The Reports of ASP's Death Have Been Greatly Exaggerated
Ask any one of these providers and you'll get a similar response -- the ASP industry is alive and well, and poised to find a measure of the success that was promised -- and over-promised -- during the past six years. They all see the moves into the market by the large enterprise software companies as a good thing, since they focus attention on the industry and add to the feeling of legitimacy for those not familiar with ASPs. And they all, predictably, think that the large companies don't stand a chance against their more agile competitors.
"What they're trying to do is basically host their existing applications. That might be OK for some large organizations. If they go head-to-head with us just hosting their existing applications, they're going to lose," says NetSuite's Nelson. "We have 100 customers sharing one box. They have to put 1 customer per box. Our cost to deliver it is one-hundredth the cost what PeopleSoft is going to be able to deliver their stuff at. We get much greater economies of scale, because we built our application to be multi-tenant. Companies like PeopleSoft still have single-tenant architecture. They may be hosting it, but it's the same old stuff."
In addition, these companies need to make adjustments to their whole business model, based on getting all the money up front, and then delivering the software, he says. "Customers don't want to give all the money up front, they want to buy it for as much as they're using, they want to buy it on a subscription. They're going to have a very difficult time coming to grips with going from a million-dollar deal to a $50,000 deal. That's effectively the magnitude you get on the revenue recognition front," he says.
Publicly traded software giants face the daunting task of re-educating not only their investors, but their sales team as well. Differences in earnings, sales commissions, and other financials can be drastically different between the two models.
"You can't mix oil and water. You have to have the business model and the inner philosophy that delivering software as a service is the right way," Atomz's Kusmer says. "If you want to become an ASP, and you're already a large installed software company, the first thing you have to do is fire your sales team. The second thing you have to do is tell your investors you're going to have a radically different business model, so they won't see earnings for the next 12-24 months."
"There's no company out there really willing to make that transition, because of the short-term nature of shareholder sentiment. If you remember the days of the PC, how many mainframe software companies became successful PC software companies? IBM did, but IBM had to buy Lotus for a billion dollars to make that happen," he says.
"Public software companies are really going to need to be able to explain the balance sheet differences based on the new way they're selling software," WebSideStory's Schulman says. "They have all these stockholders that have looked at the company in a certain way, and they're going to have to rearrange their mindset. Companies are going to have to communicate why it's different. It's going to negatively impact the big software companies, but that what happens in the computing business."
Taking It to the Street
The investor community looks at different metrics for a subscription-based company than they would a license-based company. Deferred revenue is an important metric, because it's basically how much service the company has left to deliver on its contracts. Current revenue is important, but the company can't really impact its revenue as much in a quarter with a subscription model, because new contracts only add one-twelfth of each subscription each month.
"Your quarter is almost done before you begin it. You have the revenue that's going to come in off the balance sheet -- you already know what it is and that it's not going to change that much. Investors start to look forward at things like deferred revenue, and of course they look at profitability, how efficiently you run the business," Nelson says.
Some of the most highly valued companies in the world are based on a subscription model. ADP is the classic example, with the highest compound growth rate of any company on the planet. Payroll companies like Paychex are another example of a subscription model that investors have always valued very highly.
"If we closed our doors right now, we'd still have a huge recurring revenue for '04. The market is rewarding those companies with the best visibility into real basic numbers -- revenue and earnings. ASPs have the opportunity to communicate the stability of their business by those recurring revenues," Schulman says.
In addition, if the company is successful in transitioning to an on-demand model, it will do so at the expense of its installed software base. Companies like Siebel have been making efforts to enter the market, amid ten consecutive quarters of declining revenue.
"Revenue from this model builds slower than revenue from the traditional model. We have been cannibalizing their business on the customer service side, while salesforce has been cannibalizing their business on the salesforce automation side," says RightNow's Gianforte. "Now they're cannibalizing their own business. The question in my mind is 'Can they replace that declining revenue stream with this new on-demand stream faster than the cannibalization occurs?' I think that's a very difficult equation."
The differences between a traditional software model and an on-demand model are much more than just a change in the delivery mechanism. "It's very difficult for an organization to serve two masters. In a certain sense, that's what these traditional enterprise software vendors are trying to do," Gianforte says. "This model is very different. It requires different business practices, different engagement models. The whole ecosystem around deployment, in terms of systems integrators and things, is completely different."
But the same differences that make it difficult for the traditional vendors to make the transition make an ASP that has been built that way from the ground up highly desirable to the investing community. The multiples of revenue and the multiples of earnings for ASPs are much higher than the multiples of other software companies, partly because of the huge amount of visibility into the future sales of ASPs.
"Nothing disappoints the public markets more than surprises, either on the upside or the downside. This ASP model gives a lot more consistency to earnings, which is good for public shareholders," Gianforte says.
"In a traditional enterprise software marketplace, you go out and sell a bunch of software, and come January 1, you hit the reset button and start all over again, with the exception of the maintenance stream," he says. In contrast, the ASP model is much more like an annuity model, he says. "There's a foundation to the business, and there's a much higher degree of certainty associated with the revenue streams coming in than there would be if we had to start all over again at zero every January 1."
The challenge for an investor when an ASP gets started is that three years down the road, it looks great, because by then, there's subscription revenue just falling off the balance sheet, but the problem is getting there. says NetSuite's Nelson.
"It takes you longer to get profitable with an ASP model, because you're deferring the revenue instead of getting it all up front. Once you are profitable, you're very profitable, because you have money pouring in from past subscriptions on a monthly basis," he says.
It's clear that today's ASP market is a very different place than the immature market that was over-hyped a few years ago. The companies that have adapted the model to suit the realities of today's business landscape stand poised to reap the rewards.
"I still believe the on-demand model, the ASP model, is a disruptive innovation that will replace traditional enterprise software in 5 to 7 years. We continually see the barriers to corporations deploying mission critical applications on a hosted basis falling away," Gianforte says. "I think the software industry is due for reform. We've been waging this campaign for years. To see people like PeopleSoft copying our methods, in the end is very good for customers. I would encourage other software vendors to do it as well. It allows customers to really understand what's working and what's not working, what's vaporware and what's reality."
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