Defending the (Enterprise) Unicorn

The unicorn is under attack. Not a day goes by now where the tech press is not publishing a “Who will be the first dead unicorn” story. Every tech conference contains lots of fireside chats where we opine about the overfunding of late stage companies. We also seem to now be drawing parallels between what we are seeing in 2015 and what we saw in 2000-2001.

 

unicorn

So while everyone is freaking out. I would like to write a defense for some of these unicorns and more specifically for the Enterprise unicorns. But first some caveats. I am not saying that all Enterprise unicorns are all huge winners and I am not saying that some of the Enterprise unicorns are not potentially overvalued. I am also not saying Enterprise tech companies are not immune to dying or being sold for scrap. Indeed, while Webvan and Pets.com were B2C companies and became the poster children for Web 1.0 bubble, There was plenty of Enterprise tech carnage to go around. Remember these names: Ariba, CommerceOne, Epiphany, i2? I don’t need to go on, it is too painful.

So with those caveats, let me lay out 5 reasons why there is no overarching crisis in Enterprise Tech valuations.

1. Enterprise Tech valuations are high, but not as high as B2C tech companies.

The really big private company valuations – the so called decacorns- are Consumer plays. Uber, Xoami, Snapchat, Pinterest, AirbNB, Flipkart all have valuations over $10B. The only pure Enterprise company in the $10B plus club in Palantir. And that is a very special and secretive company. Dropbox is a 50/50 play and valued at $10B.

2. Even if B2B Tech companies are overvalued, a Web 1.0 meltdown won’t happen.

This is is the most interesting thing about the unicorn attack phenomenon. I believe that unlike 2001, Enterprise tech companies are real businesses with great recurring revenue and many happy referenceable customers. In 2001, companies bought a lot of “exchange and procurement “ software from CommerceOne, but few if any every got live and the chance for repeat customers and new customers from references dried up real quick.

If Enterprise unicorns are slightly overvalued, it will not really disrupt their business. The investors, founders and employees will all make a little less money. Even the late stage investors appear to be protected by so called ratchet clauses. So in the end. if valuations are toohigh, I don’t think we have a fundamental problem.

The only risk here is that companies might be raising too much money at high valuations and not moving towards businesses with strong gross margins, acceptable customer acquisition costs and high customer retention rates. But the Enterprise SaaS model is getting well proven and I think highly valued Enterprise tech management teams understand this and are not making the types of mistakes that we saw in the first meltdown.

3. Enterprise Tech SaaS business models are inherently strong and will stand the test of time.

Enterprise SaaS is a great business model.  Contracts are typically annual commitments and renewal rates tend to be quite high. Modern Enterprise SaaS is easier to implement, time to value is quick and enterprise customers are not fickle as consumers. Ie – they don’t change their technology stacks very often. The bottom line is SaaS companies have predictable repeating revenue which makes a great business.

Secondly, gross margins tend to be good. The business is pretty simple. You charge customers  for usage. Your cost to deliver that service tends to be predictable and has high economies of scale. Most Enterprise Saas is multi tenant, so you make the software once, run it in a single or few instances. So at worst , costs scale with revenue, but more likely marginal costs drop as you add customers. That is very good!  Also, they don’t run our their data centers anymore, they run on Amazon or Azure or Salesforce. We don’t have big upfront expenses to get our business going, because we just rent compute and storage.

Customer acquisition costs can be high, but nowhere near the high costs in consumer tech ( see Fanduel or Draftkings). There are now well established models to acquire customers without blowing your bankroll and with proper investment in customer success teams, you can keep and expand customers for a decade. That makes for great margins.

Not only is this model, way better than the on premise model software model, it is much simpler that the B2C tech models that exist. Don’t get me wrong, I would love to have a advertising model like Google or Facebook, but Consumer Tech business models do not offer the type of predictable revenue and solid margins that Enterprise Tech does.

4.The trend to replace on premise software and hardware is irreversible and we are still early in the cycle in most categories

Enterprise Tech Unicorns are largely SaaS plays replacing or extending functionality provided by  on premise software vendors. The on premise software model is hopelessly broken  In those models, customers pay for a perpetual licenses and then pay about 20% per year in “maintenance fees”. Customers are also heavily incented to pre-buy software and even buy ‘all you eat” licenses. This led to a ton of shelfware, where many,many licenses go unused. The on premise software model was also famous for long expensive implementations, where time to value was measured in decades. The old model was famously inflexible. Even if you got the software implemented in was incredibly difficult to upgrade due to the massive complexity of a traditional on premise software/hardware stack. Lastly, the on premise software model is an incredibly insecure environment where tracking and applying multiple patches to many layers of the software stack lead most companies to have long periods of time where known vulnerabilities remain unpatched.

Enterprise SaaS solves almost all the problems caused by on premise software and with the possible exception of CRM software, most categories are early in adoption/replacement cycle.

5. Almost all traditional Large Enterprise players are not well positioned to compete with Enterprise SaaS.

The new Enterprise unicorns largely compete to replace solutions from Old tech – IBM, HP, Oracle, SAP, Cisco and Microsoft. With one notable exception, these companies are not well positioned to compete in SaaS organically. They have typical innovator’s dilemma problems and their size and age makes them less than nimble competitors. They also typically have little large data center, cloud experience and have difficulty attracted the employees with the skill set to compete in the new world.

I must say, Microsoft is the exception here. Their Bing and former Hotmail consumer products gave them some great cloud DNA and they have done a decent job with Office365, Azure and Dynamics. So don’t count them out.

But other than Microsoft, Old Tech is not likely to outcompete Enterprise unicorns. And in fact, their large cash hoard and slow growth rates make them ideal acquirers of Enterprise Unicorns. ( See Eloqua, Taleo, Responsys, SuccesFactors). Stock buybacks can’t buy you top line growth, so stay tuned for a more robust M&A market.

So there you have it. Enterprise Unicorns are in good shape at a macro level. Quit fretting, If you want to worry, go worry that Snapchat’s $16B valuation in a company without a reliable revenue model. Leave the Enterprise Unicorns alone. They will be just fine.