The dot-com bubble of March 2000 may have been a long time ago, but investors are driving a similar pattern for cloud computing and SaaS software vendors today. A recent article by Jeff Reeves of CBS Marketwatch describes the similarities as an eerie and familiar pattern.
Many cloud and SaaS stocks are trading at multiple times their revenue without any signs of positive earnings; saleforce.com and Workday are good examples. Maybe I’m old school, but it’s easy to gain customers when you sell your products and services below cost. Eventually, a sustainable business model with positive earnings is necessary – or is it? In an article by Eric Jackson of TheStreet.com, he suggests the reason investors like SaaS stocks is the subscription license and the predictable revenue. It’s true, the subscription model ensures a revenue stream for three, four, or five years, but if the cost of acquiring the customer contract exceeds the revenue stream, what’s the point? This reminds me of the dot-com insanity when new websites bragged about gaining millions of members or subscribers but had nothing to sell them. In those days, the valuations were based on the rate of acquiring new customers, with only the potential for revenue, ignoring earnings altogether. These members and customers had no reason to stay loyal and fled one website for another in a war for the consumer mindshare. While winners like Amazon, Google and YouTube emerged, thousands of other promising websites failed.
Similarly, investors are over-estimating the ‘stickiness’ of SaaS and cloud license contracts. I argue that it’s easier to leave one SaaS/cloud vendor for another at the end of the contract, than it is to leave a custom on-premise ERP system. PeopleSoft and SAP are sticky because of the investment and mature integration with other systems. One of the selling points of SaaS is that there’s no need to customize. Further, certain back-office processes like paying a bill or payroll, need not be unique. When customers switch from on-premise enterprise software to SaaS applications in the cloud, they’re subscribing to a common process and a common software solution, potentially giving up unique requirements. In doing so, it becomes easier to switch from one SaaS vendor to another. Like the dot com phenomenon, I predict new start-ups will target SaaS renewals with cheaper and more modern features to lure customers away. How will SaaS vendors hang on to their install base?
SaaS applications and cloud infrastructure have different value propositions. If we exclude SaaS solutions on the cloud from the core value proposition of cloud computing through Infrastructure-As-A-Service (IaaS) and Platform-As-A-Serve (PaaS), the picture looks a little different. The uptake on mobile devices makes cloud infrastructure necessary. The consumer’s thirst for storage, information, and features is relentless and is drifting into the enterprise. Cloud computing and mobile computing are co-dependent. As consumers have become more comfortable with storing their pictures, music, schedules, and emails in the cloud, so, too, are enterprises ready to trust infrastructure outside their firewall. The value is there and the companies that deploy cloud infrastructure can be profitable. It seems that should the cloud tech bubble burst, it would only weed out the unprofitable players and the strategic direction with cloud would persist.
Mark Hulbert of Wall Street Journal states that a data-driven approach to market analysis suggests a tech bubble is not likely. Key indicators like IPO volume, dividend premium, and share turnover do not mimic the March 2000 scenario. But beyond the pundits, I’m looking at the customer’s value proposition and risk, as a systems integrator would do. Organizations are attracted to saving money, lowering risk, and reducing technology spending, but are skeptical of fads. Large organizations that have made large investments in infrastructure will gradually migrate to the cloud as the returns on the internal investments mature, and this could take time. Similarly, SaaS vendors are targeting clients with a compelling event for change such as end of license agreements, upgrades or the expiration of a lease on hardware. There are cycles to these events, which is why organizations don’t make sudden shifts all at once.
It’s likely that SaaS and cloud valuations will be a bumpy road for investors until sustainable business models are fine tuned.
BTRG is an Oracle systems integrator. We believe Oracle is poised to dominate the cloud computing space while maintaining its commitment to on-premise applications and its dominance in database technology. Yes, customers who are ready for the cloud can migrate to a subscription model for licensing with Oracle HCM Cloud or Oracle Financials Cloud. Conversely, customers that maintain unique on-premise applications to gain strategic advantages can continue unfettered.
The business concepts driving SaaS adoption are more significant than just cloud technology and have yet to be proven viable. Today SaaS vendors brag about the number of users using the same software at the same time. How far can this “everybody is the same” concept go before organizations sacrifice strategic advantages? It was counter-culture five years ago to suggest all organizations could use the same payroll system, and yet it’s been a goal of ADP for the last 30 years. It is still somewhat counter-culture to suggest all organizations can use the same software to run their enterprise.
If you’re a PeopleSoft customer wrestling with cloud and SaaS, we have the capability to strategically and objectively advise your organization.