play together. According to Wainewright, the conventional software platform capabilities are all about functional scope of the development platform whereby cloud platforms add three additional distinct elements according to Wainewright: Multi-tenancy, Cloud Reach and Service delivery capabilities.  The service delivery capabilities have to do with provisioning, pay-as-you-go pricing and billing, service monitoring etc. The multi-tenancy is typically not something that the PaaS platform provides automatically without the application developer building the multi-tenancy logic to the application. I still hear people saying that a legacy application that is migrated to the PaaS platform will automatically become multi-tenant. This is not true as each application has to be re-architected to take advantage of things such as scalability (application increases compute instances based on load).

The idea behind Intuit IPP platform according to Wainewrite is that Intuit has built service delivery capabilities that can be abstracted from the functional platform that is on the left hand side of the picture. The idea that Intuit had initially was to be able to provide support for any PaaS platform to be integrated to the IPP platform which I think is a good idea by not practical considering how fast the PaaS platforms are evolving and the amount of investments that are put into them.

One thing to remember is that all cloud platforms such as Windows Azure has already moved on the horizontal axis whereby the situation and clear cut separation between functional platform and service delivery capabilities is no longer that obvious. This also means that any Microsoft ISV that builds additional infrastructure elements to Windows Azure has to be carefully aligned with Microsoft product teams as there might be a danger to be irrelevant as some third-party functionality will be covered with the functional platform itself (PaaS platform) like Windows Azure. I have seen the same situation with some ISVs working with BizTalk extensions that suddenly have become part of BizTalk itself. Microsoft is very clear with its ISV partners that they should focus on vertical functionality or features that are unlikely to be part of the Microsoft platform in the short-term.

A new post from Jeffrey Schwartz on August 11th, 2011 explains how Intuit IPP and Microsoft Azure will be even more integrated as Intuit will drop its native development stack and instead “focus on the top of the stack to make data and services for developers a top priority” according to Schwartz. In reality this means that Intuit will invest heavily in Windows Azure SDK for IPP and make developing an app on Azure and integrating it to QuickBooks data and IPP’s go-to-market services easy and effective. Microsoft released some more information about this partnership in the Windows Azure blog. The two companies have launched a program for this called “Front Runner for Intuit Partner Program” that explains what the developers get by participating in the program. The site portrays three steps: Develop, Test and Market and there is a video that explains what it means.

So what should we learn from this blog entry? First of all, every development platform (PaaS etc.) will evolve and my recommendation for the ISV is to focus and invest on one that you think is here in the long run. I think this example from Intuit is a great example of a company that was initially in the race of competing in the PaaS space to some extent to conclude that the investments to keep the competition going is just too huge and this led to the conclusion to select Microsoft Azure as the foundation for IPP. Intuit will be much better off by focusing on building logic on-top of Windows Azure by participating in SDK development an ensuring that any solution specific development can be easily integrated into Windows Azure platform. Intuit will therefore focus on providing data and services for developers to use with Windows Azure PaaS platform.

Microsoft has been in the development tools and platform development since its foundation so they are much better off to do those kinds of massive investments. I think this is very smart from Intuit and this enables Intuit to have a scalable solution that developers can rely on even if the decision was not easy according to Liz Ngo from Microsoft. Alex Chriss (Director, Intuit Partner Platform) from Intuit explains this in his blog why Windows Azure is a good foundation for Intuit development. Also, Intuit provides a tremendous opportunity for ISVs like CoreConnext and Propelware report based on the blog from Liz Ngo.

Software ecosystem will continue to evolve and EVERY ISV has to figure out how its solutions will meld to be part of different sub-ecosystems. This will also require efficient and well-defined Application Programming Interfaces (API) from all parties to be able to create an integrated solution based on service oriented architecture (SOA).

Let me known if you know other good examples where software ecosystems mesh nicely with each other.

Did Google find out that open source does not pay out as expected?

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Here we go again. The mobility world is changing with Motorola Mobility being acquired by Google for $12.5 billion. This was widely reported this morning when I woke up. Doug Barney from Redmondmag.com concludes that this move from Google might anger device manufacturers. My personal belief (that many other analysts support) is that Google woke up to realize that it might be good to make money on the phone business and not have it “free” as it is now.  The fallacy of open source might have finally caught up even with Google….. It could be that Google executives also realized that the winning formula is about ecosystems and  not only about the operating system as Galen Gruman conclude in his blog entry today.

I have stated in many of my writings that I do not believe in the open source model for an ISV and there are many reasons for it. One reason is obvious: the more success you get, you will have patent trolls suing your ass with our without reason. I have seen it so many times and it is frightening. Yes, large companies do the same thing to each other, but I guess the reasons are little different. Large companies can afford lawsuits but for the small ones this can be a death sentence.

Another reason has to do with valuation of the company in case you want to sell it in the future. There is no question that a company with real IP has more value that the one that assembles things from pure open source. In some cases this might be OK, but if you want to build something that has real value, some pieces have to be closed from competition to view it. I have been part of software organizations that have been sold (both as CEO and as Chairman of the Board) and there is no question in my mind that the buyer is interested in where the code (and algorithms) came from. I am sure there is a place for open source as well… If I had to start a company today, it would not be based on open source.

The announcement from Google to acquire Motorola is has caused a stir in the marketplace with speculation of whether Microsoft is now going to buy Nokia to have the same situation with Google. One blog entry suggested that even RIM might be a target now, but based on CNBC analyst interview this morning, RIM does not bring any additional value to the table so the market does not expect them to be bought up. This is going to be a race between Apple iPhone, Microsoft Phone and Android.

How should we now read the market and the intentions from these three players? Nokia’s share shot up 10 percent today: maybe Nokia will also be bought and or Android will be loosing attractiveness to players such as HTC and Samsung that are now going to compete directly with Google in hardware design and manufacturing. Interestingly, I read today from the news that Apple has ordered 95 million iPhones for the fall and Samsung is going to be one of the largest manufacturers, which makes this game very interesting. Samsung and Apple are fighting for the same markets and are in fact even in a lawsuit on patent infringement but still doing business together. Go and figure out……

The Business Insider blog entry today concludes that the deal between Google and Motorola might end in a disaster mainly because of Google stabbing HTC and Samsung in the back by now competing against them. At the same time, Microsoft now became the only big player that does NOT manufacture its own handsets and this could potentially be really good for Microsoft and Microsoft Phone future. It could be that Microsoft ends up also acquiring Nokia going forward, but this is purely my own speculation. Some bloggers from ZDNet think this would be the most logical option for Microsoft. It seems that the embedded software/hardware design ala xBox Kinect could work well where Microsoft would design the best handset to be optimized with Microsoft Windows Phone operating system. This is probably what the Nokia-Microsoft partnership is trying to do.

Another interesting perspective that Galen Gruman provides is to claim that Android really isn’t open source and now with the Motorola deal we are most probably going to see more closed sub-systems within Android that Google will not disclose from algorithm perspective. Gruman also concludes that the Android open source system development does not have an iron fist to make decision like it has in the Linux development environment with Linus Torvalds in the helm. Failed attempts such as Moblin, Maemo and MeeGo are examples of open source mobile platforms that never really got the traction that the platform needed.

What today’s acquisition confirmed to me was that the future of smartphones really does not have anything to do with just to operating system, but it is about software ecosystem and how software developers, handset manufacturers can manage the user experience. Nobody besides Apple is making really serious money on smartphones today as the entire market has matured and margins have come down.

IT IS ALL ABOUT ECOSYSTEMS AND FIGURING OUT WHERE EVERYBODY WILL PROVIDE VALUE.

 

Cloud ISV: Do not focus on building infrastructure, but focus on building value add for the end user

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Software developers love to challenge themselves with things that make them feel good and the trickier the problem, the merrier it is to find the solution. In some cases, this could obviously be the killer innovation that nobody else has ever done, but if it is something that already exists and can be purchased from a third-party organization, it is waste of time and money to rebuild something that is already available. Do you remember the saying “ it can’t be good as it was not invented by us?”. I do remember vividly and have been the witness multiple time during my career.

Ten years ago software developers had to work on basic infrastructure before getting the solution built, but today, the focus should be mostly on innovating and assembling solutions that bring something new to the marketplace. I still see SaaS ISVs to claim that they need to build a billing solution as part of the solution, but there is plenty of other solutions already on the marketplace that do that well an can be integrated to the overall solution scenario.

I happened to view Microsoft Windows Azure homepage today to see if there was something new and was very happy to see the homepage to include the same statement that I am bringing here: “Focus on your application. Not the infrastructure”.  A good place to start looking at other SaaS components/solutions is to visit Windows Azure marketplace that includes listings of different solutions that the ISV can use as part of their solution delivery. If you are a system integrator, you should also spend time understanding what the software ecosystem has to offer so you can become a trusted advisor to your clients.

I do recognize that in some cases there is a need to build “glue” components that can be regarded as infrastructure components, but at the same time, the ISV needs to realize that those components will be replaced by commodity software whereby the original solution needs to be reengineered in some way or the other. In the past, as a leader of a software development team, we had to spend lots of time creating infrastructure for our solution to even work. I used to be the lead for several business intelligence solutions and at that time, there just weren’t enough components or infrastructure that would take care of the basic functionality. I still remember vividly our fight in going from 16-bit Windows to 32-bit technology and we had to support APPC communication between the mini computer and the Windows desktops.  The bad news was that IBM decided to redo most of the router software with a pace that we as an ISV had really hard time to follow and we run into pressure from our clients to upgrade our 16-bit technology.  You typically do not want to be the first one on the planet to test new technology, but in this case we did not have a choice. We spent multiple months “running against the time” when trying to get our solution to work with the latest Windows router technology and it was not fun and it was very expensive.

I mentioned that SaaS ISVs should look at other SaaS solution to bring functionality as billing and organizations such as Zuora, Inc is an example of an organization that brings subscription billing and commerce platform that can be used by other SaaS vendors.

My message to cloud ISVs is simple: learn your cloud ecosystem, learn what there is that you can consume as part of your solution and focus on innovation on the solution and not on the infrastructure.

What makes a good salesperson according to research and what are most important characteristics?

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I run into an interesting blog entry by Steve W. Martin where he lists seven personality traits of top salespeople. Martin has also published a book about sales psychology with a good empirical study of thousands of sales professionals so we can assume that he knows something about this topic.

As an entrepreneur I have concluded that one of the most important decisions and selections that one can make are the salespeople for your organization. Engineer led organizations have the temptation to focus on engineering talent while sales-driven organizations understand that with a good product, the growth will come with an effective sales team. Let view some of the characteristics that Martin has identified. 1. Modesty – a salesperson that can adjust his/her skills with target has a higher chance to be successful. This means that the sales person needs to be both modes and humble and not let the customer/prospect to feel inferior. Just think about this. Would you like to feel stupid when buying something? I wouldn’t. 2. Conscientiousness – eighty-five percent of top sales people had high levels of conscientiousness, whereby they had some sense of duty and being responsible. The ole saying “close the deal and leave the customer in the dust” does not work well if you want to be a good salesperson and achieve results. In this case I want you to think what this means. You put your career on the line when buying something and you expect the acquisition/purchase to work so you do not put yourself in a position where you have to explain yourself.

3. Achievement Orientation – Eighty-four percent of the top performers score high in the achievement orientation. They want to achieve goals and measure their performance. These people also take political orientation into consideration when selling by understanding the dynamics in the purchasing process. These people understand that performance is rewarded.

4. Curiosity –a top performer is curious and hungry for information and knowledge. Eighty-two percent of top performers scored high in curiosity levels. This also leads to these salespeople to be very close to the sales process and ask the right questions, even the difficult ones. In technology field, salespeople need to be continuously educated to be able to help the prospects to do the right selection. Salespeople should be seen as trusted advisors and this will create a long-term relationship with the customer with ample opportunities to upsell and cross sell other solutions. 5. Lack of Gregariousness – this was a surprising finding in the study where top performers averaged 30 percent lower in gregariousness. This means that top performers do not become too close to the client or become too friendly. In the software business we have always known that if a salesperson starts living the life of the prospect and defending the claims of the prospect, the deal will not be what it should be.

6. Lack of Discouragement – Less than 10 percent of top salespeople were experiencing sadness and high levels of discouragement. According to the studies, a high percentage of the top performers had some type of active participation in high school sports and are competitive. 7. Lack of Self-Consciousness – this is a measure of how easily a salesperson is embarrassed and with top sales performers this is very low. According to Martin, the byproduct of high level of self-consciousness is bashfulness and inhibition.

If you look at the list of characteristics that Martin has identified when analyzing top performers in sales and reflect this to your organization’s best salespeople: do you agree with Martin’s findings?

If you are in the process of building a cloud business, you might also want to make sure that you hire people that fit into the high pace sales cycle that are part of a SaaS sales business.  Joel York explains well different SaaS sales models in his excellent blog Chaotic Flow.

Is there a Magic Number for a SaaS business?

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We have a tendency to find a magic formula for everything and this applies also to SaaS companies. In my research in this topic, I have found a few resources that give some direction of how to evaluate the healthiness of a SaaS business. It is easy to conclude that Monthly Recurring Revenue (MRR) or Average Recurring Revenue (ARR) is the driver for everything and this number is combined with Customer Acquisition Costs (CAC) we will eventually see whether the company will make money or not. If we add Average Recurring Cost per Customer (ACS) we have the main elements to figure out what the break-even point by using following formula:

BE=CAC/[ARR-ACS]

If we view the formula, it is easy for us to agree that if BE is greater or equal to 1; the company will never be profitable. In other words, Average Recurring Revenue (ARR) less Average Recurring Cost per Customer (ACS) will never be higher than Customer Aquistion Cost and that is not a good position to be in. Therefore, the ACC has to be able to cover the CAC for the company to be profitable. That is a very easy conclusion to come to. I demonstrated this in my previous blog entry where the sixth client finally was able to cover the overall CAC cost and the SaaS ISV started generating profit.

The fourth major driver is Customer Churn and this is specifically important with a SaaS business as nobody uses bad software and this will be very obvious when the customer does not want to sign up for a new contract term.  It was easier in the past when a perpetual software license was sold and the ISV got the money for it. The only thing that the ISV could lose is the annual maintenance and support fee of 15-25%. Today, an unsatisfied customer will never become profitable if walking away the first year (in typical scenarios).

A key number that seems to be a driving “Magic Number” and represent the health of a SaaS business is based on MRR growth when taking into consideration Sales and Marketing spend. The idea is that as long as the company is growing and the “Magic Number” is demonstrating that the sales and marketing spend is generating results, the company should continue on this path. The blogosphere includes a few sources in this topic and Lars Leckie was then one that came up with his blog entry that many others seem to be referring to. His Magic Formula is as follows:

QRev[X] = Quarterly Recurring Revenue for period X

QRev[X-1] = Quarterly Recurring Revenue for the period preceding X

ExpSM[X-1] = Total Sales and Marketing Expense for the period preceding X

The SaaS Magic Number = (QRev[X] – Qrev[X-1])*4/ExpSM[X-1]

Let view this formula with real numbers so we can get a feel what it means with some numbers:

 

Q1 Q2 Q3 Q4
Revenue $1.0M $1.2M $1.5M $1.6M
Sales and Marketing spend $800k $900k $1.2M
SaaS Magic Number 1.00 1.33 0.33

 

So what happens in the calculation is that the current quarter’s sales is subtracted from previous quarters sales and this is then multiplied with four (to annualize it) and then finally divided with previous months sales and marketing costs.

In the case above, the Magic Number seems to be going smoothly until Q4 when the number goes down dramatically with sales plummeting even with increased Sales and Marketing spend. According to Leckie, as long as the company maintains a ratio above 0.75 it should increase its sales and marketing spend, but if it is less than that, it should review its business as something might have changed the market condition.

Joel York takes this number a bit further by including Average Cost of Service (ACS) into the formula with the conclusion that the cost of service should be covered when calculating the Average Customer Rate of Return for the SaaS business. According to York, the Customer Rate of Return is the most powerful metric that a SaaS business can be measured on as it really shows whether the SaaS business will be a business or not. Therefore, York concludes this number (J) to be calculated in following way:

 

 

 

York also includes churn in his discussion where the growth added with churn should always be less than the average Customer Rate of Return (J). This is very logical if you think about it. The contribution from the client needs to recover the Customer Acquisition Costs, Average Cost of Service (ACS) and possible churn to achieve a situation where the customer becomes profitable for the ISV.

The common expectation is that CAC costs should be recovered in a year or so but York has put this additional requirement that the ACS costs have to be paid as well. I think this makes a lot of sense as the ACS could in some cases be considerable whereby the ISV should pay attention to them.

If we assume that the SaaS ISV has a contribution margin of 50% (Revenue less variable expenses), Joel’s Magic Number would be as follows:

When Contribution Margin = 50%

Joel’s SaaS Magic Number = The SaaS Magic Number /2

York takes a more conservative approach in his numbers where he concludes that The SaaS Magic Number of 0.75 just is not enough to “step on the gas” as the needed growth requires aggressive spending which then moves the SaaS ISV further down in time to profit scale. If we furthermore assume that the contribution margin (CM) is anything less than 50%, the time to profit is much longer specifically in start-up phases. York wants to see a Magic Number that is more or equal to 1 with the added requirement that ARR is > 2 x ACS whereby the ISV can quickly recover its acquisition costs.

We can conclude from this blog entry that the SaaS world does have some metrics to measure the health of the operation, and there are many perspectives how each analyst sees it: some view it from more conservative perspective and some have their venture capitalist perspective. The latter is very prevalent in the blogosphere and many of the SaaS authorities are from this domain. It is easy to say that they might not always represent the view of the entrepreneur, but more from an investor perspective and we all know what that means. It will be interesting to see if more entrepreneurs will provide guidance in this field like Josh James, CEO of Omniture gave at a conference and this generated the blog entries from both Leckie and York. Interestingly, Omniture was sold to Adobe and left the company soon thereafter.

Once we get enough people sharing their experiences in different aspects of the cloud business, we will eventually achieve a situation where we can provide guidance in metrics for different types of SaaS vendors.

ISV transitioning to the Cloud, Cloud Financials and Operational Metrics

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I divided in my previous blog post how a cloud transition will impact an ISV. The first blog entry was about the change in business model and this blog entry is about the impact in financial model. However, it is important to recognize that the financial side has lots of different drivers and I will only portray a few of these in this entry, and deal with some others such as sales related metrics later.

Independent software vendors (ISVs) have the concern of profitability when running a cloud business. Mature software vendors with ongoing annual maintenance and support revenue are wondering how to make a transition to avoid future cash flow issues. The most typical question that I get from ISV management team members is: “how do we transition to the cloud without jeopardizing our current business?” Unfortunately there is not one and simple answer to this and what nobody wants to hear as an answer is: “it depends”. There are many different variables to consider and some of them are ISV specific and cannot be generalized. It is like comparing two different cars that have a different purpose: one that is used for racing and the other for transportation of heavy equipment. How does one compare these two and what is the comparison metrics?

I can still remember my early career when we did a bunch of comparisons between publicly traded companies in my business school using metrics that was regarded as “industry norm”. We had to learn in our accounting class each ratio that could be calculated concerning income statement and balance sheet. When we added cash flow statement to the equation, we were sometimes completely lost… me included. Once I understood the connection between income statement and balance sheet, life become so much easier. I would argue that ISV management has to do the same thing to really get to understand where a cloud business is taking them. I am sure that the ISV CFO and controller are on the right page, but I am not that convinced that the management team members all understand the impact of the change. That is just my observation from both research and talking to a bunch of entrepreneurs.

It is obvious that accounting metrics has not changed but was has changed is how we measure our operational activities that eventually leads into the financial accounting metrics that we track and our auditors are interested of.  If we change our model from classic perpetual software licensing model to subscription-based model and keep our operational metrics in the prior, I will guarantee that the company will run into a wall pretty soon and one of the things that would be recognizable is that there is no cash in the coffers.  Do we really know how to recognize revenue in a way that tax authorities are OK with it? Do we know how to recognize service revenue with a software sale from revenue recognition perspective? You do not want to find this out later on when an audit is taking place or when you are during due diligence when selling your company.

The ISV management has many questions to answer. Is your current business and software solution built in such way that it is easy for the current client to move to pure SaaS environment? What is the current complexity of your solution and does it require lots of human interaction to get delivered? Does your solution have lots of integration points to other operational applications? Does your current software solution support a migration to a pure SaaS environment? If it does not, what is the alternative? I am sure you are getting my point here. Running a solution from the cloud is not just to “port” the solution, but it is to have it run natively and I do recognize that this is not easy for many legacy ISVs.

What about the financials? The number one term that you need to familiarize yourself with is CMRR (Contracted or Committed Monthly Recurring Revenue), Churn and Cash. Other key metrics are Customer Acquisition Costs (CAC), Customer LifeTime Value (CLTV) and there is a bunch of others that are related to different operational functions such as sales, marketing etc.

Fortunately there are lots of good resources in the Internet that I have found very helpful in doing my own research. Many of these examples come with lots of use cases and practical advice so my recommendation to any ISV is not to try to figure these out on their own, but to really learn from what is already known.

Some of these resources such as David Skolp that maintains a blog for entrepreneurs with a specific focus on SaaS business as well as Joel York that brings lots of financial mathematics to the game. He also addresses something that I have not seen anybody else do which is the concept of Net Present Value (NPV) in the calculations.

What many ISVs forget is to keep their Customer Acquisition Costs (CAC) down as much as possible as many ISVs are still used to the old model where the prospect/lead needs lots of human interaction before the deal is closed. This is no longer possible in scenarios where the price is on a level that the ISV can never achieve break-even with providing too much support in the deal closing. If you look at the Customer LifeTime Value (LTV) and Customer Acquisition Cost (CAC) figure below, the trend needs to be according to the following picture.

LTV and CACIf the ISV did not control the CAC, it would very soon run into a situation where LTV and CAC are getting closer to each other and the ISV would be bleeding money.

Following picture from Joel York gives an even more interesting view how Customer Acquisition Costs (CAC) combined with Churn will impact an ISV and how each customer adds to the accumulated CMRR until it covers the accumulated CAC cost. In the picture the sixth client creates a situation where company becomes profitable. The picture also shows how churn will impact the overall MRR with time.

Churn and CMRRThe picture gives us an idea how CAC and Churn plays a central role in SaaS financials, but there are many other financial measures that an ISV should think of and also measure. Skok provides an interesting breakdown in how key SaaS goals can be divided into different components: Profitability, Cash, Growth, Other (like Market Share) and each one of these components can be divided into smaller components.

If we further divide the profitability into components, this is how it can be seen:

Profitablity in ComponentsWhen you view the picture in more detail, you can see how Customer Acquisition Costs (CAC) and LifeTime Value (LTV) drives the customer profitability, Monthly Recurring Revenue (MRR) and Services Revenue drives the overall revenue and when you add expenses and COGS to the formula, you will have the regular accounting related profitability. Measuring your employees can be done from many perspectives and I will address sales measurement separately in a later blog entry.

As we can see, there foundation for an ISV is still the same, to generate ROI for the investment and dividends for the shareholders. What has to change is how and ISV measures the operational activities when running a SaaS business. ISVs that have not made the move towards the Cloud might really have issues with their competitiveness going forward. My recommendation to mature ISVs is to start looking what can be done in the cloud world and get the development team focused on the changes that a pure Cloud solution will require to be truly multi-tenant so the ISV can achieve the scalability benefits of a PaaS platform such as Windows Azure. Stay tuned for more about metrics and changes in operational models for an ISV.

 

An Independent Software Vendor (ISV) moving to the cloud – what are the financial implications of this?

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I have to say that I am living in a nirvana from a researcher perspective (even if I am an entrepreneur on daily basis working with practical execution). Nobody of us will have the chance to experience too many profound transformations in our lifetime. I was asked to write a report on ISV transformation from traditional software business to cloud business from financial perspective and I loved the nights and weekends that I spent on the Internet doing research. Coffee, music in the background, two large screens side-by-side and the feel of really learning and assembling pieces of information together is a feel that is hard to explain. No wonder I like to write books, dissertations, and reports…

My personal background is that I came from school when minicomputers such as HP3000, VAX/VMS and later UNIX computers where the ones that software was built to. The next era was the move towards client/server architectures where I really made my personal career in product development. Then we all remember the short period of web-enabling solutions and the huge investments in hosting facilities which many have now disappeared. This new cloud/SaaS era is much more than just making your solution web-enabled. It will change not only the way you build software, but it will change the way you run your business. Let me explain how by reviewing the picture:

The Cloud ImpactI will start with the business model in this blog entry and continue with the others in later blog entries. The change from perpetual software license model to subscription-based model will change the way the ISV sells its solution and it will change the way the ISV structures its partner channel. It will also change the way the ISV markets its solution. The main driver for this is that the ISV will not be able to sustain its cash flow with a traditional sales model as the sales team needs to keep much higher pace in sales when moving to the cloud environment. The sales model for an ISV has to be either fully automated with customer self-service or it can be highly transactional where you can have some human elements but the amount of transactions will cover the cost of maintaining people to close the deal. The ISV has to be able to control the Customer Acquisition Costs (CAC) as that is one of the key drivers to be able to achieve break-even point and start generating pure profit. This does not typically happen in less than a year, whereby the ISV has to maintain a happy client so they sign up for a new contract period assuming that the contract period is 12 months. I will analyze the metrics in my later blog entries. This just gave you an example of the operational changes that an ISV will experience.

How does an ISV manage to plan appropriate scenarios that it can take when moving to the cloud? Obviously, the assumption is that the Board of Directors have made a decision that the ISV has to make the move to survive in the new global competition where anybody from anywhere in the world can enter the competitive field. There are no geographical borders that will keep the ISV from competition. If you are an ISV from Italy, you can expect to get somebody to enter your territory from France, Germany, Brazil or Bolivia. Once the strategy has been set, you will have to use a model to operationalize your strategy and I am used and thrilled about Dr. Osterwalder’s Business Model Canvas that provides all of the needed elements to analyze and “paint the picture” on a high level. I have witnessed several experienced senior management team members to become enlightened of the power of the canvas and it really has become our number one tool when working with ISVs. The Business Model Canvas consists of nine building blocks: Value Proposition, Customer Segmentation, Revenue Streams, Cost Structure Key Resources, Key Activities, Channels, Customer Relationships and Key Partnerships.

Business Model CanvasThe power of a business model framework such as Business Model Canvas is that the management is compelled to take a position on each of the nine building blocks on a Business Model Canvas. Each building block can also have its own key metrics and these can become the foundation for a dashboard that the management team tracks on the monthly basis.

Besides the question whether the ISV has the right core competence to move towards a cloud business, the key question that any ISV has is how this change is going to impact the financial model and the canvas above shows how the Revenue Stream building block has to be in balance with the Cost Structure block. In the perpetual software business model the metrics on the cost structure and Revenue Streams are completely different.

To summarize, the ISV and its management has many different questions to answer in its journey to the cloud. The first is to make sure that the owners, the management team and the Board of Directors have a common understanding where to go with the strategy. The role of the Business Model Canvas is to help the ISV to lay out a few possible operational scenarios that it can take in its cloud transformation. In my next blog entries I will explain in more detail the financial impact on an ISV when moving from traditional perpetual software license business to subscription-based business model. Stay tuned for more.