1Disruption Happens
Technology-as-a-Service
Playbook
How to Grow a Profitable
Subscription Business
Thomas Lah
J.B. Wood
Copyright © 2016 Technology Services Industry Association
ISBN: 978-0-9860462-3-0
Número de Control de la Biblioteca del Congreso: 2016938814
All Rights Reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system without written permission from the authors, except for the inclusion of brief quotations in a review.
Printed in the United States of America.
Contents
Chapter 3 Digging an Economic Moat for Your XaaS Business
Chapter 4 Stressing Traditional Organizational Structures
Chapter 6 The Power of XaaS Portfolios
Chapter 7 XaaS Customer Engagement Models
Chapter 8 The Financial Keys of XaaS
Chapter 9 The Case for Managed Services
Chapter 10 Changes in the Channel
1
How can you spot a tipping point? Malcolm Gladwell, whose book, The Tipping Point , 1 helped popularize the term, says it’s that magic moment when an idea, trend, or social behavior crosses a threshold, tips, and spreads like wildfire. Well, we think one has come to dozens of business-to-business (B2B) and business-toconsumer (B2C) technology industries.
Ten years ago, we first stood in front of thousands of tech executives and worried aloud that the cloud era was going to disrupt the tech industry more profoundly than any other transformation in its vaunted 50-year history. Our worry was not rooted in disruptive technology but in disruptive business models. Big companies like IBM, HP, and Oracle have all weathered generational changes to computing models and architectures many times. Handling new waves of technology is old hat; they have plenty of plays for that. But we worried that this perfect storm of new technology and new business models could re-cast the very foundations of market leadership in the industry.
A lot has happened since that decade. Unless you have stubbornly avoided all business media over the past few years, it is impossible to have missed the interest in subscription business models, not just in IT but it nearly every technology-related industry. Today’s energy surrounding subscription business models is the follow-on to the buzz a few years ago about the “sharing economy”—something that Time magazine said was one of the top 10 ideas that would change the world back in 2011.The attraction of the sharing economy was and is the ability to simply access rather than own physical and human assets. For the provider, it produces recurring revenue streams that keep customers spending for years—even decades.
Although subscription business models and the sharing economy can manifest themselves in many industries, this book is concerned only with tech and near-tech industries. Even more specifically, we are focused on highly cloud-enabled, technology-as-a-service offers. The categories of these offers take many popular names. There are software-as-a-service (SaaS) offers, platform-as-a-service (PaaS) offers, infrastructure-as-a-service (IaaS) offers, managed services, and so forth. To keep it simple for the rest of the book, we are going to refer to them collectively as XaaS. You can make the “X” whatever you want. It simply means that you are offering sophisticated computer software, hardware, industrial equipment or devices, and/or services in an “as-a-service” consumption model to your customers. We would expect some or all of the offer to be delivered through the cloud. If you are selling subscriptions to razor blades or fine wine over the Internet, this book probably isn’t for you. On the other hand, if you are involved in the strategy, development, finance, marketing, services, or sales of complex, cloud-based technology solutions in IT, industrial equipment, health care, or consumer markets, and terms like SaaS and managed services resonate with you and your team . . . then keep reading. We have some interesting observations to pass along. Very importantly, if you are involved in traditional (asset-based, on-premise) technology and you are wondering what XaaS technology will mean to your job and your company . . . then definitely keep reading. That’s because your company is about to be caught up in the business model tipping point. To remain competitive, you will not only need new offers, but you will also need a new way to operate. Being connected to your customers is the catalyst.
Before you begin, you might be asking yourself: Just where are these observations coming from? OK, fair question.
Our answer begins with this statement: We don’t know all the answers, and anyone who tells you they do should be shown the door. It’s still early days in assessing how the cloud era of tech will fully disrupt the technology industry; predicting the future is dicey. It’s like predicting the future of the clean energy industry. It’s hard enough to figure out which technical approaches will ultimately win the market, much less what the best business practices of the new leaders will be. So, who are we and why this book? The answer is that we run the Technology Services Industry Association (TSIA). As one of tech’s largest industry associations, our company gets to uniquely study and talk with hundreds of the world’s most successful technology and industrial companies each and every day. We are an incredibly research-intensive bunch. We have experienced industry executives, PhD researchers, and data analysts looking at all the data we collect from public sources and from the companies themselves. We field thousands of formal inquiries annually from management at both traditional and XaaS companies wanting to know about the trends and best practices in running a successful business in this time of radical change. They want to know what lessons we are learning from our research on top-performing companies because we have access to data that is simply not available in the public domain. It’s from all this research and interaction that we draw our observations. So, though we can’t predict the future, we think we may be in one of the best positions to dissect and debate it. Most importantly, we think some winning patterns are emerging. That is what we want to share in this book. You might not agree with all of our observations, and not every one might play out. But, we think they are important for every executive and manager in the tech world to be aware of and consider. It’s a tricky time. Are we at a tipping point? If so, what will it mean to the traditional business models we know and love? How do we prepare? What will successful XaaS organizations of the near future look like?
In a nutshell, here is what we have learned after studying the topic from multiple angles for 8 years: XaaS is not just technology that is priced by the month and hosted in the cloud. If it were that simple, you wouldn’t need this book. We believe that, as the enigmatic smoke clears around the cloud, what’s emerging is an image of success in XaaS business models that is fundamentally different from traditional tech. It’s something that goes way beyond the technology and the pricing model . . . something that cuts deeply into the underlying business model the tech industry has grown comfortable with. It’s just a new way of running a tech company. And it’s powered by your real-time connections to the customer. What’s most interesting—why we wrote this book—is that NOBODY truly knows what that new way is! It’s a fact that there is no B2B subscription business that is as rapidly growing and as profitable as the traditional tech bellwethers were in their heyday. Only the XaaS CEO who can make that claim can write the definitive book. And really, they should accomplish it more than once to prove that they have perfected the formula. Until that day, we are all in this together—all trying to break the enigmatic code for the profitable XaaS business. We are debating whether the tipping point has arrived and what life after that will look like. Let’s face it: The cost of building software is dropping fast. We think it’s the business execution around the code—not just the ability to write code—that will determine the success or failure of future icons.
Just how different might the winning B2B/B4B XaaS company look? Here are 10 assertions that are a sample of things we will cover:
• The ability to “prove deliverable business outcomes’” will supplant “win the feature bake-off” as the central focus of senior leadership at tech companies. This will cause a dramatic re-thinking of investments and top talent allocation. Offers will “go vertical” in order to better deliver full value to the customer. Services will move from the back of the bus to the front of the bus. But at the same time . . .
• Software will eat services. The ability of technology companies to reduce technical complexity and build best customer practices into their software will be a defining characteristic of successful XaaS providers. Value-added services will survive and prosper as a concept. However, labor-delivered services (except highly consultative expertise) will still be viewed by management as a boat anchor. Eventually, development will accept that their charter includes the “full product” and not just a collection of features. They will build all the capabilities into the product that are needed not only to win the feature bake-off but also to enable the differentiated services that will drive adoption, encourage expansion, reduce sales costs, and have a plethora of other objectives. These are the capabilities needed to create downstream profits and sustained competitive advantage.
• Suppliers and customers will increasingly compete as every company becomes a tech company. Low-cost software development will turn industrial buyers of technology into technology producers themselves. Technology resellers will find their original equipment manufacturer (OEM) suppliers competing with them through cloud-enabled, direct models. Large XaaS providers will manufacture their own hardware and build their own software, no longer being a buyer of technology but actually overseeing the manufacture of the products they use. (By the way, all of this is already happening at scale.)
• The act of selling will undergo radical change. Customers can now self-serve a huge amount of the information they need to make a technology purchase decision. They will be able to self-serve on simple purchasing decisions like low-cost XaaS trials or renewals. Even on more complex decisions they will have less and less interest or patience for “company overviews” or “demos” from their sales rep. They will know all that. They will want to discuss the “last mile.”They will want to know specifically how your key features will lead to improved business outcomes for companies in their specific industry. Selling will become a process, not a heroic act!
• Delivering and measuring customer success will become a defining characteristic of market leaders. If you don’t have a systematic way to make more than 90% of all your XaaS successful, you will not be profitable. We are not just talking about success in your terms; we are talking about success in the customer’s terms.
• Organizational structures will be significantly reinvented with highly integrated development, marketing, sales, finance, and service teams swarming around specific customer segments. Regional autonomy over international markets will decline, and centralized processes and systems will ascend. Even traditional departmental profit and loss statements (P&Ls)—the archaic command and control systems we dearly loved—will collapse under the weight of the new operational and organizational models, where expense dollars in one department yield revenue growth or cost savings in a totally different department.
• Channel partner models will get re-thought and reconstructed. Many resellers will perish in the transition. New kinds of partners will be added. How the OEM and their partners work together for a particular customer will be radically redefined as the old notion of direct or indirect customers is replaced by a model where both parties serve every customer.
• The employee skill sets that companies covet will expand from the traditional obsession with hiring technical and sales skills (that built the last generation of tech companies) to including deep vertical industry and business process expertise. Suppliers will start hiring experts from their customers. Any human being that combines both deep vertical market expertise and either great technical skills or great sales skills will write their own ticket.
• The market advantage pendulum between innovation and scale—the one that has swung so far toward innovative new companies that are taking share against much larger, traditional tech companies—will begin to swing the other way. Large tech companies will begin to enable their global footprint of customers, partners, and employees to create competitive XaaS advantages that many small but disruptive companies struggle to match. Right now, the traditional companies just want to study the disruptors. As the disruptors grow, their interest in how to scale globally will grow. Suddenly, they will become curious as to how the traditional tech companies operate at such huge scale.
• The traditional cost structures that high-tech and near-tech industries have supported with high unit prices for their products will be destroyed. Unit prices for nearly everything will continue to come down. The labor-intensive operating models for marketing, sales, services, and general and administrative expense (G&A) will be torn apart and reinvented. Heroic acts will be replaced by processes. Those processes will become automated. They will interact with data and best-practice models. That unified model will “own” the customer—who they are, what outcomes they are trying to achieve, where they are in the process, what interactions are needed next, and how they can expand to higher levels of value. We will still need a human face to the larger customers, but they will be talking about what the model tells them to talk about.
The Magnitude of the Transformation
As part of our research, we have been tracking the performance of 50 of the largest providers of technology solutions every quarter over the past 10 years. In 2015, the companies in the TSIA Technology & Service 50 (T&S 50) index were generating average operating incomes, on average, north of 11%. Figure 1.1. demonstrates the high operating incomes of these enterprise tech companies compared to other well-known profitable companies.
As we discussed in our last book, B4B , 2 the B2B technology industry created some of the most profitable business models in the history of business models. As Figure 1.1. indicates, the average profitability of the 50 companies in this index is higher than that of blue-chip companies like General Electric (GE) and Walmart. But now these beautiful business models are under duress. Since 2008, the combined top-line revenues of companies in the T&S 50 index have been shrinking dramatically. By the fourth quarter of 2015, product revenues were shrinking at an average rate of –8% per year for companies in the index. Remember, these are companies that were always considered high-growth and highmargin product businesses! Figure 1.2. documents the dismal decline of combined product revenues and the rise of service revenues for these companies since 2008.
FIGURE 1.1 Operating Income of Legacy Technology Providers
Legacy technology companies have become desperate for top-line growth. The natural place to pursue that growth is the fast-growing world of XaaS and subscription revenues. However, the profitable business models for XaaS have yet to be proven. For the past 3 years, we have been tracking another index called the Cloud 20 that consists of the largest publicly traded XaaS companies. Although revenue growth for these companies has been phenomenal, profitability has been elusive. Figure 1.3. provides a comparison of key performance metrics of revenue growth and net operating income between XaaS companies and traditional technology companies we track. 3
In theory, these new XaaS business models have incredible potential. Tien Tzuo is founder and CEO of Zuora, a SaaS company that provides software for subscription billing, and former chief marketing officer at Salesforce. He has become an outspoken advocate for the subscription business model. In many of his articles, interviews, and speeches, he points to the following benefits of the subscription business model: 4
• Customers in all marketplaces want flexibility in how they consume.
• Customers only want to pay for what they use, and subscription models are designed to support that desire.
• Subscription relationships provide greater insight into what customers are consuming and what they value.
• Subscription business models create predictable, renewable revenue streams.
• Subscription business models create the opportunity to produce highly profitable revenue streams as more and more customers are served from a common platform.
FIGURE 1.2 Product and Service Revenue Trends in the T&S 50 Index
FIGURE 1.3 Financial Performance of XaaS versus Traditional Technology Providers
Mr. Tzuo has many valid points—especially when subscription business models are built on cloud-based platforms. A centralized delivery model enables several advantages over traditional on-premise delivery models where the customer installed and managed the technology on their own. Hosted offers allow providers to quickly release new capabilities to all customers. With customers interacting on a hosted platform, providers can gain visibility into which customers are adopting and which are not. Also, providers can use analytics to build best practices that all customers can leverage. XaaS companies should absolutely benefit from economies of scale. More users on the same platform should result in higher profits. These are just a few of the unique advantages of the XaaS model.
Unfortunately, at this point in time, the majority of XaaS companies that we track are not exhibiting proof that scale automatically equates to higher profitability. Figure 1.4. compares the financial performance of SaaS providers with annual revenues of more than $500 million against traditional license software companies of the same size.
Clearly, there are challenges facing technology companies executing subscription business models. In a subscription model, you obviously need to acquire customers. More importantly, you need to keep those customers on the platform. Most importantly, you need to convince those customers to spend more money with you over time. High sales costs, customer churn, and offer commoditization create downward drag on the profitability of the subscription business model. The sharing economy is not yet proving a panacea of profitability in tech.
FIGURE 1.4 Profitability of Large SaaS Companies
For now, investors seem to be OK with this reality for highgrowth, pure-play XaaS companies like Salesforce and Workday. However, investors have high profit expectations for legacy technology companies such as Autodesk, Cisco, Microsoft, Oracle, and SAP. As these legacy companies attempt to pivot to XaaS offers to secure growth, Wall Street becomes apprehensive. All these headlines—and many more—have starting appearing since late 2014:
• “Wedbush Downgrades Autodesk, Worried about Business Model Transition” 5
• “Will Oracle’s Transition to Cloud Impact Its Margins?” 6
• “When Will Microsoft Have to Stop Milking Its Windows Cow?” 7
• “SAP Profit Down 23% after Cloud Move 8
As these companies attempt to navigate the expectations of investors, they are dealing with the reality that new XaaS offers require a significant investment in multiple areas such as:
• New technology platforms
• New pricing and financial processes
• Revised sales and marketing motions
• New service offerings and capabilities
• Reengineered partner models
So at the same time that revenues decline from our highly profitable legacy offers and we begin to replace them with new subscription offers, additional investments must be made. In B4B , we referred to this phenomenon as “the fish” (Figure 1.5. ).
FIGURE 1.5 The Fish Model
Before this industry transition is completed, every legacy technology company will need to swallow this financial fish as they migrate from old to new business models. You can already see the consequences of this transition as companies begin navigating the rough waters. Some legacy companies signal tepid growth and lower profit expectations in the short term as they navigate the transition:
• “Adobe’s (ADBE) Strategic Shift Will Lead to Growth in the Long Term” 9
• “SAP Sees High Cloud Profit Potential in Long Term” 10
• Other companies simply take themselves out of the public eye:
• “Dell Officially Goes Private: Inside the Nastiest Tech Buyout Ever” 11
• “JDA Software to Go Private in $1.9 Billion Deal” 12
• “BMC to Go Private in $6.9 Billion Deal Led by Bain, Golden Gate” 13
• “Dell Buying EMC: Is This the End Times, or the Road to Salvation? (In any case, the enemy is now Amazon)” 14
• “Informatica, Now Private, Announces New Leadership Team” 15 And other companies are breaking into smaller companies:
• “HP’s Big Split: The Good, Bad, and Potentially Ugly” 16
• “Why Symantec Split Up into Two Companies” 17
Regardless of the tactic, the fish is still sitting there—waiting to be swallowed. The pivot from traditional technology business models to new XaaS is inevitable. Almost every legacy technology company will need to establish some form of a XaaS offer. At the same time, new, pure XaaS providers will eventually need to pivot from unprofitable, high-growth business models to business models that generate more money than they spend. This book is designed to assist in both scenarios.
The Purpose of This Book
It does not matter if you are a 50-person, well-funded XaaS startup or a $1 billion license software company: You will need to answer these three questions in the next few years:
1. How will we make our XaaS offer successful and how will we evolve our portfolio?
2. How are we going to cost-effectively land, deliver, expand, and renew customers of our XaaS offer?
3. What is our sustainable financial model for XaaS?
We have been collaborating with the industry for the past 8 years to find realistic answers to those three questions. This book provides a series of frameworks, observations, and recommendations that can help any size company navigate the gauntlet of decisions that must be made as you enter the brave world of the subscription economy. The content of this book will be highly relevant if you find yourself in any of these three scenarios:
• I am responsible for helping my company stand up and optimize a XaaS offer . If you find yourself in the middle of a XaaS offer, then this book is for you. It doesn’t matter if you are the product manager for this new offer, the services executive responsible for supporting the new offer, or the CFO who is scratching your head over how to make money with this offer. There is detailed information on the plays your company will need to run to build a profitable XaaS offer.
• I need to educate others in my company on how they need to change in order to empower our new XaaS offer. If you are convinced that XaaS disrupts many company functions but you are struggling to convince others of this reality, this book is for them. Use this book to help carry key messages to these organizational functions. Sales, marketing, services, finance, and product engineering can all benefit from the content in these pages.
• My company is not even talking about XaaS offers, but I want to understand how XaaS may impact my company. Our point of view is that this industry transition to XaaS models will eventually impact every company in some way, shape, or form. The shiny new capabilities that are part of XaaS offers are making traditional offers look, well, traditional. Dated. Limited. This book can serve as a wonderful primer for ramping yourself up on the nuances of XaaS business models.
One warning concerning the content in this book: We cover a lot of ground. Not every chapter will be for every reader. For that reason, we recommend you leverage Figure 1.6. to prioritize which sections of the book you should tackle in your first read-through.
Using the XaaS Playbook
Unlike previous books we have written, the Technology-as-a-Service Playbook glides up and down between overarching strategic frameworks and “rubber meets the road” tactics. For that reason, we have created a cheat sheet to help prioritize the content that will be most relevant to various readers based on the specific questions the reader is attempting to answer. Figure 1.6. lists some of the most common questions related to XaaS offers and highlights the recommended content.
FIGURE 1.6 Technology-as-a-Service Playbook Reader Cheat Sheet
The tipping point is nigh. Traditional product sales are declining. XaaS revenues are growing at double and triple digits. Sitting on the sidelines is no longer an option for traditional companies. At the same time, running a cash-burning XaaS financial model is becoming a riskier proposition every day. Something has to change. We hope you find this playbook useful, and we hope you enjoy the journey.
2
So Many Choices
This is a book about the plays a company can run as they work to establish and optimize a technology-as-a-service offer. Obviously, the offer has to have value to the user, or as it’s frequently called, product-market fit. We can’t help you with that. It’s up to you and your team of experts to target the opportunity and establish a uniquely valuable proposition. Fortunately, the cloud and the Internet of Things (IoT) will open up thousands of chances to do just that. But believe it or not, that’s just the beginning. Once you have the opportunity in sight and the core product working, an entire new set of issues begin to play out. That’s where this book comes in. We want to promote discussions among your team that can accelerate your thinking and increase the chances that your great idea is a commercial success.
But where to begin? What can we learn from the cacophony of XaaS offers and activities already in the marketplace? Some of these offers lead with free trials, such as McAfee’s suite of security-as-a-service offers. Customers can try the service and then determine if they want to continue paying. 1 Some XaaS offers provide all the customer requires in one simple subscription price. Apptio property management software provides a great example of this approach. On its web page, it leads with the tag line: “No surprises. No complicated list of features that cost extra. Everything you need to run a more successful business.” 2 Still other XaaS offers list multiple components a customer can choose to purchase based on business requirements. Veeva Systems, which secures over 25% of its revenue from add-on services surrounding the core technology subscription, offers professional services, managed services, administrator training, environment management, and transformation consulting. 3
Looking across XaaS providers, it may seem challenging to discern common patterns related to things such as offer types and pricing models. One industry article defines 12 distinct ways to price a SaaS offer. 4 What pricing model makes sense for your XaaS offer? What should be included in the offer? One way to bring some clarity to the chaos is to use the filter of time.
Profit Horizon
As we have studied the XaaS marketplace, we believe there is one defining factor in determining XaaS offer strategy: the profit horizon, as illustrated in Figure 2.1.
Profit Horizon: The length of time targeted to achieve significant GAAP profits.
By GAAP profits, we simply mean a company is considered profitable when applying traditional, generally accepted accounting principles. This is an important distinction, because many XaaS providers are currently applying non-GAAP metrics to communicate the financial health of their businesses. The argument for non-GAAP is that non-cash items, such as employee stock option expenses or the amortization of intangible assets obtained through acquisition, should be excluded to provide a more meaningful view. We don’t want to get into the debate about GAAP or non-GAAP, so we choose to set GAAP profits as the bar since no one will argue with you once you have achieved them!
FIGURE 2.1 The Profit Horizon
A plethora of companies are building XaaS offers that they believe may take many years to capture significant market share, aggregate customers, and create the economies of scale needed to make GAAP profits. They may not even fully understand how those revenues will be monetized or how profits will be created. These companies have a “future” profit horizon. There are different profit horizons for companies that feel they need less time. Perhaps a company established a XaaS offer several years ago. It expects to achieve a critical mass of customers and revenue in the next few years or so. Its profit horizon is “mid term,” but not current. Finally, if you have a XaaS offer that you believe can get to a critical revenue mass and be profitable within the next year or two, then your profit horizon can be defined as “current.”You are expecting or needing the offer to generate profits for your company relatively quickly.
The 3x3 of XaaS: The First Dimension
Applying this concept of a profit horizon to XaaS offers in the marketplace, we can easily recognize three common, distinct profiles of XaaS solution providers, as seen in Figures 2.2 , 2.3 , and 2.4 and described below.
1. Future Value Aggregator (FVA). These are XaaS providers that believe the real financial value of the offer will be realized at some date in the distant future. The method of achieving profitability may be vague or unproven, but there is an initial mass of believers (investors, customers, analysts) that has provided adequate support to get the company to believe in its direction. The critical success metric for these offers is the unit of future value. This is the item that the provider believes will be monetizable at scale. That item could be users buying subscriptions, but it could also be page views in an advertising model or transactions in a web services model. For one XaaS offer we analyzed, the unit of future value was the number of project plans under management on their platform. In the early days, FVAs are likely to be experimenting with revenue models; customer spending may be erratic or even nonexistent as the company endeavors to find the levers to add visitors and translate them into reliable revenue. FVA doesn’t necessarily mean that companies are not monetizing customers at all, it’s that they are in an immature—and likely unprofitable—state of monetization. The per-customer unit economics are likely to be negative or sub-optimal.
2. Mid-Term Wedge (MTW). These are XaaS providers that expect to achieve profitability in the not-too-distant future (3 to 5 years, or so) selling their core subscription. This is the most commonly advocated SaaS business model. These companies have, or believe they will amass, enough customers on the platform in this time frame to achieve the economies of scale required to be profitable. We refer to this as the mid-term wedge profile, because these are companies that are exiting the lefthand side of the classic XaaS financial curve, where the provider is investing in the platform, and entering the righthand side of the model, where each additional customer drives more and more revenue that brings the company one step closer to profitability. Importantly, the wedge model assumes that, at some point, costs are no longer increasing in a linear relationship to revenue. MTW is where companies start to hone in on their “balanced state.” Losses shrink and the economies of scale that are driven by positive per-customer unit economics begin to really become visible. The balanced state of growth + profits becomes clear and accurately projectable. It is the proof moment for the business model.
FIGURE 2.2 Profit Horizon: Future Value Aggregator
FIGURE 2.3 Profit Horizon: Mid-Term Wedge
3. Current Profit Maximizer (CPM). These are XaaS providers that are focused on maximizing the revenue and margin opportunity surrounding their XaaS offers as soon as possible. Instead of capturing market share at the expense of profitability, the companies are very focused on maximizing profitability per customer in the short term, this year or the next. Often these are large public companies with shareholders who are demanding profits now, or XaaS companies who are fairly mature and are ready to make the switch from revenue valuation multiples to profit growth valuation multiples. Most importantly, what both companies have in common is that they believe they can get their revenues to critical mass soon. Potentially this could be a new company with meteoric growth, but that usually requires a longer horizon than 1 to 3 years.
FIGURE 2.4 Profit Horizon: Current Profit Maximizer
So this leads us to the three profiles of XaaS, as summarized in Figure 2.5. These profiles are the first dimension of the 3x3 of XaaS.
Shareholder Appreciation Drivers for Each Profile
What profile is applicable to your XaaS offer? There are a few key attributes you can test for:
• Drivers for the Future Value Aggregator. This profile is applicable when there is a significant market—that may or may not be well understood by the marketplace itself—to create and/or dominate. The premise is that the XaaS offer with a dominant share of this large market will be best positioned to maximize future profits. However, to assume this profile, a company needs a critical mass of investors that drink the Kool-Aid and believe in the future payoff. If investors are not excited about the potential future state, then it is hard to raise capital to support the investments required to acquire customers. Over the past few years many venture investors have been placing high valuations on unprofitable XaaS providers with the hope that over a long horizon profits will flow.
• Drivers for the Mid-Term Wedge. This profile is applicable when the company believes it has a 3- to 5-year line of sight to making the current offer profitable. The company believes it can manage the three attributes that kill the profitability of XaaS offers: churn, costs, and commoditization. The company can keep the majority of customers on the platform for multiple years. Economies of scale are kicking in so it costs less to serve each customer. The company will be able to fend off commoditized pricing due to hyper-competition. It knows how many customers are required to cross the line to profitability.
• Drivers for the Current Profit Maximizer. This profile is applicable when a company needs or expects to generate high profits in the near term to meet shareholder approval. As just mentioned, the two common classic examples would be a highly profitable, publicly traded software company that is now in the process of starting up a new XaaS offering that competes with the legacy license offering, or a mature XaaS company that is ready to show off its ability to throw off profits and cash. Occasionally there may even be a highly disruptive and high-priced entrant that is confident it can get to profitability early in its XaaS childhood. In the first case, investors are accustomed to substantial profits from the company and may not have much appetite for significant losses related to a new XaaS offer. In the second example, investors are salivating at finally reaping the rewards of the multiyear investment to get the subscription business model to become a money-making machine.
FIGURE 2.5 The Three Profiles of XaaS
Common Behaviors
When companies assume one of these profiles, recognizable behaviors emerge:
• Common Behaviors of the Future Vaule Aggregator. Companies in this profile care more about attracting new potential customers than anything else and are willing to do whatever it takes to make that happen—almost no matter what that costs. They will offer “all in,” simplified pricing models, up to and including free and freemium. They will throw in services required to enable the customer at no cost, not focus on monetizing value-added services. Sales and marketing expenses will range from 50% to over 500% of total company revenues as the company aggressively invests to acquire new customers, add units of future value, and increase market share.
• Common Behaviors of the Mid-Term Wedge. Companies in this profile have clear signals that their revenue model and product-market fit are valid. Subscription or transaction revenues are consistently trending up each quarter. Cost of goods sold (COGSs) as a percentage of revenue might be beginning to shrink as economies of scale kick in. Sales and marketing expenses might also be shrinking as a percentage of revenue. B2B companies in this profile are often in the early stages of monetizing premium account services around the core subscription. These services typically represent 2% to 10% of total company revenues at this stage. The company has realistic models that indicate positive cash flow, and even GAAP profits, as it passes through the wedge inflection point in the next 3 to 5 years.
• Common Behaviors of the Current Profit Maximizer. Companies in this profile either have, or quickly will have, a critical mass of revenue enabling them to pass the wedge inflection point within 1 to 2 years. They are typically exhibiting slower top-line growth than the other two profiles, but are forecasting positive operating income in this fiscal year or the next. From that point forward, their models indicate strong and predictable cash flow and profit increases. If you look at their websites, you will typically see a diverse listing of multiple product and service offerings customers can purchase for additional fees. These companies may offer multiple consumption models. They may also offer to run the technology operations as a managed service.
3x3 of XaaS: The Second Dimension
Once you identify which XaaS profile you would like to pursue, you will need to answer the following three questions:
1. What is the offer portfolio and pricing model?
2. What is the customer engagement model that we will use to sell and deliver this offer?
3. What are the financial keys that will allow us to make money with this offer?
We refer to this as the iron triangle of offer definition, as seen in Figure 2.6.
A key premise of this book can now be stated:The profit horizon of the XaaS offer should drive how a provider engineers the financial model, designs the portfolio, sets the pricing, and matures the customer engagement model for the offer .While we will cover all three elements in later chapters, here is a bit more elaboration to help clarify the focus of our 3x3 matrix.
Portfolio and Pricing
Obviously, a company must determine exactly what it intends to take to market. The company needs to clearly define the XaaS offer and how it should be priced. Double-clicking into this area, the company must make decisions in the following areas:
• Technology Offer Definition. What form will the core offer take? How will you package the high-value capabilities? What is the differentiation of these offers from competitive alternatives? Will you have a single offer or multiple, complimentary offers inside a portfolio?
• Value-Added Services Offer Definition. Are there any additional services the customer may need in order to be successful with the technology? Services could include traditional customer or technical services as well as information/ analytic-based services.
• Offer Pricing Model. How will the offer be priced? Will the price be based on consumption of specific features, number of users, business outcomes, or other factors? Will required services be bundled or sold separately? How will these services be priced?
FIGURE 2.6 The Iron Triangle of Offer Definition
As discussed in the opening chapter, the answer to these portfolio and pricing questions are wide and varied in the marketplace today. Understanding what answers maximize success within each XaaS profile becomes key.
Customer Engagement Model
Next, a company must work through the appropriate customer engagement model for the XaaS offer. We break the customer engagement model into four distinct phases we call LAER (pronounced layer) :
• Land. All the sales and marketing activities required to land the first sale of a solution to a new customer, and the initial implementation of that solution.
• Adopt. All the activities involved in making sure the customer is successfully adopting and expanding their use of the solution.
• Expand. All the activities required to cost-effectively help current customers expand their spending as usage increases, including both cross-selling and upselling.
• Renew. All the activities required to ensure the customer renews their contract(s).
Customer engagement models for XaaS offers are highly diverse in the industry today. There is often particular confusion and conflict around the involvement of the channel. Many traditionally channel-focused tech companies find themselves in the awkward position of bringing out new XaaS offers that allow customers to engage directly. This channel conflict is particularly hard to avoid in many cloud XaaS models because customers often can completely self-serve from the company’s website. Partners, particularly those who sell to small and medium business (SMB) customers, find that some customers do not need to engage with them directly.
So far, many of the engagement models companies have deployed are poorly aligned with the profit horizon of the offer, often resulting in offer failure or financial failure due to intolerable levels of sales and marketing expense. One objective of this book is to help companies reduce the probability for these misalignments.
Financial Keys
When working through the financial keys, a provider is creating the parameters for how success will be measured for this XaaS offer. And as indicated in the 3x3 model, success is not always defined by profitability. But in any model, the main areas a company must discuss when setting the financial keys for their XaaS offer include:
• Revenue Mix. What percentage of total company revenue will come from the core technology subscription(s), and what percentage of revenue will come from other valueadded services you intend to monetize with the customer? We often refer to this as setting the “economic engine” of the offer.
• Margin and Profit Targets. What are the gross margin expectations for each revenue stream we have identified? What is the profitability we expect from the overall economic engine associated with this XaaS offer?
• Sales and Marketing Costs. What will the cost of our LAER model be as a percentage of revenue? How do we project that these costs ratios will change over time as our profit horizon shrinks?
• Key Performance Metrics. What are the specific metrics we will monitor to determine if we are on track to meet our financial objectives? Some of these metrics may not be financially oriented but can predict our ability to achieve our financial objectives in the appropriate time horizon as selected in the 3x3 model.
Once again, how a company answers these questions will be very different based on the XaaS profile it is pursuing. Figure 2.7. summarizes a view of the 3x3 of XaaS that provides an outline of the critical conversations a management team must have when defining a XaaS offer.
FIGURE 2.7 The Basic 3x3 of XaaS
Friction Curves
We have one final but critical thought before we continue the journey through the technology-as-a-service playbook. As you work through all the decisions associated with your XaaS offer, you will be optimizing between one of two extremes (Figure 2.8. ). At one extreme, you are doing everything possible to make it easy for the marketplace to acquire and adopt your core XaaS offer. On the other extreme, you are—at some point—doing everything possible to maximize the profits you extract from the offer.
On the left side of the diagram, you want to minimize any possible friction that prevents your units of future value from being acquired. That might mean free use of the product for a period, free services, and so forth. On the right side, you may be presenting concepts in your offers that add friction to the buying decisions but have the potential to increase per-customer revenue and profits. Maybe you are charging a premium price. Maybe you have a big professional services price tag to get the offer implemented correctly and you want to make money at that service. Maybe you have broken the offer into several separately priced modules that have the potential to increase total customer spend if the customer selects two or more. In any case, friction is a critical concept in the XaaS playbook. Most importantly, your friction strategy can and should change over time as your priorities, and your offer, mature. So let us introduce you to a model that TSIA calls the friction curve:
Friction Curve : The amount of offer complexity that balances the ease of customer purchase decisions with optimal per-customer economics.
FIGURE 2.8 XaaS Offer Extremes
Every parameter you set regarding your XaaS offer will move the offer up or down the friction curve, as seen in Figure 2.9.
There are friction curves related to offer definition, pricing, and so on. We will refer to the concept of friction throughout the book. Understanding your profit horizon objective helps you understand how much friction to insert into your portfolio.
FIGURE 2.9 The Friction Curve
Now we know that there are a lot of people in the XaaS industry who might fundamentally disagree with this premise. They argue that the best way to profitability is to make it quick, easy, and fun for new customers to enjoy the offer. The idea is to get as many as you can as fast as you can. Eventually you will have enough to make money. In a perfect world you could find a highly profitable, frictionless offer model. If you can, good for you! They do exist and that could be your goal. But we think that is also the path to commoditization. Our observation is that most of the more profitable technology offers also force customers through some amount of complexity and trade-off as they choose from among multiple, sometimes premium-priced offers within a provider’s portfolio of products and services. You may be faced with this reality as you make your playbook decisions. Again, we think friction is best thought of according to your profit horizon. You may start off with a low friction model when you are an FVA but intentionally place more and more expensive choices in front of your customers as you evolve into a MTW and CPM player.
So now let’s put together all the elements of the 3x3 of XaaS, shown in Figure 2.10.
FIGURE 2.10 The 3x3 of XaaS
Upcoming Chapters
In Chapter 3 , we will discuss how to create a XaaS offer that has the potential to create the highest and most sustainable profits possible by combatting the three “killer Cs” of XaaS success: customer churn , high costs , and offer commoditization . This is an important concept because many XaaS offers are creating a race to the bottom in terms of pricing and profitability. Chapter 4 tries to sort out how profitable XaaS businesses might eventually organize and operate differently than traditional tech companies. Chapter 5 is targeted at all those large, legacy technology companies that are struggling to pivot from traditional technology offers to new XaaS offers. In Chapters 6 through 8 we will explore the three elements of the iron triangle of offer definition in more detail. Chapter 6 will explore the power of portfolio in XaaS. We will provide frameworks for defining your XaaS offer and setting the pricing strategy. Chapter 7 will cover the LAER customer engagement model and why the concept and science of customer adoption is the best strategy for battling the three killer Cs. Chapter 8 explores the specifics of setting target financial models and metrics for a XaaS offer. Chapter 9 looks at the special case of managed services as entrée into XaaS. Chapter 10 will explore the changing channel models—how the role and success factors of go-to-market partners can alter in XaaS marketplaces.
Playbook Summary
This book is designed to provide a set of plays you can run to move your XaaS business forward. At the end of each chapter, we will provide a summary of the plays that have been defined in the chapter. As of now, you need only make one simple decision and you will have run the first play in your XaaS playbook.
Play : Setting the Profit Horizon
Objective : Align your entire management team on what profit horizon the company is pursuing for this XaaS offer.
Benefits:
• Provides context for the wide variance in behaviors of XaaS providers in the marketplace.
• Identifies the right XaaS offers to compare yourself against and model yourself after.
• Identifies the key parameters the management team will need to set for the XaaS offer.
• Minimizes behavior schizophrenia when setting the parameters for the XaaS offer.
Players (who runs this play?) :The executive management team runs this play and should include senior leadership from the areas of product development, marketing, sales, services, and finance.
3
As we just discussed, all kinds of companies are creating XaaS offers these days. Regardless of the profit horizon for your XaaS offer, at some point in time the offer will need to become profitable. It will need to generate more revenue than it costs to sell and deliver. Unless you are a market anomaly like Amazon, 1 that is just a basic business reality. But what level of profitability would you consider a success? If your XaaS offer generated an operating income percentage of 10%, would you declare financial victory? Would less than 10% be acceptable? Boards and chief financial officers (CFOs) love to set firm, and often aggressive, profitability objectives. But just because the board of directors wants a XaaS offer to generate a certain level of profit, it does not mean the offer (or the company) will ever achieve that level of profit. Why not? The answer can be found in the concept of economic moats. But before we introduce that framework, let’s review the historical profitability levels of technology companies.
The Tech Cash Cow
In Chapter 1 , we introduced the data in Figure 3.1. that demonstrates how profitable even the average large technology companies have been. The average profitability of the TSIA Technology & Services 50 (T&S 50) index of companies is superior to large-cap icons like General Electric (GE) or Exxon Mobile.
FIGURE 3.1 Operating Profit Comparisons
To provide additional context, Figure 3.2. tracks the net operating incomes of leading technology companies through the Great Recession of 2007–2009 compared to some other wellknown companies. Although General Motors (GM), General Electric (GE), and Exxon all experienced significant dips in their operating incomes in 2009, Cisco, EMC, and Oracle exhibited little pressure on their profitability.
Figure 3.2 also highlights a strike zone where we are picking operating incomes: a range from above 5% to 15%. This is a healthy range of profitability by most standards. Accenture, GE, and Exxon are operating comfortably within this range, year after year. EMC runs at the high end of the range. A few exceptional performers like Cisco and Oracle (and some other technology companies) have been operating beyond the range.
FIGURE 3.2 Operating Income Comparisons
But we are choosing 5% to 15% as a reasonable initial profit target for a XaaS offer. A big basket of hardware and software companies have been operating in this reasonable profitability range—undisturbed—for quite a long time, so we know it’s a number that the financial markets will accept. Although some companies may be able to do even better, let’s set some modest sights and start there. Let’s get our XaaS offer to a 5% to 15% GAAP profit by working together; then, you can feel free to take it to new heights from there.
So how do we do that? Well, first we set our profit horizon as was done in Chapter 2 . Now we need to figure out what strategies we can build into our offers that will be the foundation of our eventual 5% to 15% GAAP profit. Let’s approach that task by looking at the lessons of the tech industry so far. Why were large technology companies like Oracle, EMC, and Cisco so incredibly profitable, even through the difficult 2008–2009 recession? Our answers can be found by applying a framework leveraged by several sophisticated investors.
Economic Moats
The investment firm Morningstar coined the term “economic moat” to describe how some companies are able to consistently generate above-average profits. Here is how Morningstar describes the concept:
“The idea of an economic moat refers to how likely a company is to keep competitors at bay for an extended period.” 2
However, Morningstar is not the only investing entity that embraces this concept:
“In business, I look for economic castles protected by unbreachable ‘moats.’” 3 —Warren Buffett
Buffett and others are searching for companies that have a unique ability to generate highly profitable revenue. But how can you tell if a company has developed an economic moat that other competitors will find difficult to breach in the short term? Combining the insights of multiple publications on the topic of economic moats, we would like to proffer six attributes that will help determine if a XaaS offer can generate strong and consistent profitability. These attributes will be introduced from our view of least important to most important.
#6 Attribute: Virality and Other Paths to a Low-Cost Sales Model
Virality is the concept that a company has a product or service that almost sells itself. There is organic demand for the product. Word of mouth and reputation drive sales as opposed to heavy spending on sales and marketing. Think of the old Vidal Sassoon commercial:“And they told two friends, and so on and so on.” 4 Low sales costs mean the company has an offering customers are excited about, and it usually means that more money drops to the bottom line. Virality is just one path to a low-cost sales model. We will discuss other paths later in the book.
A XaaS example of virality and a low-cost sales model is mobile ride-hail company, Uber.
#5 Attribute: Diverse Revenue Streams
Most consistently profitable companies have been able to diversify their revenue through multiple offers. The existence of several revenue streams in a portfolio allows them to better weather a difficult period or intense margin pressure faced by any one offer. As an example, during the 2008–2009 recession, large tech companies faced huge pressure on new product sales revenue as customer uncertainty brought IT purchases to a virtual standstill. Fortunately, these same companies had also built strong revenue streams for both their maintenance/support and professional services businesses. Because customers were not adding new products, they relied more heavily on maintaining and increasing the productivity of the products they already owned. For many profitable tech companies, maintenance renewal rates actually increased during this period. In addition, many customers contracted for professional services to help them better leverage existing systems to the new business realities they faced. The fact that these tech suppliers had a diverse portfolio of products and services enabled them to cushion the blow to the top line and achieve continued profitability on the bottom line. Perhaps even more important, diverse product or service revenue streams give you more ways to make money. Hewlett-Packard (HP) never made much money on printers, but they did pretty darn well on ink. Diverse revenue streams are usually a win-win. They are not only good for the provider, but they also usually mean that the customer has an array of products and services that provides a more complete solution. They don’t need to shop multiple providers, and they have one throat to choke.
A good example of a XaaS company with diverse revenue streams is Veeva Systems. The company currently has over 20% of total company revenues coming from value-added services wrapped around the core product subscription. The company, unlike many similarly sized SaaS companies, is generating an operating income of almost 10%.
#4 Attribute: Network Effect
Another economic moat similar to virality is the concept of a network effect. This is the phenomenon whereby a good or service becomes more valuable when more people use it. Telephone service is a great historical example. The more people who got phones in the late 19th and early 20th century, the more valuable it was to have a phone. If a company has an offering that is valuable because many people are using the same product, then the marketplace is incented to stay with that offer. This is not the same as market share. One company may dominate the market in mittens, but that does not benefit consumers in any special way when they buy a pair of mittens. However, if a person uses the TripAdvisor website to research travel decisions, that person benefits if more and more people are using the site and posting helpful reviews. The network effect can also be achieved by becoming a technology standard, building your brand into a standard, or by having uniquely broad compatibility with a surrounding ecosystem of products from other providers. If there is a vast network of complimentary products that easily interact with it to form a more complete and robust solution for the customer, your XaaS offer can achieve this effect.
Good XaaS examples of the network effect include LinkedIn and Salesforce’s Force. com and AppExchange platforms.
#3 Attribute: Economies of Scale
A powerful economic moat for your XaaS offer can be dug when economies of scale play a significant role. This gives a company the power to have either higher profitability than a competitor or choose to use lower prices as a competitive advantage. If a company has an offer where increasing volumes equate to higher unit margins (often called “subtractive manufacturing”), then companies with critical mass and market share are in the pole position to extract high margins. Think of Intel in the computer processer marketplace. Because cloud-based XaaS offers are almost always based on multi-tenant architectures, where each incremental tenant reduces the providers’ average hosting cost per tenant, you get subtractive manufacturing economics.
In infrastructure-as-a-service (IaaS) markets today, we see Amazon Web Services (AWS) and Microsoft Azure beginning to leverage their massive scale to apply price pressure to smaller rivals like Rackspace.
#2 Attribute: Unique Capabilities
Of course, something powerful must be said for having a truly unique capability. If a company can do something few others can do, then that company is in a position to create higherthan- average profits. Unique capabilities can be created through patents, specialized expertise, or even geographic presence. Also, brand equity built up over time can be viewed as a unique capability. Why is this only number two on our list of economic moats? It’s because this moat seems to be getting narrower and shallower in the cloud. The cost and time to build or replicate features is rapidly shrinking. One XaaS offer’s unique functionality is soon commoditized as all of its competitors quickly catch up—sometimes with an even better version than the original. In addition, recent trends in patent law are making it even more difficult to secure and defend software patents. All these add up to a markedly different outlook for the decades-old tech strategy of betting the whole company on the sole strategy of having perennially differentiated features.
A great XaaS example of unique capability is Google, whose search algorithms and ad placement software are both highly proprietary and highly effective.
#1 Attribute: High Switching Costs
The traditional trump card in creating highly profitable tech revenue has been high switching costs for customers. If it is expensive or painful for customers to switch to a competitive offer or substitute, then a company is in the perfect position to extract maximum profitability from the customer. When we present this model to MBA students, they are often incredulous that this is our number one attribute. They can’t believe customers would fall for this in the long term—especially sophisticated buyers in businessto-business (B2B) markets! Yet, there are many ways to create high switching costs for customers that include:
• Requiring a large capital up-front investment that creates a sunk investment the customer will not readily abandon.
• Technically, making it difficult for customers to migrate all their data off of your offer.
• Contractually, making it financially painful to switch.
• Requiring a large training investment that makes it painful to retrain employees on substitutes and cause a protracted negative impact on productivity.
• Embedding your capabilities within the customer’s business processes so your offer becomes critical to the customer’s success.
Many SaaS application companies still benefit from high switching costs in much the way their on-premise predecessors did.
Companies like Salesforce and Workday are good examples of XaaS offers with high switching costs.
In summary, a company can generate highly profitable revenue when some or all of these attributes are present in their offers:
• Costs of selling the offer are low.
• The company has a diverse stream of revenues that surround the core offer, which helps balance out revenue or margin pressure in any one stream.
• The more customers that buy the offer, the more valuable the offer becomes to all customers.
• The more of the offer the company delivers, the lower the cost per customer becomes.
• The offer delivers a unique capability or experience to the customer that they cannot get elsewhere.
• It is very painful for customers to switch from the offer once they have decided to purchase it.
Next, let’s review how the traditional technology industry has done on building deep economic moats around its offers. This is an important exercise because, as we will later see, not only the traditionally profitable tech companies but also the XaaS companies that are highly profitable today are both leveraging multiple economic moats. Quite simply, the more economic moats you can dig, the more successful and profitable your XaaS offer is likely to be!
Economic Moats in Traditional Technology Product Markets
#6 Attribute: Virality and Other Paths to a Low-Cost Sales Model
Companies in the T&S 50 index spend an average of 22% of revenues on sales and marketing—not exactly a small number. Software companies spend an average of 29%. Accenture, with all of its advertising and direct sales costs, spends 11% to 12% of revenues on sales and marketing. Ford Motor Company spends 10% to 11% on selling expenses. So in comparison, low cost of sales has not necessarily been a strength of the traditional hightech business model.
Score: LOW
#5 Attribute: Diverse Revenue Streams
In addition to the diverse revenues emanating from their famously enormous and complex product portfolios, most large tech companies also have large and diverse service portfolios. On a combined basis, the companies in the T&S 50 index now have more than 50% of their total combined company revenues coming from services. Over the past five years, their collective product revenues—even with their diverse product portfolios— have declined 35%, and most hardware products have also suffered substantial margin erosion. But by diversifying into services that are growing at between 2% and 35% compound annual growth rate (CAGR)—many of which often have margins far superior to the products they are sold with—traditional tech companies have been able to better withstand the myriad pressures on their core offers and continue to deliver earnings per share (EPS) growth over time. So the traditional technology industry has done an excellent job of having diversity across both products and services.
Score: HIGH
#4 Attribute: Network Effect
Performance here has been a mixed bag among traditional tech companies. A few, like Microsoft Windows, have taken advantage of their vast network of users to build their products into true technology standards. A handful of others have built their company brand into a “safe choice,” like IBM or Cisco, or a social fad, like Apple. Some have even used the network effect by achieving a broad base of IT workers who were familiar with the products. This was good news for any customer who wanted to operate their technology. Some traditional high-tech companies benefited enormously from the network effect. But rarely were they able to leverage the most powerful of the network effects where each new customer they sold added to the value being received by the base of existing customers. Many of them did, however, take advantage of the vast community of third-party resellers who could make money by reselling products and delivering attached services. The greater the demand the original equipment manufacturer (OEM) could create, the more partners flocked to resell the product. The more partners that did that, the more successful the brands became, and the more other partners felt the need to follow suit. In this instance of the network effect, the traditional tech industry was successful.
Score: MEDIUM
#3 Attribute: Economies of Scale
Clearly, economies of scale apply to technology products. We already mentioned Intel, which has made massive investments in plants to build processors. That has allowed the company to maintain roughly 80% of the processer marketplace decade after decade. But those economies have not created widespread competitive advantage for most hardware companies. Only a few have been able to use price to sustained benefit or enjoy product margins substantially better than their competitors.
In perhaps the industry’s best example of how to make use of economies of scale, companies like IBM and Oracle have built vast piles of customer support and maintenance customers who pay to access a single technology service infrastructure. Once that structure was built, the incremental cost of supporting one more customer on the platform was negligible. Over time, as customer after customer was added and renewed, these maintenance empires became huge and incredibly profitable. Figure 3.3. reports on the product and support margins we track in our industry benchmarks and demonstrates how powerfully the economies of scale in the software support and maintenance business have led to gross margin that can exceed software itself!
Score: MEDIUM
FIGURE 3.3 Margin Profiles for Technology as a Product
#2 Attribute: Unique Capabilities
Technology companies have spent the last 40 years positioning around the unique technical capabilities of their products. These feature wars have resulted in a mind-boggling number of features per product. Microsoft Word alone has more than 1,200 features a user can access. Competing on differentiated technical capabilities has been the hallmark of high-tech strategy. Technology sales reps are trained to compete on “speeds and feeds” or software features. This has worked consistently and pervasively.
Score: HIGH
#1 Attribute: High Switching Costs
But as we have mentioned, the trump card of the technologyas-a-product business model, especially for software companies, was high switching costs. Technology companies pulled nearly every lever to make sure customers could not easily switch off a technology product. That meant that all downstream purchases by that customer would not be truly competitive situations. Solid revenues at solid margins could be counted on. Revenue from the existing customer base became the economic engine that propelled the company and its stock. It has been a beautiful thing.
Score: HIGH
Putting these observations together, we can rate how well traditional product revenue streams align with the attributes of high profit revenue, and seen in Figure 3.4.
As shown, these economic moats were medium or strong in every attribute but low cost of sales. There are many reasons why technology companies have been generating so much profit. Both their product and product-attached service revenue streams contain attributes that create deep economic moats.
So how are these attributes carrying forward to the world of technology as a service? How well are current XaaS offers faring in their ability to create deep economic moats that unlock the same type of highly profitable revenue? Let’s take a look.
FIGURE 3.4 Economic Moat – Traditional Tech Alignment
Shallow Moats of XaaS 1.0
The 20 publicly traded XaaS companies we track in our Cloud 20 index have been growing top-line revenues at double-digit rates. Revenue is clearly flowing nicely into these offers. GAAP profitability, on the other hand, has been extremely elusive for most, as shown in Figure 3.5. The average net operating GAAP income for these companies is –3.32%, and only 8 out of 20 made a net operating profit greater than 5%.
FIGURE 3.5 Operating Incomes of XaaS Companies
In addition, there is no consistent trend of improved margins and profitability year to year. Some companies are improving while others are not.
Now, perhaps a majority of XaaS companies in the public domain would still consider themselves to be future value aggregators or mid-term wedge companies. They may be building new markets or chasing market share and be less concerned with profitability. That could indeed be the case. However, the inability of so many XaaS companies to be profitable can be disconcerting, especially if you are a traditional tech company trying to decide whether you should take the plunge into subscription business models. This is of particular concern because many of these companies have annual revenues well in excess of $500 million—far past the point where most traditional tech companies turn profitable. Our point of view is that many of the first-generation XaaS companies are suffering from shallow economic moats.
So, let’s now apply our economic moat framework to this current generation of XaaS offers (we’ll call them “XaaS 1.0”).
#6 Attribute: Virality and Other Paths to a Low-Cost Sales Model
As seen in Figure 3.6 , SaaS companies in the TSIA Cloud 20 index spend an average of 40% of revenues on sales and marketing— much higher than their traditional license software peers (which is yet higher than many other industries).
What is driving this incredible spending? Acquiring new customers is clearly the main culprit. These XaaS companies need new customers to feed their models, and the sales cost to acquire a new customer almost always is more than the initial revenue received from them. Ironically, the more successful you are at adding new customers in a particular period, the worse your sales and marketing costs might be. It’s almost like negative leverage. If it costs $10,000 to add a new customer but they are only going to spend $10,000 in the first quarter, you have just added revenue at a high cost of sales for that year. Do that hundreds of times and it’s easy to see how sales and marketing costs in a XaaS world can skyrocket. But there is even more to the story here. In Chapter 7 we will introduce a framework on the XaaS revenue waterfall. That framework clearly demonstrates that if churn and down-selling are problems, it will take even more new customers to feed the beast of revenue growth because of the erosive effects of lost customer spending. Replacing lost revenue means that you need to land a certain number of new customers just to stay flat. If that void is too big and new customer sales costs to fill it are high, the XaaS company is destined to be unprofitable. And, the lack of cost-effective models to expand existing customer accounts can also cause sales expenses to soar. Having expensive field sales resources doing small upsell or renewal deals is simply not smart. It is our point of view that the selling models in these XaaS 1.0 business models have not yet been truly optimized. For most XaaS companies, cost-effective LAER coverage models have not yet been implemented at scale.
Score: LOW
FIGURE 3.6 Sales and Marketing as a Percentage of Revenue
#5 Attribute: Diverse Revenue Streams
This is an area of particular weakness for most XaaS companies or offers. Because these offers are often measured solely by the number of new users or some other unit-based metric, there is a massive temptation to eliminate any friction in the customer’s selection process. That means throwing everything into the bundle at one low price—no separately monetized services or chunking of certain features into separate offers. Although we can understand that logic, we also think many companies will rue the day that the “eliminate all friction” mentality took root. Once an offer has established its value in the market, it is time to start building adjacent offers and diversifying the revenue streams associated with the core offer. Rainy days do come. New price-cutting competitors do emerge. Having a diversified revenue stream has proven again and again in the history of the tech industry to be a smart thing to do.
Score: LOW
#4 Attribute: Network Effect
Some XaaS companies have done an extraordinary job of leveraging the network effect. As we mentioned, companies like LinkedIn, TripAdvisor, Yelp, and Airbnb have built their entire business models on the network effect. But consumer XaaS companies are not alone. Salesforce’s Force. com platform is a fantastic example of the network effect. The fact that a customer who chooses Salesforce knows there is a vast array of prequalified and highly compatible add-on applications is a mighty advantage for Salesforce. The more B2B XaaS providers that choose the Force. com platform, the stronger the advantage that Salesforce has over its customer relationship management (CRM) rivals. But not enough companies have built this moat into their strategy.
Score: MEDIUM
#3 Attribute: Economies of Scale
In theory, XaaS companies should absolutely benefit from economies of scale. Adding more users on the same platform should result in higher profits over time. Unfortunately, as we will discuss further in Chapter 7 , the majority of XaaS companies that TSIA tracks are not exhibiting proof that scale automatically equates to higher profitability. Many of the SaaS companies TSIA tracks are becoming less profitable as they grow in revenue. Although these companies experience incredible top-line growth, their operating incomes remain in negative territory.
Now, we do believe economies of scale should be a positive attribute for XaaS revenue streams. Cost of goods sold (COGS) and general and administrative expense (G&A), in particular, should benefit. However, the economies are not yet consistently presenting themselves—even for multibillion-dollar SaaS companies. Without clear data to support this attribute of high-margin revenue, we cannot yet assume it is a given for XaaS offers.
Score: LOW
#2 Attribute: Unique Capabilities
As we will highlight in Chapter 4 , XaaS providers are finding it harder to compete on features and are being forced to compete on price. For example, Microsoft, Amazon, and Google have been engaged in an aggressive price war related to hosted web services. The ability to differentiate their offers based on features has been challenging as the cost and time to develop new features become less and less. However, there continues to be evidence that features can determine market share, as SaaS start-ups quickly put competitive best-of-breed features on the table.
This moat works sometimes, but usually not for long. For example, have longtime competitive companies like Cisco WebEx, Citrix, and Skype been able to use unique product capabilities to win market dominance and avoid price commoditization? Not really. Many XaaS 1.0 offers have competitors that match one another on all the key features that define the category. So, unique capabilities are good when you can get them. But we see it as being a riskier and riskier strategy on which to base your entire business strategy.
Score: MEDIUM
#1 Attribute: High Switching Costs
How does the trump card of the technology-as-a-product business model relate to XaaS? In a recent study on customer success organizations, respondents from SaaS companies that were heavily focusing on customer adoption reported fighting average customer churn rates close to 20%.The TSIA benchmark tracking SaaS providers, in general, reports average customer churn rates of 8.4%.
The challenge for many XaaS providers is that an “easy on” XaaS offer can also be an “easy off” one. Many business customers of XaaS offerings are increasingly resistant to making massive up-front capital commitments or signing long-term agreements. If they dislike the offering after one year, they may indeed switch. In this regard, it is still true that the more complex your solution is to onboard, the stickier it is likely to be. Customers may resent a long and costly implementation, but from the supplier perspective it can be a powerful deterrent to attrition. So we still think high switching cost can be an important economic moat in XaaS, but like economies of scale, it seems to be present only in complex enterprise applications.
Score: MEDIUM
Putting these observations together, we can roughly rate how well XaaS revenue aligns with the economic moat attributes of high profit revenue.
Compared to traditional product revenue streams, we rate the current state of XaaS revenues the same or weaker on every attribute that drives highly profitable revenue—not for every company, certainly, but for the industry overall. We believe that just by looking at Figure 3.7 , you get a better understanding of why many XaaS companies are unprofitable or barely profitable. And the argument that XaaS companies could be profitable if they chose to simply scale back on sales and marketing efforts is a shaky assumption—certainly an assumption that should make any CEO unsettled. If the core XaaS offer is surrounded by a shallow economic moat, then there is no reason to believe high margins and high profits will ever be realized. Keep in mind that there is not one real-world example of a XaaS company flipping negative GAAP operating income to positive operating income by simply slashing sales and marketing costs. No one has really tried because of the obvious and potentially huge negative impact on growth rates of such a move. If your stock price is largely supported by your growth rate, cutting sales and marketing costs is a risky call. It could work as a way to increase profitability, but to date no one has really played that card.
Overall, we think XaaS 1.0 is weaker in its economic moats, but this also brings us to a critical point: Not all XaaS businesses are losing money. A precious few are highly profitable on a GAAP basis. Why? We think it’s largely because they have been able to build and maintain multiple economic moats around their core XaaS offer.
FIGURE 3.7 Economic Moat – XaaS 1.0
As a reminder, looking at the Q4 2015 operating incomes for the Cloud 20 index on page 52, we see the following breakouts:
• 45% (9 of 20 companies) were unprofitable.
• 15% (3 of 20 companies) were marginally profitable (5% or less operating income).
• 35% (7 of 20 companies) were VERY profitable (over 10% operating income).
Let us look at four of those seven companies that were highly profitable. Why were they so profitable? The short answer is that they are all leveraging multiple economic moats (as listed below), and the more they employ, the more profitable the business.
Google: 25% operating income.
Economic Moats in Place:
1. Unique capabilities (product patents).
2. Low cost of sales.
3. Network effect.
Rackspace: 11% operating income.
Economic Moats in Place:
1. Unique capabilities (managed services, not product).
2. Low cost of sales.
3. Diversified revenue streams.
Veeva Systems: 18% operating income.
Economic Moats in Place:
1. Unique capabilities (products and services).
2. Diversified revenue streams.
3. High switching costs.
LogMeIn: 11.3% operating income.
Economic Moats in Place:
1. Unique capabilities.
2. Ability to offer outcome-based services.
So, it can be done. It is being done. These are levels of GAAP operating income that most CEOs would be thrilled to have for their XaaS offer. And it’s being done by successfully surrounding the core offer with multiple economic moats.
Digging Deep Economic Moats for Your XaaS Offer
So in short, we believe XaaS business models can be profitable. We believe some XaaS business models will be highly profitable. However, to achieve profitability, XaaS providers must use economic moats and operating best practices to battle the three key enemies of XaaS profitability. We call them the killer Cs:
1. High selling costs.
2. High customer churn.
3. Rapid commoditization of the offer.
These killer Cs can and do weigh down XaaS profitability. How do we successfully combat them? XaaS companies must review each of the six attributes that create highly profitable revenue and determine how they can build as many economic moats as they can. Building these moats into your offer as early as your profitplanning horizon allows is the smartest thing you can do to increase your chances of having long-term GAAP profits for your XaaS offer. So let’s look at ways you might be able to innovate around the six economic moats to combat the killer Cs.
#6 Attribute: Virality and Other Paths to a Low-Cost Sales Model
In our view, one of the primary challenges facing unprofitable XaaS companies, especially those in the enterprise space, is that they have pulled forward the expensive sales models of the traditional technology industry into their XaaS offers. These sales models rely heavily on a highly paid, field-based direct sales force to conduct nearly all the activities needed to build demand and land and grow new customers.
These conventional approaches are often proving to be too much cost to bear given the slow revenue recognition models associated with subscription and pay-per-use contracts. Successful XaaS companies will need to be open to different ways of creating demand that rely more on marketing and less on sales. They will need to debate alternative, less-costly sales models. And importantly, they must realize that in XaaS, profitable revenue is dependent not only on cost-effectively landing customers, but also cost-effectively renewing and expanding them. In traditional pay-up-front models, legacy tech companies really didn’t even have to spend real sales and marketing dollars on these later-stage tasks. The only thing to renew was the maintenance contract, and any expansion was usually associated with the next big refresh a few years later. But XaaS offers face a different challenge in the form of the revenue waterfall model. They incur sales and marketing expense up and down the line throughout the entire customer life cycle!
At the same time that sales models are coming in for inspection and updates, the customer-buying landscape for purchasing technology is also changing, as shown in Figure 3.8.
Most traditional enterprise tech companies sold their wares to the IT buyer; it was a well-understood process both on the selling and buying sides. But XaaS has accelerated a shift that was bound to happen as the tech industry matured. Both TSIA and Gartner research indicates that conventional IT budgets are shrinking. 5 A growing number of enterprise technology decisions are now being made by business buyers. The complexity of implementing and adopting XaaS offers is often far less; the prices are often lower than many traditional on-premise solutions were and are available for monthly fees that fit neatly into the business buyer’s own operating budget. That means HR picks its own tools; so does finance and marketing. XaaS offers give them the ability to choose best-of-breed cloud solutions and get them implemented with little or no involvement from the IT department. In many cases, individual employees are even making their own independent decisions to purchase personal technology tools.
FIGURE 3.8 The Shifting Sales Landscape
These business buyers speak a different language. They are not interested in speeds and feeds. In fact, many don’t care at all about the underlying technical attributes of the offer—they care about the business outcome the technology will lead to. This is causing massive reverberations in many traditional sales models. Sellers must now learn to speak the language of business, not the language of IT. They must know how their offers translate specifically into the business outcomes their buyers seek. They must be conversant in the business functions and in the industry each customer operates in.
The shifting buyer landscape and the killer Cs are all forcing successful tech companies to rethink and innovate their sales and marketing models for all the phases of the customer life cycle. How companies land new deals, drive broad adoption, facilitate systematic expansion, and efficiently achieve renewal is in the process of a major modernization.
Obviously, “going viral” is the land goal of every early stage XaaS offer. Achieving this, especially if you are a future value aggregator, is the central focus of both your R&D and marketing organizations. By combining an addictive and immersive technology, a compelling or fun experience, a cool brand, and a lowfriction offer, early stage XaaS offers seek to achieve the holy grail of viral adoption. If you can do that, many of your sales cost problems go away. Together, these elements make up your brand experience. It’s your secret sauce and, as we said, we don’t purport to have simple or universal tactics for achieving the magic of a viral offer. And no amount of offer structure or go-to-market strategy is going to substitute for a serious weakness in these core areas. But offer structure and innovative sales tactics do accelerate the success of the core offering and increase their chance of long-term profitability. So, assuming your offer has at least some degree of success in the market and customers see value in it, now it’s time to drive more customers onto the platform, but with an eagle eye on the sales and marketing cost structure you are building as you go.
Fortunately, there is new thinking and experimentation taking place out there. Here are some provocative approaches to selling up and down the LAER cycle that we see taking root in innovative XaaS companies:
• Marketing-Led Selling. You could argue this concept has been around forever. But as we look across the hundreds of TSIA member companies, we would assert that it has really not been a staple activity in tech. This is reflected in how sales and marketing dollars are allocated. In an informal survey with technology companies that we conducted in 2015, we found sales organizations were receiving five dollars to every one dollar spent on marketing activities. Most traditional tech companies simply have not trusted marketing to own the conversation with the customer once they have been identified. Leads from any source have typically been passed to field sales as soon as possible. It was up to the sales rep to qualify and cultivate the prospect, and sell the deal. This has resulted in expensive sales resources being allocated to very early stage—and often poorly qualified—opportunities. Marketing was often measured on lead volume , not lead quality . That is starting to change. Today’s buyers are much better informed than at any other time in history. They can find information about your company, learn about the features of your product, and maybe even find pricing—all without talking to anyone. As a result, marketing’s role is eating into the sales cycle. In addition, individual buyer behavior can now be tracked across marketing channels, and their engagement and propensity to buy can be “scored.”Thus, marketing organizations at many XaaS companies are being charged with owning not only the identification of a lead but the cultivation of a lead, as well. That means when leads are finally turned over to sales, they are often highly qualified and deep into the sales cycle. This shortens deal windows, improves win/loss percentages, and increases sales productivity.
• Bottom-Up Selling. This is a marketing-led sales strategy where individual users or small teams within a large enterprise customer are approached to become customers individually. They use a credit card to make a personal decision to use the product. When that happens enough, the customer decides it needs an enterprise-wide license. Bottom-up selling reduces the enterprise license sales time and virtually locks out the competition.
• Remote Selling Models. This is another concept that has been around forever, but is now being beefed up and given far greater responsibility in XaaS. Historically, most inside sales teams either did lead generation for the field or sold only small, incremental add-on transactions to existing customers. But now some enterprise XaaS companies are successfully conducting the entire XaaS subscription sales process without ever going to the customer’s site. These teams rely heavily on web meetings and phone calls as their key engagement tactics. In most cases, these sales teams are initially directed at small or mid-size customers, but as their effectiveness is proven, companies are experimenting with taking these teams “up market.” By their nature, these teams can operate at higher efficiency and achieve greater volumes than their field-based counterparts. They don’t have travel time, they don’t wait in lobbies, and, when combined with the following tactic, they simply don’t cost as much.
• Process-Driven Selling. Obviously, the number one expense line item in overall sales and marketing budgets is labor, specifically, sales labor. For decades, companies have been comfortable paying high annual compensation to recruit and maintain experienced enterprise sellers. But many XaaS companies are finding success with hiring less-experienced talent and then teaching and enforcing very tight adherence to a proven sales process. These multi-touchpoint sales processes control everything from who is contacted, what messages are delivered, what meetings are held, and what products are offered. This approach is often used in concert with remote selling and, thus, is usually piloted in smaller accounts. Most—but not all—companies are still relying on experienced enterprise sellers to manage their largest accounts. However, this is a trend we think has much potential for success.
• Land-Only Sales Teams. Due to the growing understanding and sophistication of the LAER model, some XaaS companies are bifurcating sales into two (or more) teams: The land team and the customer success team. In this model, sales lands. That’s what they do. They don’t own adopt, they don’t own renew, and they even don’t own most of expand. These later-stage tasks are relegated to specialized customer success teams who use “extreme adoption” as their leverage to ensure easy renewals and certain expansion. In some cases, the adopt and renew motions are driven by customer success managers (CSMs), but in others, the renewal and expand motions are done separately by purpose-built remote selling teams. No matter what the structure, the net result is that the land sales team makes their money from landing. Usually, that’s landing a net-new logo customer, but it can also be cross-selling a second major offer platform to an existing customer. In fact, we see this practice becoming fairly standard: The adopt/expand/ renew team(s) own growing a customer’s spending on the offer platform already in use (adding more users, more transactions, more services), but they hand opportunities to land an additional (major) offer platform at that customer to the land team. Land-only sales is a fascinating and potentially huge win for the company because it guarantees a steady stream of netnew customers every month. For the sales team, it’s a real challenge because they cannot rely on renewals of easy expansion to retire some of their quarterly quota. Often the quotas are lower for these land-only reps for this reason. However, the company balances their overall sales costs by blending a higher cost of land with a much lower cost of expand and renew.
• Automated Sales. Everyone has had the experience of buying something or signing up for a subscription on a website. The site is optimized to inform you and escort you through a self-service buying experience. Often this experience is integrated with other marketing tactics designed to attract and inform the buyer, eventually leading them to the automated sales experience. Obviously, this is a great low-cost sales model, one we are all familiar with and are probably consid ering or using in our current XaaS offer. However, a new and far less-used tactic is to imbed upsell and cross-sell offers that present themselves to the customer directly through the technology. Customers encounter the offer contextually as they are using the product, and they simply click a button to complete the transaction. Apple has a classic example of this capability related to their storage services. When a subscriber is getting close to exceeding their current capacity, Apple sends an email providing options on how to reduce storage needs or to purchase more storage. To purchase more storage, you simply click a button. This offer can be made separately via email or during the use of the product. This mentality of making it easier for the customer is migrating to enterprise XaaS. Unfortunately, we have seen resistance to this tactic. We had a TSIA member company that created an automated offer that was presented to their SMB customers through email. If the customer wanted to buy the offer, they simply clicked a button. When the sales organization learned about the offer, they vocalized concern: “We are losing an opportunity to talk to the customer and potentially upsell them.” As a result, the automated offer was killed. Now, if a customer wants to make even a relatively small purchase, they are required to speak to a salesperson. In our opinion, this is a step in the wrong direction if your goal is trying to optimize sales costs.
• Blended Sales and Service Models. At TSIA, we predict there will be a massive blurring of the historical lines that separated sales from services. In the 2009 book Complexity Avalanche, 6 we asserted that “helping will sell, selling won’t help.” By that, we meant that service motions designed to improve the business value that a customer derives from a technology solution is bound to lead to expansion opportunities that benefit both the customer and the tech company. You can call identifying that moment “selling” if you want, but we actually like the term we first heard used by TSIA member company Blackbaud called “up-serve” (who got it from the book To Sell Is Human by Daniel Pink).You empower service and marketing teams to up-serve the customer by both providing services or information and recommending those new products and services that the employee truly believes would benefit the customer. Just look at Rackspace with their Fanatical Support team. They sell by helping, and they start that motion in the pre-sales stage. They act as both the sales rep and the service rep, but it’s all done in the context of making customers fantastically successful. We are seeing examples all over the industry of innovative practices designed to leverage the vast array of services touchpoints with customers to create logical, deftly appropriate sales transactions or leads. It just makes sense to leverage the trusted advisor status many service organizations have achieved to make trusted expansion recommendations to customers. Our TSIA touchpoint calculus indicates that service interactions can occur 15 to 20 times more than sales interactions. Service staff can be trained to listen and identify new sales opportunities. We are seeing technology companies implement incentive programs for service employees to identify and log sales leads. For one company, we saw a new program implemented to incent service employees to log new sales opportunities for the sales force. In six months, the services organization had identified more than $100 million in new sales opportunities. Of course, all of those leads do not close—but over time, the services employees become more adept at identifying highly qualified leads.
• Outcome-Based Selling. Let’s face it: Tech has always been a product industry at heart. We love our products, and rightly so. So, it was just natural that our sales conversation with the customer started right there—with the product. The demo, the side-by-side feature comparison, trotting out the performance benchmarks . . . this is how we loved to sell. And our traditional IT buyers loved it, too! They were connoisseurs of technology. They simply orchestrated the feature “bake-off” and leaned it toward the sales team they liked best wherever possible. Selling to business buyers is fundamentally different. They don’t want to start the conversation with the product; they want to start the conversation with their business outcomes. How can more revenue be generated, how can costs be cut, how can competitive advantage be gained, how can end-customer results be improved? Business—not technology—is the new language of sales. Many XaaS companies are reorganizing their sales messaging to start with the customer’s business outcome and work backward to the differentiating features of their products and services rather than leading with them. They are also becoming much more vertically aligned in order to ensure that sales teams can speak the language of the customer.
Score Improvement Opportunity: From LOW for XaaS 1.0 to MEDIUM for XaaS 2.0
#5 Attribute: Diverse Revenue Streams
As we mentioned, this is an area of particular weakness for most XaaS 1.0 companies. The low friction mentality of the early days often takes root and proves hard to shake from the cultural mindset of the team. More and more and more features get added, and more and more services get given away, all inside the core offer. Although this may be the right strategy in the early days to keep friction low among early adopters, the winning XaaS 2.0 company will have specific plans and time frames to diversify their revenue streams.
The obvious starting point is diversifying the product portfolio by surrounding the core offer with complimentary adjacent modules. Both Salesforce and AWS have done excellent marketleading jobs of diversifying their product portfolio. They are not only growing and diversifying their revenues, but they are also eating their way into adjacent markets and taking share from the legacy competitors that once owned them. They lever the strength of their core by creating adjacent offers that integrate seamlessly and create customer synergies when they choose to select the same provider for more than one application. AWS customers can manage more of their IT infrastructure from a single place, at lower overall costs, on a single bill. Salesforce customers can better coordinate the activities of the sales, marketing, and customer service activities when they are using modules from Salesforce. The lesson here is to be courageous and aggressive on your unbundling. Look for opportunities to create separate offers through acquisition or organic R&D, not just have your core offer endlessly grow its own footprint.
The same is true for your services portfolio. Traditional, onpremise technology products came with a classic portfolio of product-attached services designed to help customers scale the mountain of complexity that often came with installing, integrating, and maintaining what they bought. These legacy tech companies intelligently leveraged that need for assistance into multimillion (or billion) dollar service franchises. As we mentioned, collectively the T&S 50 index of companies has over half of their revenue coming from services today. The good news is that for many XaaS 2.0 companies, customers still want and are willing to pay for many of these same services. As we mentioned earlier, companies like Veeva Systems and Ultimate Software have very strong service revenues coming from professional services around their XaaS offer. In its last fiscal year, Workday got more than 20% of its total revenue from professional services. So, the opportunity to monetize traditional professional, education, and premium support offers still exists for XaaS offers.
But what is more exciting to us is that XaaS 2.0 companies can choose to build a host of next-generation service offers around all the products in the portfolio. Figure 3.9. shows TSIA’s latest technology services portfolio listing for cloud-based offers. In it, you will see exciting new offers that can be built in operational services, adoption services, and information services.
By designing and engineering these service capabilities deep into products, you can create adjacent offers that result in a better customer experience, act as competitive differentiators, diversify your revenue,and do all of the above at very attractive margins. For too long, traditional tech companies did not truly engineer new service capabilities into the products from the start. Services were largely an afterthought to the R&D teams, who often defined a set of end-user features or performance characteristics as “the product.” Profitable XaaS companies will realize that the entire portfolio should be considered as in-scope for the R&D effort. By building service-enabling capabilities into the core products, services can be automated and delivered to the customer at margins equal to or better than the core offer itself.
FIGURE 3.9 Emerging Service Opportunities – Optimize Services
There is no reason that XaaS 2.0 companies can’t also one day count on having half or more of their revenues coming from cloud-enabled operational, adoption, or information services along with traditional professional, educational, or premium support services.
Score Improvement Opportunity: From LOW for XaaS 1.0 to HIGH for XaaS 2.0
#4 Attribute: Network Effect
The legacy technology companies took advantage of their product complexity to build network effects like partner reseller communities and vast technical talent pools that made their products easier to buy. XaaS providers have another network effect opportunity at their disposal by virtue of the vast data sets they are amassing. Every XaaS company is sitting on top of an incredible data set being generated by customers that use the offer. The opportunity here is to aggregate and analyze that data to create additional offers for customers. These are the adoption and information services mentioned earlier. Industry examples of these types of services include IT help desk benchmarking by Zendesk, 7 industry key performance indicator (KPI) benchmarking from SAP, 8 adoption scoring by Salesforce, cost optimization recommendations from Amazon, 9 and retail performance assessments from JDA Software. 10 Each of these offers creates unique, value-added insight to the customer, and each offer is driven by the network effect. The more customers on a specific XaaS platform, the more valuable and insightful these data-driven offerings become to customers.
In addition to benchmarking, technology suppliers can capture and promote many best practices as their network of customers gets larger and more diverse. Infor, an application software company offering both hosted and cloud offers, specializes in “micro-verticals.” It has software for more than 400 highly targeted market niches. As an example, they don’t just offer software for the food services industry; they have offers for beverage distributors and fast-food chains. Thus, they leverage their experience with a growing customer base to create ever-more-targeted offers that make competitors look broad and unfocused. So, the more customers you acquire, the more targeted and focused your offer can become. Although this may add to your R&D and marketing costs as the number of flavors of your offer increase, it might be more than offset by positive impacts on your market share and reductions in your selling costs.
Many cloud XaaS companies don’t put enough emphasis on network effect, and this opens the door to new competitors. Take web meetings, for example. Cisco WebEx and Citrix each own a large share of the cloud-based meeting software. In a B2B environment, valuable meeting time is often lost when meeting organizers attempt to introduce new meeting tools that require participants to download and register—sometimes even leading to failed meetings when corporate firewalls prevent the new client app from being downloaded. Yet, why don’t Cisco WebEx and Citrix leverage their “sure bet” meeting status against the numerous start-ups they face?
Another key strategy to leverage the network effect is to create compelling revenue generation opportunities for third-party partners. As we just mentioned, this is another of the network effects that traditional tech companies did quite well. However in a XaaS world, as we will discuss in Chapter 10 , new models for incenting and rewarding channel partners may need to be devised, and new kinds of partners may need to be attracted. More on this later.
Score Improvement Opportunity: From MEDIUM for XaaS 1.0 to HIGH for XaaS 2.0
#3 Attribute: Economies of Scale
Cloud-based XaaS offers are naturals for this economic moat. That’s because many of their incremental customer development and hosting costs are relatively low. The more customers they add to their platforms, the lower the average cost to serve. The incremental cost to serve a new customer can approach zero in some cases. No one is better at leveraging economies of cloud scale than Amazon. AWS has publicly committed to waging a volume-based price war with competitors Azure, Google, and Rackspace. They plan to use low prices to attract more customers, which allows them to reduce their average COGS per customer and thus to further lower prices.
The objective is to maximize spend per customer. As discussed in Chapter 5 , a majority of XaaS companies are maximizing the addition of new customers but are under-focused on increasing the amount of money those customers spend. The XaaS 1.0 revenue mix is shown on the left side of Figure 3.10. This may be fine for the future value aggregator, but once a customer is on the platform, XaaS companies eventually need to maximize the revenue opportunity and create multiple economies of scale. Spinning up scalable new product lines or transaction offers or services is one method many enterprise tech companies employ. These tactics, as the right side of Figure 3.10. suggests, help both diversify the revenue streams and create the opportunity to generate several economies of scale within the offer or the company.
Score Improvement Opportunity: From LOW for XaaS 1.0 to MEDIUM for XaaS 2.0
FIGURE 3.10 XaaS Revenue Engines
#2 Attribute: Unique Capabilities
As we pointed out, differentiating based on more user features or better technical capability is still a critically important tactic for XaaS companies. It’s just getting harder to keep them as an advantage for very long these days. More and more XaaS companies are also successfully differentiating based on unique service capabilities enabled by technical capabilities. Industry examples of profitable XaaS offerings that leverage interesting service capabilities include the following:
• OpenText wraps both professional services and managed services around subscription revenues to generate an operating income of 16%.
• Granular is leveraging technology and analytics to create a managed service designed to help farmers maximize productivity and profits. 11
• TravelClick combines a hosted cloud offering with valueadded services to help hotels maximize revenue. 12
Each of these offers is proof that service capabilities can marry with product capability to become a market maker for XaaS offerings.
Continuing to invest adequately in unique capabilities is always a prudent decision. What’s changing is that companies are thinking much more broadly about what those capabilities are. It’s not just about features; it’s about any unique capability that expands the number, depth, or breadth of your economic moats. That might be building application programming interfaces (APIs) that broaden the interest of third-party channel providers, or allocating development resources to building a marketplace for supplemental offers by other XaaS companies. There are many great opportunities to leverage unique capabilities around your core offer in the cloud. It just takes imagination and a broad charter for your development and marketing teams.
Score Improvement Opportunity: From MEDIUM for XaaS 1.0 to HIGH for XaaS 2.0
#1 Attribute: High Switching Costs
As previously noted, technology companies have done an outstanding job of making it painful for customers to easily switch technology providers. Many first-generation XaaS companies have not done as well here. Yes, business process-intensive applications like CRM and ERP are always difficult to swap out, even if they are SaaS based. But even here, if the customer does not have a large sunk investment in licenses, they will be more tempted to make changes early if the cost savings are significant enough or if adoption of the current XaaS offer is low. However, there is a real opportunity for XaaS companies to make switching unattractive to customers. Once again, services can be of strategic help. XaaS providers that create sticky service offers that deliver business value that is hard to replicate are much harder to dislodge. The proof point is what TSIA sees regarding the renewal rates on managed service offerings from TSIA members. As shown in Figure 3.11 , TSIA members with managed service offerings are experiencing higher revenue renewal rates than they achieve on traditional support. We know from our managed services benchmark data that renewal rates for managed service contracts hover in the high 90% range. If a customer is buying your managed service offering, they are also buying your technology.
FIGURE 3.11 Revenue Renewal Rates
It’s the same logic for investing in a strong customer success capability. When XaaS companies drive high end-user adoption, they increase the barriers to switching. End-user training and business interruption due to the introduction of new software is a well-understood and feared cost to business customers. The more application software complexity in your XaaS offer, the greater the opportunity to drive business value lock-in through high end-user adoption.
In addition, stickiness can be achieved through very smart use of the data customers generate in your system. Every business trend report, every business outcome you can quantify, every usage report you can flash, every valuable analysis you can muster—all of these make the customer hesitant to turn your product off and turn a competitor’s on. But like most everything else we have identified, this demands a broader line of thinking on how to design and build economic moats into your offers.
Score Improvement Opportunity: From MEDIUM for XaaS 1.0 to HIGH for XaaS 2.0
Putting It All Together
If a XaaS 2.0 company or organization pursued all of the tactics listed in this chapter, we believe their long-term profitability will be optimized (Figure 3.12. ). By developing intelligent product, service, and go-to-market strategies that wrap their offer in multiple economic moats, companies can accelerate growth, defend against commoditization, and optimize shareholder value.
No law states that technology companies should generate double-digit operating incomes. As Nick Mehta, CEO of Gainsight, likes to point out, “Not everything in business ends well. Look at the music industry. They are experiencing an all-time high for unit sales and plays. At the same time, their revenues are plummeting as disruptive new sharing models make buying music nearly a thing of the past.”
FIGURE 3.12 Economic Moat — XaaS 2.0
Historically, the deep economic moats of traditional technology business models enabled wonderful GAAP profits. Most XaaS business models so far do not share that good fortune. XaaS companies will need to work harder and employ new tactics to create their own deep and wide economic moats. These tactics are designed to reduce the cost of sales, minimize customer churn, and prevent commoditization of the offer. Without these tactics, XaaS providers may want to begin comparing their financial models and profitability profiles to companies operating with shallow economic moats and in hyper-competitive marketplaces like the music industry. In the near term, many future value aggregators and mid-term wedge companies have stock prices that are being rewarded for catching the next wave of market disruption. However, in the long term, if they have shallow economic moats, they will face both razor-thin operating margins and anemic stock multipliers.
XaaS Playbook Play
The XaaS business models are currently proving much less profitable than the previous business models of the traditional technology industry. To determine how to add more margin and profit to a XaaS business, management should run the following play.
Play : Economic Moat Assessment
Objective : Determine what attributes you will leverage to create a more profitable business.
Benefits:
• Identifies attributes that have the potential to unlock higher profits.
• Aligns senior management team on what attributes they will invest in and optimize.
• If no attributes are found, forces leadership team to reset profitability expectations.
Players (who runs this play?) : The entire executive management team runs this play: CEO, CFO, sales executive, services executive, and product executive.
4
It’s human nature to respond to any life disruption with one simple question: “What does it mean to me?” In Chapter 1 , we emphasized our belief that the cloud and XaaS will fundamentally transform the business models of most tech companies. So, it’s no surprise that human nature kicks in and business leaders want an answer to the question: “What does this mean to my/our organization? Who should own what?”
Fair questions. Organizational structure can reflect an organization’s priorities as well as act as its command and control system. We totally understand why companies are keenly interested in having this conversation, but frankly we don’t think it’s the right starting point for your XaaS discussion. Our general recommendation is that technology companies delay the conversations on specific organizational structure until after they have designed the operating model they are building, how the customer experiences that model, and the capabilities needed to execute it well. They also should get some experience under their belt before they start stressing out the current organization. But, we know from our work with all these companies that they urgently desire to discuss and debate this topic. With this reality in mind, we wrote this chapter. In this chapter, we will cover some thoughts on XaaS organizational structure—but remember, it’s still early, and the definitive, profitable XaaS model is not yet known. Areas we’ll discuss include:
• Traditional technology supplier organizational structure.
• Drivers for change.
• Capabilities assessment.
• Wave 1 and Wave 2 moves.
• Timing.
We want to give you things to ponder concerning how profitable XaaS organizations might look and behave differently from traditional tech organizations. This is also relevant to many bornin-the-cloud XaaS businesses because most still look exactly like traditional tech companies. We think there may be more changes to come, even for those companies.
Traditional Tech Organizational Structure
We would assert that the common organizational structure in place at most enterprise tech companies today is built on three main intellectual pillars. They are:
• Emphasize the “make, sell, ship” organizations:
o R&D and sales, not marketing and service.
• Focus on maximum scalability:
o Horizontal go-to-market model, not vertical.
o Indirect channels for SMB.
• Establish clear command and control:
o Geography-based command and control of the field.
o Siloed P&Ls by organization.
We see these pillars at work not only in traditional companies but in most XaaS companies as well. That’s because much of the senior leadership at large XaaS companies grew up in traditional tech companies. That’s where they learned how a company organizes and operates. Often, they carry that forward into the XaaS businesses they now supervise. However, we’re not sure that’s going to ultimately deliver the profitable XaaS model we seek.
So, let’s quickly review the legacy organizational structures at work in tech, and then discuss why your profitable XaaS offer may be better served with some slightly different approaches.
In B4B , 1 we explored the history of the high-tech business model. We traced the roots all the way back to the National Cash Register (NCR) company in the late 19th century, when CEO John Patterson established a formal R&D function as well as a large field sales organization to drive his company’s products to market. His approach was mimicked by Thomas Watson when he left NCR to join the fledgling IBM Corporation. Many others then followed the IBM model. At the heart of this early B2B organizational model was a manufacturing mentality: “Make, Sell, Ship.” The majority of technology product companies—including software companies—have kept Patterson’s spirit alive by maintaining this manufacturing mentality. Product companies have optimized their organizational structures to develop differentiated product capabilities and then rapidly land those products in the marketplace at scale through sales. It worked well for most enterprise tech companies. Their deep economic moats didn’t often force them to diversify their strategic investments into other organizations; they funded things like services and marketing almost like they were just COGS.
Not only did “Make, Sell, Ship” influence their organizational structures and strategic investments, but it also drove how strategic decisions got made. In B4B , we called it the B2B Decision Totem Pole:
In B2B suppliers today, the chief executive officer (CEO) is obviously the final decision maker. But what really happens is a strategic thought process conducted by a collective “brain” derived from many people on the executive team. However, those people, even if they are all at the same executive level, do not always have the same influence on the collective brain. The people often have a sort of status rank, almost like a totem pole.
In most large high-tech and near-tech B2B companies today, research and development (R&D) and sales own the two top “heads” of the totem pole. Which one is on top and which one is in second position on any given decision is not what is critical. What matters is that, as it was at NCR and at IBM, these same two influencers most often take the lead when B2B companies make critical decisions. At young B2B companies, R&D or engineering executives usually occupy the top spot. Once B2B companies become large, they come to have a huge investment in the sales force or reseller network that they rely on to provide a “return” in the form of revenue and growth. Together, the two influences work to keep sales channels fed with products to sell and optimized for coverage and quality. These become the driving considerations of the collective brain of most B2B companies. The two levers of growth are assumed to be adding products and adding salespeople.
By contrast, services and marketing are often seen as important but nonstrategic heads on the totem pole. Service quality is important because it maintains customer satisfaction and it can be a profitable adjunct to the core product business—important roles to be sure, but not strategic. Marketing in B2B companies often finds itself limited to making the sales effort easier, ideally by providing high-quality leads for the sales organization to pursue. Although B2B marketing may once have been the home of strategic planning, marketplace decision making, and business model selection, this is rarely the case today. In most B2B companies we see, those roles are ceded to the top two heads on the totem pole. Services and marketing usually occupy the spaces near the ground, not in the rarified, strategic air of sales and R&D. A key part of the sales organization’s qualification for sitting in one of the top spots has to do with its esteemed position of speaking for the customer’s wallet. If you walk into the headquarters of most medium-size or large B2B companies today and scream, “Who owns the customer?” the answer you are most likely to hear echoing through the halls is, “Sales!” That is one of the strongest legacies of men such as Patterson and Watson. They built pioneering, world-class bridges between their companies and their customers, and in most B2B companies, those bridges were—and still are— owned by the sales organization.
Because the critical success factors were what the product did and how big a sales effort you could mount, sales and R&D were the most heavily funded organizations. Currently, software companies in the T&S 50 invest an average of 28% of revenues on sales and marketing (S&M). The vast majority of those S&M dollars are spent on sales, not marketing expenses. These companies also spend an average of 18% of company revenues on R&D, making it the second best-funded organization (Figure 4.1. ).
But the complete thought for organizational structure and behavior doesn’t stop at the top of the decision totem pole; we still have to deliver our offers successfully with the customer. That dramatically expands the complexity of global tech organizations. Many functions must be performed in many places around the world. This brings us to a critical point.
FIGURE 4.1 Traditional Tech Organization Funding
In traditional enterprise tech, the only one who had a chance to master the complexity of the technology was the supplier. After all, they built it. They support it every day, all over the world. They have seen thousands of deployments, and they employ far more experts on their products than any one of their customers does. For those and many more reasons, traditional tech companies became fullservice suppliers, as illustrated in Figure 4.2. Throughout virtually every step in the customer life cycle up until the operate phase, they were in the lead. Today, managed services that help operate the technology are the fastest growing part of the traditional tech industry.
Think about the customer life cycle. For almost every major step in the journey, a separate organization inside the tech company leads it. Somehow, remarkably, the customer is handed from department to department as they make their way from being a new customer to a successful user. We call it the bucket brigade approach. And because many of these stages required activities at the customer’s site, many or most of the employees in these organizations were in the field. To ensure local command and control, the field was thus logically organized by region.
FIGURE 4.2 Traditional Full-Service Business Model
It’s a familiar story. At their founding, most traditional tech companies designed a cool new product and defined some great use cases. They would then hire sales executives to land that cool product in specific global regions. How these regional sales leaders sold the product was largely up to them—just as long as they sold lots of it! As the region grew, the sales executive had significant latitude in how they ran the region. Service delivery and field marketing then followed suit, usually reporting to the head of sales in the region. The feeling was that each region had nuances that dictated management at the regional level.
This geocentric heritage means that resources within regions often report hard line up through the region—not hard line into a central or global function. This structure has always made it challenging to land global processes consistently. More importantly, it is challenging for regional executives who are primarily responsible for driving revenue growth to also be adept at driving delivery efficiencies or globally consistent customer experiences. It’s just not job #1 for them, and they often lack scale. Over time, some functions have been globalized to create more consistency and efficiency. Global customer support is a classic example. Yet, the pull of geographic autonomy remains a strong influence on the organizational structure of tech companies of all sorts.
To make it easier and less costly to scale these organizations as they grew, they were instructed to take the same product and land it in as many vertical markets as possible with minimal customization in either the product or the surrounding services (Figure 4.3. ).
That horizontal go-to-market approach massively reduced complexity and cost for all the organizations in a tech company. It could successfully be argued that many infrastructure products, especially hardware, operated pretty much the same from industry to industry. Even most software products could claim they did the same. If the product needed to be customized to meet specific vertical market or customer needs, the customer or partners could go work on that. It was the right decision. Customers were enamored of these products. They were willing to accept that the product wasn’t a perfect fit, but its core value proposition was still compelling. They and their IT teams would make it work. So, if you were running that tech company and customers weren’t demanding vertical solutions, why would you volunteer for the headaches of coming to market differently in each industry?
FIGURE 4.3 Horizontal Go-to-Market Approach
We would argue that these are the drivers of organizational structure in the world of traditional, full-service tech:
• Sales and development are highest influence organizations.
• Each function has its own organization.
• Field functions are organized geographically.
• Horizontal, not vertical, go-to-market.
• Each organization performs a task for the customer. Many handoffs.
• Budgets weighted heavily toward execution/delivery, less on planning/design.
• Goal: Optimize the function, control the organization’s performance.
Each organization was focused heavily on two goals. The first was making their function the best it could be for the customer, usually on a deal-by-deal basis—resulting in lots of heroic acts. Most of the budget for sales and service organizations went toward employees who actually engaged customers, not ones who thought about, designed, and built an experience.The second was to control the human and financial performance of their vast organization. Most of their focus was intraoa 3. How do we optimize and account for resource investments that cut across thernizational. The most potent command and control device was the organizational P&L. They made decisions about how best to achieve their organizational goals; then, they memorialized that thinking in their budget. That budget got approved. They implemented it and held managers accountable for their revenue and costs. Importantly, because they were thinking primarily intraorganizationally, their P&L impact and return on investment (ROI) decisions were based on impacts inside their own organization. The majority of organizations inside traditional tech companies operate as siloed P&Ls. It’s a great way to get everyone thinking about the bottom line, but it also leads to intraorganizational thinking and behavior. A dollar of cost in my P&L has to result in more than a dollar of revenue in my P&L. We’ll come back to that thought later in this chapter. It also led to massive redundancies as these “businesses within the business” built capabilities that already existed somewhere else in the company. There is no doubt that this intraorganizational approach had pros and cons.
Before we go any further, we want to be clear on an important and undisputed fact. For traditional tech, this model works amazingly well. With these parameters in play, technology companies have established some of the most profitable business models in the history of business models. This heavy investment in sales and R&D combined with a geocentric bias, an intradepartmental approach, and a “one size fits all” go-to-market mentality has led to organizational structures that support highly profitable, multibillion-dollar businesses. However, these structures do have four stress points that executive teams still debate to this day:
1. How seamless is the customer experience across all these organizational handoffs?
2. What processes and resources should be optimized regionally versus globally?
3. How do we optimize and account for resource investments that cut across the P&Ls of different departments?
4. As software and IoT eat the world, how do we align resources across sales, services, R&D, and marketing to develop and land vertical solutions?
Drivers for Change
Why rethink organizational structure now? After all, the current models have served the industry extremely well for decades.
The advent of XaaS is forcing almost every technology company to rethink and revise their product strategy. We also think it is going to lead to significantly different thinking about organizational behavior and operating models. Lex Sisney is a specialist and consultant on the topic of organizational structure and has written some great articles on the whens and whys of organizational change. He states that the number one mistake companies make is that they change their strategy but keep basically the same organizational structure:
“Every time the strategy changes—including when there’s a shift to a new stage of the execution life cycle—you’ll need to reevaluate and change the structure. The classic mistake made in restructuring is that the new form of the organization follows the old one to a large degree. That is, a new strategy is created but the old hierarchy remains embedded in the so-called ‘new’ structure. Instead, you need to make a clean break with the past and design the new structure with a fresh eye.” 2
Now, we’re not advocating for radical organizational restructuring. As you’ll see, we don’t think the big organizational boxes need to change, at least in the beginning. But the shift to XaaS offers is creating several drivers for organizational change within technology companies:
1. The organizational decision totem pole needs to broaden to capitalize on the opportunities for automation and direct customer self-service throughout the customer engagement life cycle of XaaS.
2. New organizational capabilities are required to be successful with XaaS offers. They have to be identified and added.
3. You have to fix the old stress points:
a. Create a totally seamless customer experience across the life cycle.
b. Guarantee global consistency in the customer journey.
c. Possess the flexibility to share resources and spread investments across functions and engineer out the redundancies in the operating model.
d. Successfully develop and land vertical solutions (in many cases).
Let’s start our discussion with a new picture of how we think XaaS, particularly SaaS, works or could work.
In Figure 4.4 , the rectangles represent “objects” like the customer engagement technology platform. Another example would be the specific XaaS offers you can purchase and enjoy from the cloud. Together, customers might call it “the website” or “the product,” but really it’s much more. The ovals represent the organizations of the company. They are the people and functions that design, build, and augment the functions of the “objects.”They are also the organizations that may interact with customers off the platform. The big arrows represent the customer engagement process.
In this model, marketing still has to go out into the world and locate prospects. They have to hand them off to sales. Sales has to land the deal that puts the customer onto the XaaS customer engagement technology platform. It is the existence of that platform, in our view, that is going to stress out traditional organizational behaviors. Although the friction points of traditional models might have been tolerable, they become much more dangerous if left unattended in XaaS. Lines are going to blur as ser vices, customer success, sales, marketing, and finance become one big integrated motion, all delivered on the customer platform. Intraorganizational behavior and control are insufficient—even dangerous—thoughts here. We must truly increase the capacity of the organizations to think interdepartmentally. We need to think more about how one organization can improve the customer experience or create financial synergies that benefit other organizations. We have to learn to think and act with one brain, not several.
FIGURE 4.4 XaaS Self-Service Business Model
As consumers, we all experience this notion of the customer engagement platform every time we buy software or content on the web. When you go to the website, it’s going to market to you, let you purchase, and aid in the delivery of whatever you bought. It will then help on-board and train you, even provide customer support. Once you are using the actual offer, it will market upgrades or other offers to you. When you purchase those expansion offers, it will lead you back through the adoption sequence.
In Chapter 2 , we summarized the concept of the LAER operating model—the fact that XaaS offers require engagement activities that take a customer from the initial sale (land) through successful adoption, expansion, and renewal. In Chapter 7 , we will double-click into the differences between traditional tech engagement models and XaaS engagement models. For the purpose of organizational structure, though, it is important to internalize that profitable XaaS offers will need a single, unified structure that cost-effectively drives customers across the entire LAER life cycle. To achieve this, we believe marketing and services, in particular, will need to be higher on the organizational totem pole. These two organizations will need to have a strong presence when designing the XaaS offer experience.
So, what are the key organizational thoughts around which a profitable XaaS will organize or operate? Below is a list of XaaS customer platform organizational constructs:
• Current organizations remain the same.
• Add customer success, success science, analytics, and infrastructure organizations.
• All organizations work closely together to build a single customer engagement platform that lowers sales and delivery costs.
• Customer self-serves through as much of the life cycle as possible.
• Budgets weighted more toward planning/design, less on actual customer delivery.
• Far fewer customer handoffs.
• Much more central, less geographic (field) orientation.
• Goal: great, easy customer experience.
As we will conclude later in this chapter, we don’t think this needs to trigger a major rethink of organizational boxes on day one. The functions of business are the functions of business. Yes, we will need to add new capabilities and maybe even create a couple of new organizations, but we still have marketing, sales, services, and finance. What is different is how they think, interoperate, and very importantly, how they are measured.
Let’s start with what we believe should be the two overarching goals of the combined organizations (beyond product-market fit, of course):
• Great customer life-cycle experience.
• Lowering cost of sales (COS) and overall delivery costs.
We don’t need to explain why these are important. We have already pointed out how damaging a high sales cost can be to XaaS profitability. It is easy to imagine how great customer experience will make LAER operate more smoothly and achieve better results. But, let’s spend a few minutes talking about how these need to play out as part of your profitable XaaS offer.
Earlier we pointed out the important idea that traditional tech companies offered a full-service experience. This was driven primarily by the complexity and risk associated with their offers. Customers paid us, or our channel partners, a lot of money to master that complexity. In XaaS, we have a completely new ball game. Complexity is your profit enemy, not your friend. You want to make it easy for prospects to learn and buy. Configuring and tailoring the product to their needs should be something that they can do for themselves. In the course of enjoying the offer, they should be able to get help or learn about new things they can do. They can choose to add new features or offers. They can pay their bills. In short, they can SELF-SERVE!
We think this “aha!” is significant as it relates to your organizational behavior. We think it puts some new realities on the table:
• You will have more direct customers—that is going to mightily impact your traditional channel strategies.
• You will have more central resources and fewer field resources—that is going to change budgets and command and control strategies.
• You will concentrate more on planning and design and less on actual delivery—the more you get the planning and design right, the fewer the customers who will require human engagement from you in the field during their delivery and realization of outcomes.
• The lines will blur—services will make sales, finance will design experiences, marketing will appear in the product. They will all be working together on one, interdepartmental customer experience. Ideally, the customer will not perceive any handoffs at all.
The impact of more direct customers is mostly an issue for your channels organization to ponder, and we are going to dedicate Chapter 10 to that. If channels are important to your business, please take a look.
Because your XaaS customer engagement platform can be accessed from anywhere, you may find that customers from around the globe can operate successfully without a lot of local resources. That has an impact on the balance of resources in traditional field-oriented organizations. They may have a greater percentage of their workforce in centralized locations versus in-region. A great example from the consumer world is how Netflix can open up a new country with only a small team of people. Yes, they have to source some local content and comply with local legal and tax regulations, but the countries largely rely on centralized technology and corporate resources as much as possible. To achieve that lean regional model, it takes real planning and investment in the operating platform. We don’t see many XaaS companies doing this well. Either they struggle to grow internationally or they throw tons of people at the problem. Then, the geographies begin to grow, but they are wildly unprofitable. Just think of how much money you can save as you globalize your XaaS offer if you build a truly global customer engagement platform!
The point is that, in profitable XaaS, the emphasis shifts from the execution of a full-service model to the design of a selfservice model as much as possible. The goal is to spend dollars and resources once on automating a task, not repeating it over and over again in the field. We think this is one reason why AWS is already profitable when some SaaS companies of equal or larger size aren’t. Again, the key is to spend centralized cycles on the planning, design, development, and optimization of the function. That will change the capabilities and skills that organizations need. It will probably mean fewer hires that are deeply involved in the bits and bytes of technology and more that are steeped in how the customer uses the technology. The ideal staff member is someone who combines a product marketing mentality with some years in the field. After you find them, you focus them on working centrally and thinking interdepartmentally.
We predict that organizations will become more centralized, integrated, and focused on how the platform operates, and these XaaS teams will unite around a set of cross-company goals. Many departments and resources will work across organizational lines to create a single, killer platform. Often their activities may benefit other organizations more than their own. Maybe spending more R&D labor lowers service costs. Maybe more service costs result in more product sales. Maybe marketing is spending money to promote the adoption of features that lower customer success costs.
As a result, we would like to put a challenge on the table for chief financial officers in the industry: How will you develop budgeting, accounting, and performance measures that allow— even promote—this kind of cross-organizational activity? Departmental P&Ls have been the mainstay of organizational command and control. Managers could do what they wanted as long as their bottom line was at or better than plan. Then, companies added up all the departments and got to the company’s overall profit number. Adding costs against their P&L that added revenue to another P&L was usually not encouraged. In fact, many times it was a non-starter. Arguing that was a sign of weakness, and the benefiting department rarely acknowledged the effect. The fact that they did better than plan was because of something they did, not something the other department did. In XaaS, that kind of mentality can kill your profitability. So Ms. and Mr. CFO, how will you cure that behavior? We think it’s going to prove to be one of the most important contributions to profitable XaaS that internal finance and HR organizations can make.
So, again, the punch line is this: We don’t think the big organizational boxes will need to change right away. Ultimately, some may converge. At some point soon, you will need to add one new box for customer success and one for the platform infrastructure. Up front, though, we think you can stick with the big organizational blocks. We will discuss a few specific adaptations later in the book. However, what does have to change right away is how the organizations work interdepartmentally, the skills they acquire, and whether their focus is central/global or regional. Skills-wise, we think you should be looking into the regions for people with deep customer expertise and the skills to engage in planning and design activities.
New Capabilities Assessment
But what skills? Well, the second factor forcing organizational change is the capabilities gap. As this book will hopefully articulate, selling and delivering XaaS offers is not the same as selling and delivering technology as an asset. Once again, we define organizational capabilities as “the ability to perform actions that achieve desired results.” We organize the capabilities required by all organizations into the nine categories shown in Figure 4.5.
In each of these categories, there are capabilities that organizations must master in order to scale and optimize a XaaS business. Through interactions with technology companies, we have inventoried more than 380 distinct organizational capabilities. Currently, we tag roughly 150 of these capabilities as being tied to the success of XaaS business models, and we’re adding more at a brisk rate. Figure 4.6. provides a sampling of some of these emerging capabilities.
FIGURE 4.5 Organizational Capabilities Categories
You should inventory the specific capabilities needed to be successful with your XaaS offer. You need to identify the ones you already possess somewhere in the company. You need to identify the ones you don’t have currently. If you do have them, you need to locate the specific people and teams who do them well. Their capability and skills need to be centralized and amplified. They have to change jobs to emphasize planning and design rather than daily execution. For the ones you don’t have, you need to develop a plan to go get them. Maybe you need new technical skills to build the customer engagement platform. Maybe you need to hire some customers who can close any knowledge gaps you have about how customers translate your offer into business outcomes. You might need a leader for your customer success organization. It doesn’t matter. What matters is that you do a capabilities assessment. Start prioritizing and filling your gaps. Don’t worry so much about where they report to for now. Just make sure they have the freedom to work together—interdepartmentally—to make sure you improve your product-market fit and build your customer engagement platform.
FIGURE 4.6 XaaS Emerging Capabilities
Still Wanting Some Immediate Actions?
So, the forcing functions are starting to bang on your door. Your company wants to rethink the organization, and they want to have that conversation NOW! You really want specific answers to the two most common questions we hear today about how future XaaS organizational structures might be different:
• Are there any massive organizational changes we should do right away?
• Who owns the new pieces/functions?
Some caveat emptors before we attempt to answer: We are not organizational theorists. Historically, our insights have been driven by the benchmarking we conduct. We can usually test for proven best practices and relate those to the industry. However, it is still early days on the topic of best-practice organizational structures for XaaS companies. All we can do at this point in time is try to put together pieces of the puzzle from what we see at the companies we work with and marry that to our perspective on how the industry will ultimately transform. Even the largest and most successful XaaS companies are continuing to experiment. Seventeen-year-old Salesforce is constantly reorganizing even today. The point is: The winning organizational structure for XaaS is a moving target. Yet, we do believe there is a model that can provide an interesting baseline for the conversation.
In short, our best answers to these questions are as follows:
No, the big boxes of sales, marketing, services, and finance do not need to be changed immediately. If you look at the executive team pages of most leading enterprise SaaS companies, the titles of the executives look just like a traditional software company. As we said, we think that partially stems from the previous experience sets of senior leadership. They are comfortable with traditional models. We also think that the major functions are the major functions. So, if the big boxes in the traditional organizational structures simply didn’t work in XaaS, we would all already know that. However, as we will soon cover, there are several changes below the big boxes that will need to be considered.
The answer to the question about who owns the new pieces is covered throughout the book. Ultimately, there may be two big boxes added at the top. Many companies are creating chief customer officer (CCO) or chief revenue officer (CRO) and senior vice president of infrastructure roles.
In Chapter 7 , we talk about the new functions of customer success, success science, and consumption analytics. There is a lot of context-setting to our recommendations, so please read that chapter carefully. Many XaaS companies have some of these functions reporting to the new CCO role, reporting directly to the CEO. You will see that in our “org chart of the future” diagram.
Who will own the new customer engagement platform infrastructure? Ultimately, you will want a senior vice president of infrastructure who is a peer to the top execs of all the other functions. You will see him/her on our chart, too. In the interim, we have seen R&D owns it, IT owns it, the CTO owns it, and the COO owns it. There are just so many layers, and they are a combination of in-house and third-party applications. Some companies put many of the operating characteristics inside individual products initially. However, as the portfolio grows, it makes sense to invest in a single, integrated, and branded operating platform infrastructure. It is that platform that becomes most of the customer experience. It doesn’t make sense for one company to offer different shopping or payment experiences, or to offer the same service in different ways for similar products. What matters is not who ends up initially owning the platform. What matters is that the owner truly understands how incredibly important that platform is—both to the customer experience and to the cost structure of the business. It’s one of the most important tools you have to ease the burden of customer success and lower the cost of sales. Put it where it gets the most attention and investment in the beginning, and make sure it’s somewhere that considers all the heads on the totem pole to be equally important.
Wave 1 Moves
Altering organizational structure is painful—especially when departments and P&Ls are owned by executives that historically have been very successful. But, the times they are a changin’.We thoroughly believe that XaaS offers will demand organizational behaviors that are different from the ones tech companies have been perfecting since Patterson paved the way. If we had to pick, we would recommend the following six organizational changes early in the journey.
1. Consolidate portfolio management. Right now we see product managers and service marketing managers spread throughout different P&Ls within tech companies. Each of these people is working to maximize the revenue for their specific offers. Many of these offers are beginning to overlap. Where does premium support end and a managed service offer begin? Where does a managed service offer end and a new SaaS offer begin? These are just some of the grey areas that are quickly emerging. Bring all of these offer management resources together into one team. Ideally, they are part of your revitalized marketing organization, but this group can also live separately and report directly to the CEO initially as they take ownership of rationalizing all company offers.
2. Identify the key members of your platform infrastructure team. This is truly a cross-functional team that focuses on customer experience design and the technical execution of the platform. You will need active interfaces with marketing, finance, services, R&D, sales, and channels. You can actually bring representatives from each of those functions onto a centralized team or you can just point them out, leave them where they are, and simply assign them as the liaison to the platform infrastructure team. In any case, you need to start thinking about who those people will be and who will lead the technology development strategy for the platform. In Wave 2, this becomes a department of the company.
3. Establish a customer analytics team. As covered in Chapter 3 , data and analytics are a critical enabler to digging a deeper economic moat around XaaS offers. The sooner you start investing in this capability, the better. Also, this should be a shared resource being leveraged by both product and service groups within the company. Once again, ideally this capability is part of marketing or customer success, but that is not critical in the beginning. What is critical is to start building the capability.
4. Establish a customer success team. Someone in the company must take responsibility for driving customer adoption. The most common move we see in technology companies that are migrating to XaaS is to establish a new “customer success” team. We have seen this work well, but we have also seen it not have much effect, mainly due to poor implementation and half-baked commitments. If you can’t get that strong commitment, an alternative may be to establish a customer success initiative and clearly identify what existing organization will now have the charter for customer adoption.
5. Begin planning to migrate renewals away from sales resources you want focused on “land.” This is the first step in restructuring the sales motion to be optimized for the entire LAER life cycle. Some sales resources need to be laser focused on acquiring new customers or selling new offer types. By relieving them of renewal responsibilities, you free up selling cycles. Also, the renewal responsibility can be migrated to more cost-effective resources that are running a process, not a sales event. Now, we know this move may appear very risky. We recommend you work your way from the bottom up. Start by migrating your smaller accounts to this new model first. When you have proven the process, migrate larger accounts to this model. In Chapter 7 , we will provide some specific tips on how to do this.
6. Collapse the service delivery P& Ls. As a first move toward creating a global service delivery capability that can seamlessly apply any type of service expertise to any offer, we recommend all of the current service P& L be pulled together under one executive. The objective of that executive will be to maximize and integrate delivery efficiencies across all service resources— to globalize and automate as much of the process as possible. The portfolio management team sets the revenue targets across offers. The sales and customer success teams are given quota to sell those offers. The consolidated services delivery team is responsible for having the capacity to deliver those offers. That is how the combined services P&L is achieved.
7. Add a chief customer officer (CCO) or chief revenue officer role (CRO). The purpose of these two roles is to look at end-to-end processes. The CCO is looking at the customer experience, and the CRO is looking at revenue generation processes. Both are trying to optimize a life cycle, one from the customer perspective and the other from an internal perspective. Both are working across functions. They have high influence but small staffs.
Some of these first moves are easier to make than others. However, we are already seeing evidence of large technology companies making some of these required changes. In 2015, SAP made the following announcement at their annual Sapphire user’s conference:
“The different units of the services organization (support, education, consulting, custom development and cloud delivery), which have so far operated relatively independently from each other are going to merge their forces under a new “One Services” organization.” 3
EMC has made moves to bring portfolio management resources from across multiple service lines into one team that focuses on rationalizing the entire services portfolio. Another large software company we are working with is in the process of moving subscription renewal responsibilities from sales account executives to service account teams.
Still not enough? Here is a pick list of guiding principles and specific actions we would encourage you to consider as you think forward. Pick the ones that resonate with you for immediate action.
• Redundant functions focused on efficiency should centralize and standardize whenever possible. Our friend Geoffrey Moore recently published a great book titled Zone to Win . 4 In that book, he discusses the six levers companies can drive to wring out efficiencies. Centralizing functions and driving common standards across regions are two key levers that Geoff and we advocate. This is a particularly good thought for services and customer success.
• Maximize the ability to share resources across organizational lines. Instead of running into the departmental P&L wall, the organizational and P&L structures should facilitate the ability to assign diverse resource types in various scenarios. This could include delivering a new managed service, building more service enablement into the products, or working cross-functionally with a high-potential account that is lagging with adoption.
• Separate long-term focus from short-term focus whenever possible. This is another Sisney observation where we agree. This is why sales (short-term focus) and marketing (longer-term focus) should not be combined into one organization. The same exists with offer development and offer delivery.
• Leverage proven best adoption practices across regions. Driving customers through the entire LAER life cycle will be a process that will be highly leveraged by both data and proven customer success science. We predict that asking individual regions to solve this adoption Rubric’s Cube in their own way will prove suboptimal. Leveraging proven best practices across regions will be a necessary approach to accelerating customer success. It also provides the benefits of creating a consistent customer experience for global customers.
• Expand sell in a cost-effective manner. Historically, the main sales organization has owned all selling activities, from the initial landing of the customer, to any expansion large or small, and for any renewal activities. Not only do we recommend a separation of land and renewal responsibilities, but we also believe the new organizational structure should be optimized to drive the lowest costs possible related to renewing and expanding existing customers. We cover this in detail in Chapter 7 .
• Educate prospects and customers through marketing in a cost-effective manner. As we mentioned earlier, the majority of sales and marketing dollars are spent on sales expenses. Marketing needs to be elevated on the totem pole and given both the funding and responsibility to create a pipeline of well-educated prospects for the land sales channel to work against. Also, marketing should have the responsibility for educating existing customers on new capabilities they should consider purchasing.
• Support vertical solutions via outcome engineering and success science. The organizational structure may need— depending on your product—to facilitate the development and selling of solutions that are designed to meet specific business challenges within specific vertical industries. To help customers achieve targeted business outcomes, technology providers need to better understand specific customer environments. This culminates in a requirement to create technology solutions that map to specific vertical industry requirements and the path customers will take to get to their outcomes. Pulling together marketing, product engineering, and service thinking into an outcome engineering function inside a success science organization to define and land vertical solutions moves beyond a “nice to have” capability. Back in 2014, John McGee, the chief marketing officer at GE Software, spoke at one of our conferences. 5 Backstage, after his presentation, we talked about the changing technology industry. John made a prescient comment to us: “At GE we realized that all technology needs to go to market vertically.”Wow, what a statement from a company that has been selling technology since 1892!
We know this is not a short wish list. Companies will not be willing to apply all of these guiding principles right out of the gate. Hopefully, you can pick a few off this list to add to your current initiatives. At a minimum, keep these goals in mind as you design how your XaaS organization will operate.
Wave 2 Moves
Once the dust on Wave 1 restructuring begins to settle, you might end up with a few further enhancements and elaborations on the big blocks of your organization structure. It may look like this after a few years in the XaaS business.
• Land sales segmented by vertical industry (if applicable). There is a sales organization or sales overlay specifically focused on landing new customers by vertical industry, not region.
• Customer success segmented by account size. There is a customer success organization that applies coverage models based on account size. Larger, more strategic customers receive one-toone coverage models. Customer success ultimately owns adoption, cost-effective renewal, and small-scale account expansion.
• Big M marketing. There is a marketing organization that owns three critical activities for the company: (1) lead generation for sales, (2) portfolio management for all the company offers, and (3) customer analytics that inform offer development and offer success. Success science may live here.
• Global customer growth team. This organization owns successfully delivering company offers at the best margin possible, having two parallel but highly integrated functions: customer success and service delivery. This organization is responsible for all the various service skills sets—from support technicians to technical educators to on-site project managers to adoption experts.
• Big-picture product development. This organization is responsible for developing products scoped by marketing in the most cost-efficient way possible. They don’t stop at features. They build in the data streams, analytics, intervention capabilities, operating model requirements, customer outcome metrics—everything needed to make customers successful and minimize LAER costs.
• Customer engagement platform infrastructure leader. The leader of this team owns the platform and works with every department of the company to ensure that customer handoffs are minimized and the experience is great. This is an organization that has technical chops, embraces best-of-breed solutions (no “not invented here,” please), and has incredible empathy for the customer.
Putting this all together, a target organization structure would look like Figure 4.7.
Here, you have added an executive who owns customer success, renewals, and expansions, as well as service delivery, and a senior vice president of infrastructure who owns the customer engagement technology platform.
We can also think about the funding for this organizational structure. Not only have the charters been altered for functions such as marketing, but how revenue is reinvested into these various organizations changes as well. Instead of the vast majority of revenue being spent on sales and product development, revenue is reinvested more evenly across these functions (Figure 4.8. ).
However, these are longer-term changes. We think you can start your XaaS journey without making all these huge moves. But, you do need to begin taking many of the specific actions we have outlined in this chapter. On what timeline?
FIGURE 4.7 Target Organization Structure
FIGURE 4.8 Funding Customer Engagement
Timing
We will talk a lot about timing in the next chapter, but a few major factors can help box in the time you plan to take for building out your profitable XaaS organization—as well as when you make public announcements, as discussed in Chapter 5 .
The first and easiest to understand is the search for talent. The people you need to empower the capabilities you want are in much demand. In this regard, traditional companies may have some advantages in that they can shop within their own ranks and within their vast external networks.
However, we think the speed advantages of traditional companies end there. That’s because two other very important considerations can delay the speed with which traditional companies can address organizational challenges. Both challenges involve dealing with expectations—the expectations of your current employees and your current customers.
Traditional tech companies who are pivoting to XaaS have to “swallow the fish.”They have to keep the traditional revenue and profit streams flowing while they stand up the new ones. They can’t afford to send the entire company into organizational shock. They need to keep the plane in the air. Disruptive new companies don’t have that problem. They are building organizations from scratch. They can build them to operate in the new model, not the traditional one. We think traditional companies must excel at communicating two central principles to employees as they make changes. The first is this is not about the new business versus the old business. Both the traditional offers and the XaaS offers are important. Customers need and want them both. Their job in the traditional business is still both financially and strategically important. After all, it is massively larger than the fledgling XaaS offers you are standing up. So, be big and proud about your role! The second point is that all these innovations will eventually reach scale, and they will get to play with the shiny new objects soon enough. Major innovations driven by XaaS will invade every offer. They will change every part of the company, not just the XaaS offers. Be patient and be a great operator. The new toys will be available soon.
The other internal struggle is going to be around existing organizational inertia and power bases—the human nature part. New companies don’t have those legacies. It is up to the leadership of traditional companies to battle these evils. They need to rally everyone around the customer-led transformation of the industry and bring the shareholders along. They need to excite everyone about the possibilities.
But, we think that the really interesting drag on the timing of organizational changes at traditional tech companies is expectations of your existing customers. If they are used to you as a full-service supplier, how long will it be before they are willing to self-serve their way through much of the journey? If they are used to demanding that their global account manager appear on site rather than e-mailing their customer success manager every time they have a question, how long will those expectations be a drag on your new plays? You not only have to bring employees along on your XaaS journey, but you also have to bring along your existing customers.
It’s a problem with a flip side to it. Some of your customers will want the new model. They will be disappointed that you are not moving faster. For those customers, you will need a road map. To have a road map, you need to make commitments. To offer commitments, some important decisions regarding swallowing the fish will need to get made. We discuss this further in Chapter 5.
However, those two customer expectations can help box in your timing decisions. The time when your big customers place ultimatums on your new capabilities sets the end date for your transformation. The time it takes for you to condition your early XaaS target market customers to consider you in a new light sets the earliest time that your go-to-market changes can take root. You can start them earlier, but you can’t scale them until your customers are ready for the new you.
So, in terms of the timing for moving to the new business organizational models, we think new companies get there first. But, here’s the one thing to remember for traditional companies ready to make the pivot. For many of your largest, global customers, it’s not about first to market; it’s about first to scale and breadth of portfolio . That is where you have the advantage over disruptive new entrants. To do that, though, you need to get the existing organizations and customers through the knothole. You need to outline your organization’s plans and incubate them so they are proven and debugged. In short, we think most traditional tech companies aren’t moving fast enough. They need to get going on changes. Expectations need time to adjust.
A Suggestion: Disrupt from Below
AWS didn’t start with a big sales force or a global service organization. They built a customer platform, started at the low end of the market, got it to work well, and then took it up-market. Their selfservice model largely negates the need for sales and service motions at most of their customers. AWS focuses on trying to engineer the entire customer life-cycle experience into their platform. That was OK for SMBs. And today, AWS has low operating costs as a result. That is why they are so profitable and can still offer the lowest prices.
But the point is, they started at the low end of the market. In their case, it was start-ups that didn’t want to build their own data centers. AWS figured out how to meet that need; then, they moved up-market. In 2016, more and more mission-critical, large enterprise applications are moving to AWS. We think that is a great approach to your XaaS transformation.
However, there is another big difference in the AWS lesson: They went to enormous lengths to engineer out complexity. In fact, that is their business. They cure traditional customer headaches by making complex computing tasks far simpler and cheaper to set up and operate. If you are a traditional enterprise application provider pivoting to XaaS, you didn’t build your products with that thought at the forefront. You focused on winning the feature war and were willing to put many people in the field or require your customers to staff up to handle the complexity that you didn’t engineer out.
Let’s bring back this picture, seen in Figure 4.9.
If you remember, the rectangles are objects and the ovals are organizations, most of which interact with the customer. Those ovals could be staffed by your employees or those of your channel partners. In either case, here’s the point: AWS has big rectangles and small ovals. The customer can get most of the things they need done on the engagement platform all by themselves. Most enterprise applications—even SaaS ones—have big ovals and relatively small rectangles. For example, they still require large professional services implementation projects to make the product work.
FIGURE 4.9 XaaS Self-Service Business Model
We are not going to debate whether enterprise applications can master complexity or remain a slave to it. Infrastructure companies argued the same thing. Now multiple IaaS companies are proving there is another way. Even SAP is on record saying that once they made it a priority, they were able to engineer out 70% of the services spending that was required of a customer to implement their products. It can be done; it just takes a commitment to mastering complexity. If you start as an SMB where the complexity is less, you stand a chance of building a platform that can host the entire customer experience for customers large and small. Get your XaaS organization to focus there first. Master the complexities they encounter. Then you can move upstream.
We are sure you’ve noticed that our answer to new organizational structure was not to throw a dozen guys into a nondescript warehouse, tell them to work together as a team, and not let them out until they have a $100 million XaaS business. That works great if you have the time. Apple does this pretty successfully, but it doesn’t change anything we are saying. At some point, you have to scale that offer. You need the big company to on-board the offer that your incubator built. It’s the same when a traditional company buys a XaaS provider. While your new offer is in the oven, how do you prepare the restaurant to offer and deliver it at scale? That’s what we are addressing. If you have that luxury to incubate, if you haven’t been sidelined too long and your large customers are still patient with you, then this is the way to go. But if not, or if you have done some acquisitions and the mother ship isn’t doing much good with them, you may have no choice but to rattle the organization and move quickly.
In the end, tech is maturing. We don’t think we will ever again see the high price points for technologies that were present when IBM, Oracle, and Cisco were built. In B4B , 6 we covered the four levels of supplier business models. Level 4 was for suppliers/providers who were willing to price as true services based on usage or outcomes. We described it as the most exciting and most dangerous of all the models, but led by Amazon, it is where much of tech is heading. As we leave this chapter on organizational impacts and before you attempt to make similar claims in the marketplace, we would ask you to keep the picture seen in Figure 4.10. in mind.
FIGURE 4.10 XaaS Self-Service Business Model
Playbook Summary
In this chapter, we put many concepts on the table regarding how the organizational structures of technology companies will change. However, in terms of working through how your XaaS strategy will impact organizational structure, we still believe the first play to run is assessing your capabilities gap.
Play :Capabilities Inventory
Objective : Determine what organizational capabilities will be required for your XaaS business to succeed. Understand which of those required capabilities already exists in the company. Determine who will be responsible for building up the missing capabilities.
Benefits:
• Helps you assess the capabilities gap. Organizational structure will not win markets—organizational capabilities will.
• Assigns ownership for specific missing capabilities.
• Starts the process of pivoting company capabilities toward supporting XaaS offers.
Players (who runs this play?) : Executive leaders of all the main functions of the company, facilitated by a resource that can identify the inventory of organizational capabilities that will be required for the XaaS offer(s) of the company.
Play : Capabilities Gap Test
Objective : Determine what aspects of the current organizational structure will be most problematic in supporting your XaaS offer(s).
Benefits:
• Aligns executive leadership on the “why” of organizational changes.
• Has a set of design objectives that guide the structure conversation.
• Prioritizes organizational changes based on impact.
Players (who runs this play?) : Executive leaders of all the main functions of the company, facilitated by a resource that can identify the inventory of organizational capabilities that will be required for the XaaS offer(s) of the company.