Vendor Margins and the Cloud

It’s all cloud all day in the buzz about the software business, and that definitely includes ERP software. With conventional wisdom pointing to a need for purpose written cloud software (multi-tenant architectures etc.), it is no surprise that on the acquisition front

81% of respondents in SEG’s 2011 survey said it is important or very important that the investment target be all or substantially SaaS/subscription-based, up from 51% in the 2010 survey.

The cloud gets the money and the attention. What does this mean for the rest of the ERP software customers? Does research and development for current products continue? What happens to the wonderful margins vendors command with on-premises ERP products?

Bob Evans provides a cautionary example in Cisco.

So because it was not—and perhaps still is not—keeping pace with the requirements and demands of its customers, Cisco’s high-margin legacy products are being cannibalized by its new gear, which offers the performance levels customers need but can’t yet deliver the profit margins investors demand. And this deep-seated problem of Cisco’s

Will ERP vendors keep pace with the requirements of their legacy customers, or do they face self cannibalization and margin erosion? For now the common approach is to price cloud offerings so that a customer on three years of the cloud product pays the same total dollars for software licensing (plus more for hardware and operations) as they would pay for comparable on-premises software. Of course any customers retained after three years would yield a far greater margin to the vendor (no break for paying the “original license fee” over three years). ERP vendors believe they can avoid Cisco’s fate by forcing higher margins on the innovative new products than they received with their traditional products.

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Make ERP Interesting

Blimps, like ERP, used to be interesting. Back when only a few were flown a blimp sighting was unusual enough to attract attention, less so today with several different branded blimps and at least one of them flying over just about every major sporting event. Today the most memorable blimp event was the Hindenberg disaster. [ed. a zeppelin is a blimp with hydrogen gas for lift]. It seems that disasters are interesting for quite a while, but trouble free service becomes boring.

ERP has its share of disasters including many well known companies and governments. A quick Google search for ERP success yields few lists, but a ton of critical success factors. Disaster is more interesting than hard work so an ERP disaster is more interesting than an ERP success. A disaster is also much more likely to be reported in the business press where your senior executives will see it.

The challenge is to make your ERP project interesting to management in a positive way. An ERP system is basically a tool for automating accounting entries and tying them to business documents (orders and payments) – the drab work that used to be performed by white collar automatons with desktop calculators. That orders are shipped complete, on-time every time with month end sales and cost of sales accounts properly updated is a sign of ERP success is beside the point , the executives tasked your organization to accomplish those objectives whether or not the ERP worked – they attribute the success to the organization and not to the ERP. However should excitement occur, say your biggest customer did not receive what they ordered, that is a sign the ERP failed and the failure will interest executives. The challenge becomes:

how to take a tool that performs boring functions, where success is defined as performing these functions in as unexciting a way as possible, and make it interesting.

The answer is to tie your ERP project to new possibilities for the executives to take credit for, self interest is always interesting to oneself. Wouldn’t it be great if the executive could announce shorter lead times for user customized product delivery? The executive would bask in customer accolades while the ERP made delivering on this promise a boring non-event (provided it supported user customization of products and lean manufacturing processes you need to be able to deliver). Tying the ERP to the executives business innovations is the way to make it interesting.

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Multi-Tenant ERP Solutions: A Fundamentally Bad Idea

Sometimes, a really good idea gets pushed too far with really bad results. For example, someone once invented a bathroom computer workstation so you can skip the newspaper and roll a computer workstation in front of you and use the Internet, check emails or write a memo to staff or family. There’s nothing wrong with inventing a computer workstation, but designing it for bathroom use is taking it too far. It’s the same thing with a multi-tenant ERP solution – multi-tenant applications make sense, ERP solutions make sense, but a multi-tenant ERP solution is a fundamentally bad idea.

The ERP Cloud News article “Multi-tenant versus Single-tenant ERP – a comparison” defines multi-tenant application, in simple terms, as a single piece of software shared by multiple users. Internet applications you use every day – like Gmail from Google – use a multi-tenant approach to make it easier and faster to deliver new features (and fixes) to all users of the system at the same time. Based on some clearly successful multi-tenant applications, some analysts and ERP solution providers have erroneously concluded that ERP solutions must be multi-tenant applications to be successful.

There has been a lot published on every side of the argument. Phil Wainwright, at ZDNet, argues passionately that a multi-tenant architecture is as critical to a SaaS application as the WinTel standard is to a PC. Josh Greenbaum, from Enterprise Matters, disagrees completely, and says it’s really just a vendor issue. Meanwhile, Oracle’s Larry Ellison is trying to change the definition of cloud computing to suit Oracle’s marketing objectives. The question here, however, is whether a multi-tenant architecture is a good idea for an ERP solution delivered through the cloud.

The primary benefit of a ‘complete’ multi-tenant architecture is efficiency, with the presumption that greater efficiency translates into cost savings for the vendor that are passed on to the customer. (Even this simple conclusion is likely wrong. The application software market is not very efficient – just look at the profit margins of Oracle and SAP and try to justify the view that cost has anything to do with price.) The gains in efficiency come from the ability of the vendor to perform software upgrades and system maintenance one time for the entire community of users, rather than going through the effort to perform upgrades and maintenance for each customer’s system separately. Clearly, this is a more efficient way to approach the problem, but does it work for ERP solutions?

Technically, yes, but one of the primary responsibilities of an ERP solution is to account for the flow of money, materials, and time through a modern organization. With this comes the responsibility to manage and present the financial statements of the organization. I emphasize ERP solution – not software – because ERP software doesn’t make the financial statements accurate and complete. ERP software enables the policies, procedures, and processes of the organization to be consistently applied with reliable results (like accurate and complete financial statements). The financial statements are accurate and complete when the organization’s policies, procedures, and processes are effectively adhered to by the organization’s people. The people held accountable for the policies, procedures, and processes (and for their organization’s ability to adhere to them) are the senior managers of the organization – not the software vendors.

This distinction between software and solution is critical. The SOX regulations that govern every public company in America (and many of the private ones) don’t care much about whether the software is on-premise or hosted, whether you pay a lot up front or less each month, or whether the solution is single or multi-tenant. In the words of Renee Boucher Ferguson at e-Week Magazine, get your “…house in order for compliance, lest your company executives wind up in jail.” In plain English, management must be able to assure shareholders that the policies, procedures, and processes used to generate the financial statements (on which investment decisions are made) are being adhered to, or face legal penalties.

As a result, ERP customers facing SOX regulations are reluctant to upgrade their systems without careful planning. They must carefully consider each change to a procedure or process caused by the upgrade, review and document the internal changes that will result, and have the changes reviewed and approved by outside auditors. Consequently, an upgrade to financial systems (and any systems that affect the financial systems) is frequently held off until a fiscal year end, when newly documented and approved processes and procedures can be effectively deployed to the staff. The truth is, many organizations today would prefer not to upgrade their financial solutions until the benefits of the upgrade to their organization dramatically outweigh the cost and grief of upgrading and deploying new the policies, procedures, and processes that go with it.

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Cloud not Cheaper than On Premesis

As the cloud reality replaces the hype machine, sober
analysis of costs and benefits is becoming available. Chris
Chiappinelli
sums it up nicely:

A few
years ago, there was a rampant assumption that software delivered
via cloud computing was automatically cheaper than traditional
software deployed on-premises and bundled with costly hardware.
Over the long term, however, the assumption doesn’t hold—and it’s
important to remember that business software is meant to be enjoyed
over the long term.

More detail on the cost
breakdown of cloud vs on premesis computing is here.
No way to improve on Chis’s close :

Cloud
computing and SaaS have matured enough to compete on more important
grounds. It’s time to take the mythical “50% off” sign out of the
window.

Read Chris’s entire post.

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Optimizing Dynamics for the Stack

Microsoft’s latest investment in Dynamics is aimed at developers, not business users. The focus is independent software vendors (ISVs) which build vertical ERPs using Dynamics as a base.

The new version, now code-named Microsoft Dynamics AX 6, should reduce the need for customized code, and will be more tightly integrated with a range of other Microsoft software, such as SQL Server and Microsoft Office, according to the company.

Microsoft strategy is to rewrite Dynamics to get outside developers to use more of Microsoft stack. No mention of actual business customers of Dynamics, just the ISV / Microsoft distributors.

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Leader of the Stack

A very interesting post from Josh Greenbaum of ematters frames the ongoing ERP market in terms of the “stack”, the hardware, operating systems, databases, development kits an so on that are behind the curtain of any ERP software product.

So, with Ellison talking Oracle into a corner with SAP, HP, and IBM – one based, in my opinion, on a theory about the value of the hardware “stack” that is hugely outmoded – it’s interesting how little time he spends dissing Microsoft.

The implication is that for Oracle and Microsoft the primary value of ERP is in the additional revenues from otherwise generic products that form each firm’s stack. The ERP is the vendor monopoly foot in the door, and the revenue pulled in behind that foot is surprisingly huge.

Today, every dollar of Dynamics generates from $3 to $9 in additional software sales for Microsoft. Now that is what I call a stack sale.

Thus a $100,000 Dynamics ERP license sale turns into a $400,000 to $1,000,000 license event for Microsoft. Microsoft’s distributor reaps the services dollars needed to make it all work, often measured in increments of $100,000. That explains why Dynamics is the “former bastard step-child” of Microsoft. No numbers are presented, but if Oracle pulls through a similar pile of additional stack money it explains why Ellison is willing to fight his old friends at SAP, HP, and IBM.

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Traditional ERP and the Cloud

Now that Microsoft is “All In” for the cloud, can a traditional ERP solution such as Microsoft Dynamics make the transition to a cloud solution?

If getting to the cloud were only a technology problem, the folks at Microsoft could eventually solve it – even with the four distinct and different solutions lumped together into the Dynamics group. The four products would have to be merged into (or replaced by) a single offering (a challenge the company already seems to have abandoned with the end of Project Green). The merged or replacement product would have to be designed for the web from the ground up, not a hybrid of client/server and web services as announced last month. These are challenges that can be overcome, given time and money.

Where will Microsoft and other traditional ERP vendors most likely fail in bringing ERP to the cloud?

  • Architecture. Analysts will tell Microsoft that a cloud-based Dynamics solution must be based on a multi-tenant architecture or it’s not really a cloud solution. Multi-tenant solutions can offer some flexibility in the way customers use the solution, but when all customers share exactly the same software, the flexibility is limited. ERP solutions are complex and far-reaching in an organization, and must adapt to the needs of the organization. Customization of the solution and integration with best-of-breed extensions to the solution are critical in the successful implementation of ERP in most organizations. Although there are some organizations that are willing to do whatever the software vendor says, most will happily pay additional money to get the solution to help address the innovative processes that make their company unique. A simple, multi-tenant architecture doesn’t extend well enough. They need to invent a web-based, single-tenant architecture that can be unique for each customer, but still manageable and upgradable without undue expense. This will require Microsoft and other traditional ERP vendors to turn to a more innovative strategy for applications.
  • Channel. ERP solutions are complex and difficult to evaluate. The sales channel is critical to the success of any ERP company. Customers want to understand how the software will benefit their company before investing the time and energy to implement it. The major benefits come from re-thinking and streamlining (or eliminating) current processes. The sales channel is critical in translating and communicating the benefits to prospective customers, and in differentiating the product from competitive solutions. If Microsoft transforms Dynamics into the low cost, pure out-of-the-box cloud solution envisioned by many, the channel will have no incentive to push the product.  They can’t make money up front to cover sales and marketing costs, there isn’t much left from the monthly fee, and they can’t make money on customization services. Cutting out the channel for Dynamics means cutting off the revenue. Transforming a sales and marketing team from the traditional value proposition of license, maintenance, and services into a cloud-driven team is difficult enough. Transforming a channel will be even harder.
What could Microsoft do to overcome these obstacles? If they can’t transform the channel, they’ll need a reason for customers to buy Dynamics that needs no explanation. Perhaps they could change the rules – try to make cloud ERP all about integration with Office 365. And hope people believe the marketing hype.
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Focus on Customer Requirements for Quality Software

[This post is the eighth of a series defining software quality].

Software vendors spend a huge portion of development budgets on software quality, yet industry news is filled with examples of software failing during implementation. Why can’t the vendors get things right with software quality? Part of the problem is that software products are complex logical systems (especially ERP products) and share a key characteristic with all complex mathematical and logical systems:

if such a system is also capable of proving certain basic facts about the natural numbers, then one particular arithmetic truth the system cannot prove is the consistency of the system itself

To put it in plain language modern software products are complex enough that no quality program can be created which can be proven to remove all errors. This leads some vendors to give lip service to quality and produce good enough software, but most realize that in order to attract and retain customers a serious quality effort is needed.

Even though we cannot create a proven quality program, some approaches to quality are known to be more effective than others:

Quality demands requirements specifications in enough detail that the products produced can be quantitatively measured against those specifications. Many organizations are not capable or willing to expend the effort to produce specifications at the level of detail required.

This is the most important effort in any quality program – requirements document what the customers need and expect from the software product. From this foundation flow a series of quality assurance opportunities. As developers translate the requirements into a product design, quality translates requirements into a test plan, and tech writers draft documentation. These must be compared and corrected before any code is written. As programmers code the design into software, quality prepares test cases and sample data, and a second draft of documentation is written. Once these are completed, quality is able to execute the test plan through automated and manual test cases and quantitatively measure results. The end result is software, supported by documentation, which meets the requirements and performs to expectations in customer environments.

HarrisData’s Aggressive Quality program is based on the idea that documenting customer requirements is the most important thing we do. Effort spent on requirements not only ensures customer satisfaction, it saves valuable time and effort downstream as we transform requirements into software products.

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Open Software for Quality

[This post is the seventh in a series defining software quality].

Software vendors often try to cash in on their customer footprints by operating as a one stop shop – providing everything the customer needs. The problem with this is not that sole source can be very expensive (it is), but that no software vendor knows everything. When software vendors solve unfamiliar problems, quality suffers. Once again, a software vendor desire to gain monopoly power (and profits) should be balanced by the customers’ agenda to solve actual business problems with quality solutions at a reasonable cost. Software vendor partner programs offer one step in the direction, providing customers some choice when extending business solutions. For many software vendors, partner solutions too add monopoly control and profit as commissions or finders fees are charged behind the scenes [ed. HarrisData does not accept commissions or finders fees from our partners], or requiring partners to gain certification at a substantial fee [ed. HarrisData asks potential partners for customer references using the combined solution]. What happens when the customer prefers a product not on the vendor partner list? Will maintenance and warranty services continue?

The route to quality is to open the software product to whatever combination of add-on product or custom programming maximizes customer return on investment. This is the key to Open Architecture. In practice such openness requires standards, documentation, and source code. Applicable standards include Service-Oriented Architecture (SOAP), Web Services Architecture, HTML. Use of data transferred between the vendor product and other applications requires plain language definition of what the data elements are used for – information provided in technical and user documentation. Manuals addressing How to Interface to Product X are particularly useful here. Access to product source code allows the customer (or the customer’s agent) to identify and access any data not included in vendor supplied program access points. The vendor’s high quality execution of these elements allows the customer a low cost escape route from the vendor’s monopoly power.

Unfortunately, it is still possible for a vendor committed to an Open Architecture to exert monopoly power to constrain customer options. Software vendors extend monopoly power through the use of proprietary technology by requiring vendor approved certification programs for partners (e.g. NetWeaver, .Net). Open technologies free both customers and partners from this obstacle to success. A software vendor might choose Java, PHP, or HTML as open technologies with thousands of potential partners for customers to choose among. Customers then choose the combination of product capability, cost, and availability that meets their needs (not the vendor’s monopoly desires).

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Acquisition focus harms customer support

“Oracle has lately devoted itself to becoming the largest and most mission-critical IT systems vendor in the world,” using acquisitions to increase both market share and the share of IT budgets. No doubt the recent court victory over SAP ($1.3 Billion) will ultimately provide funds for even more acquisitions. Unfortunately, the technology titans like Oracle who seek to monopolize technology markets are acting like monopolists in other ways as well. In particular, their focus on making customers successful over the long term takes a back seat to acquiring new customers.

Consider the data recently reported by research firm Computer Economics, and published by e-Week.com. While Oracle continues to spend billions on acquisitions, 42% of customers polled are dissatisfied with quality of support. Further, dissatisfaction increases with age. Once the excitement associated with buying and implementing new software wears off, customers discover what the relationship with the vendor will really be like. With Oracle, the longer it’s been since the initial purchase, the unhappier customers become.

Software vendors that place market domination ahead of customer satisfaction will inevitably fall into increasingly monopolistic practices. They work to limit choices and raise prices, and work to aggressively reduce the cost of customer support. Of course, if you only expect the vendor’s customer support to provide fixes to software bugs the vendor didn’t catch in the first place, you may not care much. However, a new kind of customer support is emerging focused on creating business value for customers. Software vendors that embrace this new model will have more satisfied – and successful – customers. Customers who implement software from vendors focused on customer support will find annual fees in line with the value provided by the vendor (unlike the 58% of Oracle customers who think Oracle customer support fees are too high).

Quote and research data from: “Oracle Support Too Costly, Say Business Customers: Study”, Nicholas Kolakowski, e-Week.com, dated 2010-11-18

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