JCL Blog

Getting to the Future

Last year the Microsoft Office team produced a video showing their vision for the future.  It is pretty cool.

Technology companies produce mountains of these aspirational works -- probably mostly to inspire their own people to get motivated and build the stuff.  I still remember this video Apple showed in the 90s.

Dr. Francis Colins said:  

The First Law of Technology says we invariably overestimate the short-term impact of a truly transformational discovery, while underestimating its longer-term effects. 

At the time he was talking about he the human genome sequencing project, but it applies to all technological advances.  We always want the future to get here sooner and we often are dejected, or at least frustrated, by the time it actually arrives.  But arrive it finally does and we only have to look at the amazing things around us to confirm Dr. Collins' first law.

The buzz about the Internet of Things is roaring and we are not so much talking about how refrigerators are going to be on the internet, but an avalanche of billions and billions of sensors reporting everything from the proximity of cars to each other to advances in industrial automation.

China is doing its top down thing in an effort to lead in the industry.  They just concluded their third Internet of Things Conference this last weekend.  The EU has gotten underway with an initiative to establish standards and information sharing with their own IOT web site.

Here in the US it does not appear that there is a governmental initiative, but plenty of companies are working on building the tools we will need to make the most of the concept.  IBM was probably first with its Smarter Planet initiative, now in its 4th year.  Microsoft has StreamInsight, Oracle has its initiative, and there are many others.

It took the introduction of the iPhone in 2007 before people could visualize a world with billions of little computers in people's pockets.  There had been smart phones before, there had been PDAs, but for some reason the iPhone showed us the way.

What is going to be the thing or event that breaks through and enables everyone to visualize the Internet of Things revolution?

What is going to get us to that future?


Center of the Ecosystem

Vertically integrated technology companies like Apple and Oracle have established themselves in the center of the the consumer and enterprise ecosystems by building proprietary systems with just about every feature contributing to customer lock in.  The strategy has clearly worked for them, so far.  Getting new customers is going to get more and more difficult for them as the world moves away from lock in and the competition does something other than push customers away by throwing up ill conceived and poorly executed competing products or services.  

In this context a diverse and horizontally oriented technology firm will have a once in a decade opportunity to establish itself in the center of the new world -- not unlike the way IBM did in the ‘90s.  In fact, we can learn a lot from Lou Gerstner's playbook from nearly 20 years ago.  Here are the three partner relationship management things a company could do to establish itself at the center of the technology world of the next decade:

Embrace Open

The difference between open-ness and open source are more nuanced than can be described in this post.  One similaritiy however serves our purposes.  In an open system everyone is welcome.  Everyone.  Some companies can do this and others just cannot get their brains around it.   Companies that are insecure about the value they deliver -- build walls and moats. Companies that are good at what they do are the ones that can let everyone in.  

Love Engineering Great Products

A company with an engineering pedigree and that is full of talented people that love building great products has what it takes to be open.  Such a product focus injects confidence into the decision making about being open.  

Deliver Value Every Day

The irony of the lock-in strategy is that its is a cancer that eats the host from the inside out.  IBM has shown us that the discipline of being open inspires everyone in the company to deliver value every day. 

A company that works to immobilize its customers with contracts and proprietary and non transportable systems sends a message to customers -- but more damaging is the message it sends to the people inside the company.  Soon the company is hiring more lawyers than engineers.  And that cannot end well.

Oracle and IBM: Making Tracks in the Enterprise Market

The papers love to report on the consumer end of the tech industry.  All the while, a great deal of business is being done on the enterprise side.  Admitedly, the consumer angle is tough to resist because if I had put Apple on this chart it would be up 373% in this same time period.  So it is easy to see how journalists get drawn to Apple and the consumer business.  

This chart shows how the big enterprise players have performed over the past 5 years:

(click on the chart to go to Google Finance for a larger view)

Microsoft and HP, the two companies that are drawn to the consumer flame but also have a majority of their business in enterprise computing, have not done as well as Oracle and IBM -- who are completely focussed on winning the enterprise marketplace.   Microsoft just acquired Yammer - which shows a focus on business computing, but they also introduced the Surface, which is aimed back at the consumer.  

Now would be a good time to show the focus that Oracle and IBM have shown.  


Bigger Was Better Until Now

The Factors of Production Disassemble and Big Business Dissembles

Companies have been citing economies of scale as reason to acquire, merge, or grow ever since the beginning of industrialization.  It is not hard to grasp the idea that the cost of each additional unit will drop as more units are produced.  There are every day examples of this from ordering business cards to getting the next bigger bag of popcorn at the theater.  Doubling the size of the order rarely doubles the cost.  In addition to increasing competitiveness by lowering production cost, manufacturers have also been heavily incented to acquire their suppliers to secure raw materials consistently.  In addition, when significant research and development investment is required - large scale is required to justify that investment.  Bringing a new drug, airplane, or car to market can only happen when large scale production is the likely outcome.

Natural monopolies are sometimes formed when new technologies are discovered and more so when large initial investments are required.  The first railroad, telegraph, and electrical grid are good examples of natural monopolies.  Once the track was laid down, the cost of running the train was so much less than the next competitor (who still had to build their track) that protecting the monopoly and remaining profitable was not only conceivable by likely.  In the case of the telegraph, the network effect rewarded the first to market because the usefulness of the network increased as more people were connected to it, further securing the monopoly.

For all of these reasons we have lived our entire lives in a world where bigger was better.  Until now.

Over the past 30 years just about every part of business has been disassembled and the parts can now be purchased as needed, when needed, and for cheap.  Big time computing infrastructure is available for rent.  Enterprise quality business process systems from the mundane (travel expense management) to the exotic (advanced materials management) can be provisioned in a matter of days and delivered economically to large and small teams alike.  Anyone with an idea, some know how, and a credit card can bring it to life and to market faster and cheaper than ever before, and tomorrow it will be even faster and even cheaper. 

The railroad company may still have a monopoly on the use of its tracks, but the customer can pick from any of dozens of carriers that are putting containers on the train, so businesses large and small are able to ship their products anywhere for no initial investment, and very low cost.  Amazon.com may own all of the distribution centers, but anyone can sell their products through Amazon.com.  Apple may own the iPhone, but just about anyone can put an app in the app store.  Google may have the biggest search engine, but anyone can buy an ad.

However, before we get too excited about this new world of entrepreneurship we must look at the remaining barriers.  There are still two large hurdles: government regulation and selling cost.  Any large firm not offering access to its railroad tracks is doomed unless government regulators can be deployed to prevent competition. Also, in selling, some large businesses can prevent their customers from being exposed to new entrants by blanketing the market with salespeople.  Oracle and its mini-me Salesforce.com, dedicate $5B (20% of revenue) and $700M (50% of revenue) respectively to sales and marketing.  They have the reach to simply shout down any competition for customer mindshare. 

These government and selling advantages are significant because to date they have overcome the many large firm disadvantages.  Poor performing employees have many places to hide in big firms, even top performers spend an inordinate amount of time fighting internal battles, and real live feedback from the marketplace rarely makes it through the ranks to the top decision makers.  For these reasons top talent gravitates to smaller firms where the opportunities for advancement and the big payday are greater and there is just plain less brain damage.  The small firms have the smartest people, whose motivations are more closely aligned with business success, who are closer to the customer, and who have access to all of the tools and infrastructure previously only available to the big players. 

Both of these problems are self-correcting. 

Government protection may benefit a business but it kills the market.  More people every day make their residential location decisions based on access to high speed internet.  Taken to the extreme, these decisions may not be between one part of a city and another, but instead over an international border.  People went to Canada to escape Nixon’s draft, why not Australia to escape the reach of Genachowski’s FCC?  It is not hard to imagine a young software engineer with school age children attracted to Australia by fiber to the home and good schools.  Comcast and its lobbyists win in the short term, but even they lose in the end as they ride their shrinking market into the ground.

WikiLeaks may offer a middle ground to the all or nothing proposition of killing the entire economy.  They have announced plans to release documents targeting big business starting with the big banks.  It is suspected that the first target is going to be Bank of America.  This will expose the tactics large enterprises use to protect their positions.  In banking it is likely the manipulation of the bank regulators and deceiving their government and shareholders about their financial condition.  In technology it will probably be the anti-competitive behavior associated with patent trolls, mergers, and the implementation of standards.

In Selling, the small firms need to push forward while gravity does its work.  Salesforce.com spends fifty cents of every dollar of revenue on sales and marketing because they can.  With 95% gross margins, they have the money.  The increased competition from the many small businesses offering sales process automation tools will drive gross margins down. Each bee sting may not seem like much to worry about, but even Microsoft expects its margins to drop from over 80% now to 40% as their customers move to a cloud computing model.  This is happening to the entire industry and the big spenders on sales and marketing are going to either get crushed, or adapt.  Either way, there will be much more oxygen available for the little guy at the customer’s table.

As the disassembly of business offers opportunity to small up starts, the big established firms will dissemble.  Watch for support of entrepreneurial activity while absorbing potential competitors, claims of working with the government to open markets while increasing regulatory burden, and ever increasing attorney headcounts.  Change is hard for anyone and really hard for the big guys.  

Who Is Driving Technology Sales: The Consumer or the Enterprise?

Even though a significant majority of technology purchases are made by businesses, the consumer is rapidly gaining a meaningful position in the market.  According to Gartner, in 2010 businesses will drive 72% of technology purchases.  The iPhone/iPad revolution is largely driven by consumer purchases.  As these devices are introduced into the enterprise computing environment, IT professionals are developing strategies for managing them.  Forward thinking technology marketing people are presently working to understand how these changes will impact IT purchasing decisions in the enterprise.

Here we examine the arc of this revolution and make an attempt to help marketers position themselves for the evolved technology marketplace.

The Cost of Selling is High for the Enterprise and Low for the Consumer

Maybe it is cheap to sell to the consumer because consumer products are cheap, or maybe consumer products can be offered cheaply because it is cheap to sell them.  Either way, it costs much less to sell to the consumer than the enterprise, and in some cases the cost of customer acquisition is approaching zero.   Alternatively, over on the enterprise end of the spectrum, we find companies like Salesforce.com – whose largest expense is for customer acquisition.  For 10 years SFDC has spent over 50% of their gross margin on sales and marketing – and this year they will spend over $700 million.  Ten times as much as it will cost them to deliver their services.  Right behind Salesforce.com are Oracle, IBM, HP and Microsoft each spending over 20% of their gross margin on Sales and Marketing. 

When it comes to selling the approaches cannot be more different, consumer companies like Google sell by getting their customers to act as their own salespeople (filling out a form on the web), quite a contrast to Salesforce.com and the others who are seeking business customers by blanketing the earth with salespeople and partners.

Getting to Market:  To Advertise or Not To Advertise

Even companies with buckets of money must select a go to market strategy and concentrate their resources in what they believe are high value activities.  There are as many opinions about which strategy works best as there are CMOs – but just about all CMOS will agree that resources must be concentrated in high value activities consistent with their strategy.  Anyone spreading their resources thinly over too many activities is doomed.  The decision tree starts with advertising.  There are companies like Apple and Dell that go big on advertising and PR and companies like Microsoft and HP that invest their resources in building partner ecosystems.  A completely different third approach is lowering prices so far that solutions sell themselves.  Google and Craigslist price their services at 1/10th of their offline competitors.  Prices this low promote themselves – a $3,000 car or a $1 movie ticket would not require advertising or salespeople – the newspapers would write about it and the message would spread virally.

Let Someone Else to Pay

There is no charge for using a search engine or web service like Twitter or Facebook.  Using a free product does not make you a customer however.  The customers of these companies are the advertisers, and their payments for advertisements make it possible for companies like Google, Twitter and Facebook to offer valuable services for no charge to those benefiting from them.  No monetary charge would be a little more accurate.  The truth is:  those not paying for a service are not the customer, they (or their data) are the product being sold to someone else.  This is where the gulf between consumer and enterprise gets interesting.  Individuals are much more willing to give up their data in exchange for a free service.  Enterprise data is almost always a strategic asset and therefore most businesses are reluctant to trade their data for services.  Salesforce.com’s clients are businesses and they pay for the service because giving up their data to be sold to a third party would undermine their viability.  Google gets right up to the line on this one because they are selling the data they have about their customers to third parties – and many of their customers are businesses.  Admittedly Google is not going to one client and saying they will sell the content of another client’s searches or emails.  They will however allow one client to present advertisements to a targeted audience that is likely to include its competitor’s customers or employees.  This is evidence that the gap between consumer and enterprise buying habits is closing.

Mixing it up:  Put the Blender on Whip

Twenty years ago, with the exception of a few intrepid door to door salespeople, the consumer went to the store and salespeople called on businesses.  Then Amazon.com brought the store to the consumer’s home, and Dell cut out the salesperson by giving businesses the ability to serve as their own salespeople over the phone and web.  The consumer and business buyers including those in the technology market had been oil and water, and they were about to get poured into the blender.  When the first killer app for the consumer oriented Mac turned out to be the business oriented use case of desktop publishing – it was like hitting the chop button on the blender.  Employees connecting their home computers to corporate networks, enabled largely by broadband deployment, was the equivalent of the stir button. Social media tools like MySpace, Friendster, LinkedIn, Facebook, and Twitter turned the blender up to puree.  And as we are learning in our one question survey this month, the iPhone and iPad have cranked the margarita making machine up to whip and the water and oil have emerged as thick as chocolate mousse.  With consumer tech and enterprise tech all whipped up together, selling technology now takes on a combination of enterprise selling and consumer selling tactics. 

Enterprise Marketing Must Change

Right now there is a great deal of energy being invested by enterprise marketing people in social media.  This is important, but not the only area where the enterprise / consumer collision is impacting the market.  We will never know if the big brains at Apple developed their iPhone/iPad strategy with an eye on the enterprise market.  Intentional or not, their shiny new devices are changing the marketplace and buying patterns significantly.  Starbucks is moving to HTML 5 and away from dot net as a result.  Flash is being marginalized.  And products like those from Parallels that tie the new environment together, are ramping fast.  Enterprise marketers need to free their minds from a focus on making the things they have always done more efficient and start experimenting to develop new strategies that are effective in this new marketplace.

On the Horizon

As participants in technology marketing for the enterprise, these are the trends we expect to see accelerate as a result of the blending of the consumer and enterprise markets:

Social Media:  Clearly social media will be central to these changes, both driving and being driven by the marketplace evolution.  The key to social media is authenticity.  They key to authenticity is flexibility and IQ.  Companies with intelligent and autonomous actors on social media platforms will win.  It does not hurt that the highest value customers are the early adopters of social media.  100 years ago, when telephones had been deployed in 10% of the households, companies realized that the early adopters of the telephone were on the high end of the socio-economic ladder and should be treated as such.  Once telephones achieved 98% penetration, and the overwhelming majority of phone calls came from average customers, companies shifted their approach from high investment in high value customers to cost containment.  This is why a Comcast customer can get a high quality response from @comcastcares, and not from the Comcast call center.  Comcast knows the demographics of their social media savvy customers.  It will be some time before social media is democratized.  To Do:  Get smart people into the social media game.

Computer Operators:  Before the computerization of the telco central office, switching was done by telephone operators.  An operator could manage approximately 200 telephone lines.  We now have 180 million land lines and over 200 million mobile lines in the US.  If we had to rely on manual switching – we would now require 1.9 million telephone operators.  Thanks to automation we only have 22,000 telephone operators now and none of them are switching calls.  In the early days of the computer an operator with significant training was required to run the device.  This continued during the early days of the PC.  The devices were complicated enough that every user was essentially a trained computer operator.  It has only been in the last 10 years that computers could be operated without the barrier of significant training.  The iPhone and the iPad are revolutionary in that they require no specific training at all.  A child can pick one up and figure out how to use it.  Many businesses now operate without a single IT resource on staff.  Computer operators are not dead however, they have shifted to managed IT service providers, web service operators, and application developers.  This trend will continue to accelerate.  Business will be less technically aware and will purchase services from specialized service providers.  The service providers will have all of the computer operators and accordingly will increase in sophistication and technical capabilities.  This will split the marketplace into the sellers of the services and the sellers of the underlying technology.  The services will be purchased by people with business needs and a low level of technical sophistication.  The underlying technology will be purchased by people with an extremely high level of technical sophistication.  To Do: Market services by business use case and technology by engineering merit.

Partners Migrate to Service Sales:  The bifurcation of technology into unsophisticated (technically that is) buyers of services and very sophisticated buyers of the underlying technology will force a split in sales and marketing strategy.  The big technical deals will get bigger and will be increasingly sold using internal salespeople.  This will shrink the high end of enterprise technology sales and marketing done through partnerships. Who is going to sell servers to Amazon.com?  IBM, Dell, HP, and others will be competing for that deal directly.  Who is going to sell desktops to the law firm?  Channel partners.  Historically those partners have been companies.  Of course because partnerships are relationships, and relationships are between actual people, the reality has always been that the success of these partnerships depend heavily on the relationships between the people inside the companies.  For fifty years, people have been getting more and more mobile, a trend that has been accelerated by the latest economic challenges, and facilitated by social media tools.  Technology companies that are able to shift their thinking from partnering with companies to partnering with people will jump well ahead during this transition.   To Do:  Orient partner programs to individual people that sell services.

In the years ahead businesses will remain the most significant source of revenue in the technology industry. Businesses will however increasingly behave like consumers when purchasing service offerings. They will be looking for cost effective solutions to their most pressing needs, and they will be buying those solutions on short lead times and with relatively low technical sophistication. Vendors and solution providers that position themselves for this change will win in the transition.

Facebook is the Paris Hilton of Tech

Smart phones, tablets, TVs, app stores, Twitter, and Facebook (and the movie) sure seem to get the bulk of media attention.  HP now has over $114 billion in revenues, the largest part generated selling to the enterprise, but their consumer products get all of the coverage.  IBM has 400,000 employees and also generates nearly $100 billion in revenues – rarely ever mentioned – because it is focused on the enterprise.  Microsoft, well Microsoft just never gets mentioned.  See my post the other day on the Pew Study.  If Larry Ellison wasn’t pulling stunts with the Americas Cup or Mark Hurd, no one would ever cover Oracle in the media.

Real work is being done hardening networks against cyber terrorism, lowering total cost of computing, developing and enforcing enterprise standards, safeguarding large amounts of sensitive data, and developing industry specific solutions.  This work is done with rarely a mention in the press.  My explanation:  enterprise computing is complicated, hard to understand or explain, and most of all it is boring.  To Journalists, Facebook is Paris Hilton.  Write about either of them and your web site gets hits.  Write about lowering energy consumption in data centers and you might as well be covering anything having to do with sub Saharan Africa’s problems.

We really have not had big coverage of business tech issues since Y2K – over a decade ago.  Could it be that we are due for a surge in enterprise coverage?  It may make sense to think for a minute about events that could cause this to happen and how it might impact the technology industry.

Here are three things that could bring enterprise computing closer to the center of technology media coverage:

  1. A Big Security Event:  Let’s hope it never happens, but if a big section of the power grid goes down, or all of the credit cards become inoperable, or a cyber attack crashes the stock market, the media will start to pay attention.
  2. Follow the Jobs:  If big tech starts hiring again and makes a dent in the unemployment rate it will be a big story.  Unfortunately, this probably is a result of the changes we would like to see instead of the cause. 
  3. Someone Connects the Dots: Google and Facebook are largely considered consumer businesses.  They are however, big enterprise operations in their own right however.  The media could latch onto the fact that Google’s network of data centers, gigantic databases, and all of the infrastructure required to run its business is cool and worth paying attention to.

What would change and why should we care?

  1. The Money Follows the Media:  A lot has been written lately about how the VC business is changing.  The story is that the investment exits are not there and new tech start ups don’t need as much money to start.  It is true that someone building for the Apple App store does not need to raise much if any venture capital, and may never go public.  Venture capital is needed just as much now as ever before.  The VCs do seem to follow the media, so if the media goes enterprise, maybe the VCs will too.  Thomas Friedman would sure be happy if we started funding green tech instead of another Twitter clone.
  2. Exports Up:  Technology innovation is something we can do well and we can export.  Enterprise computing is harder to knock off than a movie or an iPhone. If we build more capacity in our big business computing services – we could export it.  Companies like IBM, HP, Microsoft, Oracle, and others are already doing this in a big way – so we know how to do it.  And the balance of trade needs attention.
  3. Do Our Part:  If this were to happen, all of us could be proud of our contribution to the worldwide economic recovery.  Instead of presenting a military face to the world, or fancy financial engineering – which deploys just as much of a scorched earth approach as the military, we could be helping companies and governments around the world increase their productivity.  And they would pay us for it!  Good for us and for them. 

I hope someone figures out how to make enterprise computing interesting enough to get some media attention.  Could do us all some good.

Selling to the Enterprise is Hard Work

Selling is getting harder and this is causing a vicious cycle.  The harder it gets the more desperate salespeople get.  Desperate salespeople do unseemly things (lying to my gatekeeper is a minor offense compared to full on deception through the sales process).  Bad behavior by salespeople brings down any prospect's willingness to engage in any sales process -- making selling even harder.  And so on...  The deflationary trend in the economy only amplifies these problems.

Some companies get around this by eliminating salespeople all together.  Amazon and Google really don't have salespeople.  They have developed self service sales processes and have lowered their prices to a point where customers sell themselves.  I have a few posts on the topic of selling, here is a list.

Companies that sell complex products or services to big business clients (aka the enterprise), do not have the luxury automating and lowering the cost until the thing sells itself.  The most dramatic proof of this can be found in the sales and marketing budget of Salesforce.com.  I have a few posts about that as well, here is another list.  

What then do we do in an age where white papers and webinars and spam are well, just spam, and salespeople don't add value because any person with both the technical capability customers value and the social skills to be a salesperson increasingly chooses a technical career?   Here are two trends I have observed in the marketplace that may be the manifestation of this new reality:


Companies that know how to sell have a big advantage. Oracle is a company that knows how to sell.  Their sales practices are both legendary and ruthlessly efficient.  Sales and marketing at 20% of revenue may seem high, but only a fraction when compared to Salesforce.com's 50%+.  Think of it this way, when Salesforce.com spends a dollar on sales and marketing -- it gets $2 back.  When Oracle spends a dollar it gets $5 back.  Big difference.

It is this ability to sell to the enterprise that Oracle is counting on when it buys all of those companies.  Here is a blog post on SoftwareAdvice that has a great chart of the last 100 or so Oracle acquisitions.  There is no reason to think that Oracle is going to shy away from exploiting its unique ability to sell to the enterprise.  Gotta wonder of Oracle could fix Salesforce.com's cost of selling.  Hmmm.

More Dependence on Partners

Microsoft is a company that knows how to build partnerships.  In fact, running its channel partner program may be its core competency.  Microsoft partners know that Microsoft is committed to making them successful and both Microsoft and its partners invest side by side in the pursuit of new business.  Dell has recognized this and is working hard to build out a channel partner program as fast as possible.  If you sell to the enterprise, partners are critical.  

Consolidation + Partners = Opportunity

If companies that know how to sell to the enterprise acquire other companies, and companies that know how to sell to the enterprise rely heavily on channel partners, then the real work is going to happen when combining channel partner programs of merged or acquired companies.  We already see a great deal of this, and I suspect there will be more in the near future.  

The bottom line:  Highly valued high performance partners will benefit through this evolution.  Low performance partners will be redundant.  


Lowering Sales Costs

SoftwareAdvice.com had a great post recently about Oracle's next acquisition.  I encourage you to click through to the piece if for no other reason than to look at the great chart of Oracle acquisitions from PeopleSoft to the present.  

Clearly Oracle knows it is an enterprise computing company.  Selling to the enterprise is difficult and expensive and no one knows how to sell to the enterprise like Oracle.  Detractors often claim that acquisitions are a waste of money, and the recently announced Intel/McAfee deal will certainly add fuel to that fire, but when talking about the enterprise -- the cost of selling and long sales cycles is enough to make sense of many deals.

Ironically, Glen Hodges, President of McAfee until 2006 explains the Intel/McAfee deal with the same lowering the cost of selling angle in this post in the NY Times.  He points out that Intel's excellent channel partner program is underutilized and that the $7.8B price tag for McAfee could make sense just by having more for Intel to push through its highly efficient sales channel.

Now back to one of my favorite rants -- Salesforce.com.  One of the potential acquisition targets for Oracle listed in the SoftwareAdvice.com post is Salesforce.com.  Even Larry Ellison is not that crazy.  True, Salesforce.com proves the point that selling to the enterprise is difficult by spending over 50% of revenue on sales and marketing and combining the Salesforce.com and Oracle sales teams would represent hundreds of millions of dollars of savings.  But Wall Street never seems to notice this fact about Salesforce.com and has priced the stock at 193 times earnings!  In March I thought investors had lost their minds when the P/E was 114!  The industry is still in the low 20s.

Lowering the cost of selling is as important now as ever.  And it is on its way to even more significance as the talk of a double dip surges. 

Picking the Winners

I am not smart enough to pick the big winners in advance.  So I don't play the stock market, and at CSG we sell shovels to the gold miners instead of prospecting for gold ourselves.  Sure striking it rich would be a thrill, but the world is littered with hundreds or even thousands of would be Googles.  I was going to say would be Twitters, but they have not made any money yet!

This strategy has provided us with a very interesting vantage point from which to watch the show.  And it is quite a show these days.  I sure am glad I am not a telecom equipment vendor or a distributor -- it is easy to see what is going to happen to them.  It is much easier to pick the descending parts of our industry than the ascending.  Who in tech is going to do well?  

There has been so much talk about services over the past ten years that we have both lost interest, and lost track of the definition of services.  There are hosting services, IT services, software as a services, software + services -- and each time the word services means a different thing.  IBM, Dell, HP, Microsoft, and Oracle all have significant services organizations.  IBM generates more revenues from services than all of Microsoft's revenue.  What is IBM doing when they deliver services to their clients?

Business pay IBM 50 billion dollars a year for services.  And everyone in tech wants to get into services.  I propose that we could learn a bunch about the future winners by digging into the question -- what are people paying IBM 50 billion dollars a year for?

Stay tuned, in tomorrow's post I will dig through IBM's annual reports.

One Example of Irrational Exuberance Meets the Cloud

Disclosure:  My company competes with Salesforce.com from time to time, but our product is a niche extension of what SFDC does and we have never claimed to be a replacement for their product.  I doubt Mark Benioff has ever even heard of our 150 person company.  This post can be read as negative on Salesforce.com -- buy my point is on the irrationality of the stock market more than on the performance of the company.  Salesforce.com has done a great job blazing a trail in our industry.  

Salesforce.com recently released their earnings and the trends I pointed out in my posting: Sales vs Engineering continue.  In short it is another impressive performance.  Growth, profits, and one amazing P/E!  At Friday's close the stock was trading at a price earnings ratio of 114.5!  Yow!  The industry is listed at 21.8 and the S&P 500 at 20.5.  I know there are some irrational investors out there but I just don't get this -- Salesforce.com trades at five times the P/E of the rest of the industry.  No less than 14 analysis have the stock at a strong buy, 4 at moderate, and 14 at hold.  Not a single analyst in the sell column.  

I suppose the logic must be to pay in advance for growth.  A quick look at the articles referencing Salesforce.com from this last week alone and you would think CRM was just getting started and the buy ratings are based on the incredible growth.  I just don't see that either.  It is true that salesforce.com is highly scalable because it offers hosted software and adding a new customer does not cost them much in terms of manufacturing cost.  However, the thought that this cost is lower than other software companies is not true.  Sure they don't have to ship anything -- but neither do any other software companies.  The cost in added bandwidth required for a new customer of a hosted solution like Salesforce.com probably exceeds the cost of delivering an executable over the web as typical software companies do now.  The whole industry operates on a very low marginal cost for adding another customer.  Once the software is developed all software companies (yes Salesforce.com is a software company) keep 90%+ of each additional dollar.

What matters then is the cost of selling.  When your product is nearly free to produce, the biggest expense is either R&D or Sales.  And Salesforce.com takes the cake in high sales cost.  Salesforce.com spends 50 cents of every dollar it takes in on selling costs.  This has been the case from the very beginning.  The fans must argue that awesome growth costs money and when Salesforce.com decides to slow growth, they will be able to radically reduce sales spending and the profits will skyrocket.  So let's dig into that thought a bit.  Over the past three years the company has had an impressive growth rate.  Even now, growing at over 20% per year is impressive.  But 2008 was 50% over 2007 and the deceleration is steady however you run the numbers.  All the while the sales spending is keeping pace with the growth -- last quarter it was 48%. 

Here are some other interesting ratios:

  • Salesforce.com spends 5 times as much on sales as it does on research and development.
  • Salesforce.com spends $2.50 on sales for every $1 increase in revenue.
  • Salesforce.com spends $170,000 on sales per employee per year -- that is every single employee in the whole company.

In the last earnings release conference call Salesforce.com indicated that growth will be declining further to 17% and they are continuing to hire more salespeople.  So the cost of new business acquisition is going up even further.

So here is what I conclude.  High sales cost is heroin.  If you stop doing it there will be serious consequences.  The only logical explanation for the steady investment of 50% of revenue on sales is that no economies of scale in selling have emerged.  This company sells to the enterprise and enterprise selling is hard and expensive work.  It is not like consumer companies that go viral and all of the sudden the product starts selling itself.  They spent $600M last year to produce 20% growth and in 2008 they spent $375M to grow 50%.

So while it is possible that no new competitors will come on the market, no setbacks to cloud computing in general will occur, and Oracle and Microsoft will continue to give up marketshare, I have to think that this valuation is about as good as it is going to get for Salesforce.com. I think even Salesforce.com agrees in that last year they took advantage of their incredible market cap to raise $500M in debt and now sit on a $1.7B pile of cash.

More on Disclosure of my interests:  I do not hold and of Salesforce.com's stock nor do I hold a short position. 

Sales vs Engineering

We are coming into earnings season and accordingly we have the chance to look at the financial reporting of companies in our industry. IBM and Google both posted their numbers last week and that got me to thinking about one of my favorite subjects -- how companies choose to spend their money. Specifically I am interested in how much a company spends on sales and marketing, how that compares to engineering (R&D), and how they each compare to the amount of money a company has available.

We know that gross profit as the amount a company has available to spend on all things not associated with delivering their products or services to customers. There are essentially four places this money goes. General and Administrative, Sales and Marketing, Research and Development, and Profit. A company cannot survive without just the right balance of each of these four things. So I thought it would be interesting to take a look at how eight well known companies in the technology industry choose to spend their money.

Here is a graph comparing the companies on sales cost as a percentage of gross profit. Google has made a big point that their products are so good they sell themselves. They clearly are backing that up with good performance. They are only spending 13% of their gross profit on sales and marketing. The only company spending less is Amazon at 11%. One could argue that insufficient investment is sales will show up in slower growth rates -- but both Google and Amazon are defying that with 8% and 20% growth rates respectively. Salesforce.com is also growing at 20%, but is spending 57% of its gross profit on sales and marketing. So I think you want to be on the left end of this chart -- spending enough to grow the company but not too much.

Anyone wishing to have products that are so good they can sell themselves should be investing in R and D. One of the highest impact decisions a CEO can make is allocating resources between sales and engineering. The temptation is to invest more in sales because the results will show up faster there. But a company that starves its engineering effort in order to invest in short term sales results will pay the piper later. Here is a graph showing R&D spending as a percentage of gross profit. I think the left side of the chart is where you want to be for long term health in the company.

Once we add the two together, it is interesting to see that Apple, Google, and Amazon end up on the good (left) end of the chart. And all three of them are also turning in impressive growth numbers. The stock market agrees with this analysis because these three companies are on the high end of P/E ratios as well. Strangely, the highest P/E ratio of all is for Salesforce.com -- a staggering 110. I don't get this. To me it seems like Salesforce.com is having to try very hard to generate revenues by spending 57% of its gross profit on sales and is investing less than anyone in R&D. Could be a correction in the works there.

Finally, I think sales spending and engineering spending diverge in one significant area. Sales should always be compared to near term revenue, but investments in engineering can in some cases be disassociated with current revenues. In other words, size does matter here and this is where we see Microsoft flex its muscles. Microsoft is not spending the highest percentage of gross profit on R&D, but it is way ahead of the pack on total dollars committed -- over $9 Billion! This is a full 50% more than the next biggest number which is IBM -- who has 4 times the employees and two times the revenues.

Microsoft is spending six times as much as Apple. So far Apple has been the premier innovator -- something that will be hard to forget this coming week. But don't count Microsoft out yet.