In the PwC Global 100 Software Leaders report of two years ago, it was clear that cloud computing was already starting to change the software industry. It wasn’t clear how much it was going to change the industry. Customers were originally attracted by the lower cost structure, but now they see they can be much more agile with cloud computing. The most recent PwC Global 100 Software Leaders report makes one thing clear: What were once clouds on the horizon—pardon the expression—are now hovering above, affecting the climate of every software company. For example, SaaS/ PaaS revenues of the Top 50 software vendors now approaches 10% of their total.
Companies are more dependent on software as a service (SaaS) than they were before,” says Mark McCaffrey, PwC Global Software Leader. “Software vendors who’ve made the transition are well on their way to restructuring their operations to the new realities of lower average sales prices (ASPs) and margins. The companies that haven’t done so may not be on the 100 list anymore―and we haven’t seen the effects shake out yet.”
Transition to the cloud means more than just a change in pricing. To be successful with cloud offerings, software vendors must retool their operations and remodel their business structures to achieve greater efficiency and adapt to the new realities of lower ASPs and lower margins.
At the same time, customer expectations are higher and the risk of turnover is higher due to agility the cloud offers. Software vendors need a sharper focus on customer satisfaction and a clear realization of reduced cycle time in addressing customer issues.
What does this climate change entail? It doesn’t just change how software vendors distribute software—it’s bigger than that. Cloud computing changes how software vendors run their companies. Sure, there are technical issues such as reliability and security. But there are also business and cultural issues affecting all phases of a company, from product development to marketing and sales, extending to customer service and support (in fact, that may be the most important facet of all).
To help us understand what drives success when software vendors move to the cloud, we partnered with International Data Corp. (IDC), a research firm, to compile a list of the 25 Fastest Growing Cloud Companies. We ranked these 25 software vendors based on the percentage increases in their 2014 cloud revenues from SaaS and platform as a service (PaaS). Hardware-oriented elements of IT cloud services, including Infrastructure as a Service (IaaS), that contain some software, are not included in the fastest growing cloud figures. (See Methodology for more details) For the 25 companies the increases ranged from a low of 62.5% to a high of 799.4%; the top five companies each had triple-digit percentage growth.
We then spoke to executives from some of the 25 Fastest Growing Cloud Companies, from some of the Global 100, and with PwC consultants, to develop a snapshot not only of how successful software companies are navigating the transition to the cloud, but what other software companies need to think about to avoid getting washed away by the oncoming deluge.
In studying the data and the trends, we identified several key themes:
This first-time ranking is itself an intriguing list, suggesting that no one type of company has the secret formula for success in the cloud. At least one third are established companies that flourished for years from selling on-premises software licenses, from OpenText at #1 (see OpenText transcript excerpts) to Esri at #22, and including Microsoft (#8), BMC (#13) and Apple (#14). Esri is a particularly interesting example because it’s been selling geographical information systems software, to private and public sector entities, since 1969, which covers industry transitions almost too numerous to count.
The list includes a smattering of startups: not surprisingly, some high-profile companies, including Box (#9) and Dropbox (#16), whose business models rely on the cloud, but also some with a tight focus on specific areas: Coupa (#7; expense management), Workday (#19; HR and financial management) and Exact (#21; mid-market ERP and accounting); (see Exact transcript excerpts).
Perhaps most surprising, at #3: Dassault Systèmes, the industrial giant that could be accurately described as France’s counterpart to General Electric. The takeaway? There are no tactical requirements to thriving in the cloud, only the need to execute well.
Cloud computing, of course, encompasses many areas. SaaS enables customers to use applications without deploying them on-premises, and thus avoid procurement, deployment, upgrade, and management issues and costs. While it is in this area that PwC sees the most impact on software vendors, IaaS―the ability for customers to deploy processing power when necessary―is no less viable, with Amazon (#90 on the Global 100), Google (#20 on the Global 100) and Microsoft (#1 on the Global 100) offering new levels of flexibility to customers. (Their revenues from IaaS, which is predominantly hardware, are not included in their cloud software revenue, but are included in their total revenue figures in the Global 100 list.)
Nor can vendors ignore the concept of PaaS; while it initially meant a development platform for offsite programming, thanks to the success of Salesforce (#8 on the Global 100), it increasingly connotes an ecosystem in which customers can invest to take advantage of granular, but valuable, applications.
However, it’s clear from the IDC analysis of SaaS and PaaS revenues of the Top 50 software vendors (see SaaS revenues of Top 50 software companies list) that SaaS is by far the predominant model. Far fewer companies will be lucky enough to create the kind of ecosystem that becomes an industry standard, so those proportions could remain consistent.
Some of our customers determined that it would be safer to go to a cloud provider like us because we have certifications and can show we’re compliant
However software vendors might view the cloud, customers see the silver lining. They like the idea of subscriptions over licensing—to pay for an application only for as long as they use it, eliminating shelfware. It’s also easier and less risky to budget for the operational expense of a subscription than the capital expense of an on-premises deployment.
Businesses also like the agility that SaaS applications offer. No one misses deployment cycles of 18 to 36 months. The deployment time for cloud applications can be weeks rather than months; their time-to value is remarkably shorter. “Cloud business models allow customers to deploy software projects at a much lower risk,” says Lars Wiesner, Vice-President of Retail Software at Wincor-Nixdorf (#66 on the Global 100), a Paderborn, Germany-based company offering hardware, software and services for the financial services and retail industries. He declined to share the company’s cloud vs. on-premises revenue, other than to say that “software and services” represent a majority of its revenue. “The risk is not just lower for IT, but for the business units as well. Without any capital investment, a small number of users can try out software before a broader rollout.”
Initial concerns about cloud computing’s security and reliability have abated. Security is still an issue, especially for certain highly regulated industries such as finance and health care, but there have been no splashy headlines to make customers reconsider cloud computing’s viability. The splashiest headlines have involved companies that have failed in their own internal security efforts; as a result, companies are open to hiring someone both experienced and certified to handle security. “Some of our customers determined that it would be safer to go to a cloud provider like us because we have certifications and can show we’re compliant,” says Gary Weiss, SVP Cloud Services OpenText (#1 on the Fastest Growing Cloud Company list), a Waterloo, Ontario-based developer of enterprise information management software. “They would have to expend a lot of resources doing the same thing.”
Customers are also increasingly turning to IaaS for its reliability. As more retailers, banks, airlines and other companies open up customer-facing applications to access by mobile devices, clouds help them handle the ensuing web activity that may be round-the-clock, or spike at a moment’s notice. “Once end-customers start carrying a banking app on their mobile phones, the number of transactions go up to create quite a dramatic peak load,” says Bernd Kraus, Vice-President of Banking at Wincor-Nixdorf. “Most banks don’t have that kind of infrastructure, so they rely on IaaS to play a role.”
With cloud computing thoroughly enticing customers, software vendors have little choice but to respond. But adapting to cloud computing represents a significant shift for software vendors. It’s not just a hosting model, says Donna Wilczek, Vice-President of Strategy and Product Marketing at Coupa Software (#7 on the Fastest Growing Cloud Company list), a San Mateo, Calif.-based expense management software developer. “The cloud provider has to provide measurable value, especially when it comes to time-to-value. The world has gotten faster.”
Thus, cloud computing presents new technical and business issues for vendors. They are entering a transitional phase where they will need to think about how they will effectively address these issues. In many cases, the aspects of cloud computing that customers love best are the ones that present the most challenges from a technical standpoint.
While customers are comfortable with cloud computing for many applications, they still avoid it for mission-critical activities. They worry about turning over compliance issues to vendors, and demand high levels of certification and/or experience when it comes to security audits. If software companies want their business, the vendors not only need to ratchet up their skills in compliance and security, they need to be able to prove those skills to prospects.
Reliability also becomes a different challenge. Even a global company could shift maintenance and downtime to weekends or local holidays, but when customers expect round-the-clock availability for their applications on a hosted system, that becomes a different support paradigm than most software companies are used to providing.
Technical issues are only one element of what software vendors face in this cloudier environment. Cloud computing affects almost every facet of software vendors’ business. Consider these key issues:
Product development. Cloud computing is changing innovation cycles, which means that vendors may be forced to adopt agile development protocols to upgrade software more frequently. Vendors should also deploy methods for customer feedback so they can focus their development efforts on the features customers most want. Because vendors may be taking on more of the support function from the customer’s IT staff, the software they offer must become more like consumer software—more intuitive and task-oriented.
Marketing and sales. Moving to cloud computing requires a different mindset about sales. Not only must salespeople be compensated differently (based on subscriptions rather than licenses), but vendors may have to rethink their sales strategies. Because customers want the cloud to solve business issues, software sales teams may be dealing more with business people than with IT people—a shift that will require changes when it comes to the vocabulary and style necessary to sell. These are no small matters. “It’s a real cultural shift,” warns Tara Ryan, Chief Marketing Officer of Coupa. “Internal people now need to understand more than speeds and feeds. They need to understand how people use their software.”
Vendors may also have to think differently about how they segment their customers beyond small, midsize, and enterprise categories. “Many of these applications bring a personalised environment that is very different from the enterprise applications that dominated in the early 2000s,” says Romit Dey, Principal, PwC US. “The ones most like consumer software are almost fun to use.”
With the cloud, too, it’s easier for someone to download test software on a self-service basis; that is, beyond a traditional sales cycle. “It’s no longer just B2B or B2C,” says PwC’s Dey. “There’s a B2I—business to influencer—component.” That means companies may need to market to influential individuals and figure out how to track that influence. If a strong influencer has created a core of usage within an enterprise, the vendor must be able to identify this to more-easily offer volume discounts and support contracts.
Customer service and support. To go along with round-the-clock availability, customers expect 24/7 response time to trouble tickets. Because of the shift in internal customers, support staff may not be talking to technically astute IT staff. “The learning curve for customer service in the cloud is different from that of on-premises software,” insists OpenText’s Weiss. As a result, software companies need to think about new training regimens for support staff.
“Our customers are using our software in different ways,” says Brian Cross, Director of Professional Services at Esri (#22 on the Fastest Growing Cloud Company list), a Redlands, Calif.-based developer of geographical information systems software. Its customers are frequently municipalities who are “using it both as a system of record internally and as a system of engagement for their end-users, giving them access to information about transportation and public works.”
Revenue issues. The cloud shifts revenue from big upfront fees to subscription payments over time, which may affect vendors’ quarterly sales reports. A vendor’s shift to the cloud requires the collaboration of its finance department. This shift affects revenue recognition rules, which are slated to change again in 2018.
The shift to the cloud may also affect valuation. Erik van der Meijden, CEO of Exact Software (#21 on the Fastest Growing Cloud Company list), based in Delft, The Netherlands, encountered this challenge. “After we had completed an internal restructuring and we had put [our] cloud solutions on a solid growth trajectory, I wanted to grow even faster in the cloud. Our shareholders were divided on that, and we had to temporise our transformation in order not to alienate investors and the stock market from us.” (In 2014, private equity firm Apax converted Exact from a publicly traded firm to a privately held one.)
But revenue issues are not binary—subscription or license—when it comes to customers. “Our view is to be agnostic,” says OpenText’s Weiss. “We let the customer make the decision because the market won’t shift to one method or another.” Some customers, having paid a large licensing fee, may not want to shift to subscription immediately, forcing software vendors to manage multiple licensing models.
For instance, Esri divides its customers into four categories, three of which use the cloud and each with a different payment plan: on-premises (no cloud); in a third-party cloud; in an Esri-hosted cloud; and SaaS.
At the same time, with the shift to the cloud, many software vendors are offering services, too (different support tiers, for instance); this requires different prices and bundling structures. Savvy software vendors understand the over-arching impact of a move to the cloud―that it affects far more than just the distribution model, and that their preparations must take all of cloud computing’s facets into account.
“After we had completed an internal restructuring and we had put [our] cloud solutions on a solid growth trajectory, I wanted to grow even faster in the cloud. Our shareholders were divided on that, and we had to temporise our transformation in order not to alienate investors and the stock market from us.”
Some companies have managed the transition to cloud well. Adobe, which recently added subscriptions, increased revenue quarter to quarter as the company made the transition, in large part because the initial entry cost of its suite was lower than with a license. The higher number of customers more than offset any drop in licensing revenue. Adobe did not make the list of fastest growing cloud companies, but it is #11 on the current Global 100 list, and its SaaS revenue accounted for 23% of its US$4.2 billion in total software revenue in calendar 2014. Microsoft (#8 on the Fastest Growing Cloud Companies list) is another example of a legacy firm that has smoothly shifted into a position of cloud eminence with its Azure offering.
Other companies have not managed as well. “The ones that aren’t making the transition well face gloom and doom,” warns PwC’s McCaffrey. “The ones that are large enough to survive, that have cash and wherewithal, have acquired cloud companies, and are succeeding.” Those not so fortunate face a number of challenges. For example, serious problems could arise if they launch two sales forces, one that sells the cloud, and one that sells everything else. If the two sales forces operate in separate silos and do not communicate, this tends to confuse customers (an idea with which OpenText’s Weiss agrees). “At companies that have bobbled the transition, growth rates deteriorated and market capitalisation went down. We haven’t seen the end of the shakeout yet,” McCaffrey adds.
If software vendors only had to think about the internal ramifications of the cloud, of course, the transition might be manageable. But there are other issues software vendors must be aware of. Perhaps even more challenging, software companies must navigate the transition to cloud computing in the middle of a more broadly changing world. One issue is the increasing importance of software overall. More companies than ever, including several traditional industrial companies, are including software in their products. As PwC US Principal Aritomo Shinozaki puts it, “That’s how products become special.”
That means software vendors will be competing for software talent with companies they’ve never before considered as competitors. When it comes to weathering this, they may want to think about partnering rather than competing―that is, offering their skills as developers to companies they may not have previously considered customers.
Another external ramification relates to customers, something we’ve alluded to many times in this report. It’s worth emphasising, though, because customer interactions in specific departments add up to an aggregated customer experience. Software vendors are going to have to think even more carefully about their customer interactions throughout the entire product lifecycle.
Why? Because thanks to cloud, they have the opportunity to increase engagement through ongoing interaction―whether it’s product feedback, technical support, or wherever, cloud eliminates the paradigm of a one-time transaction, silence, and then renewed interaction when upgrades are available a few years later. Product development has always been key, but the importance of customer service will cast an even bigger shadow in this new world. “Legacy providers have lived in ivory towers and told users they know best for them,” Coupa’s Wilczek says. “Cloud providers have an opportunity to create a community where customers can share best practices and even technical support.”