Businesses to Business Cloud Computing valuations have dropped off the cliff in 2016. And I mean a big cliff. Its bad! If your heavily invested in B2B SaaS, you have been puking on your shoes for all of 2016. The Bessemer Cloud Index that does a decent job of tracking B2B companies is down 33% year to date versus S&P500 being down 9.1%!! And the biggest independent SaaS companies are way down: Salesforce -24%,; Workday -42%, Splunk -47%; ServiceNow – 42%; Netsuite -49%. Athena Health -26%; Even market darling Atlassian is down 33%. If this were a prizefight, they would stop it! If cloud stocks were their own market, rule 48 would have been invoked in 2016 and circuit breakers would be getting a frequent workout.
Things have gotten so bad on valuations that revenue/market cap ratios for SaaS companies are similar to those of old line on premise software companies.
Now, I am an operator and company builder, not an investor or valuation expert, but this blog post is here to say that multiples of B2B SaaS companies should NOT be similar to old line on premise hardware software companies.
Why? Because the new B2B SaaS companies will eventually get a majority of the old line hardware/software company’s customers and revenue. Cloud computing is simply a vastly superior way of delivering value for clients.
So it’s worth revisiting why cloud computing wins over the old paradigm. I gave the “Why cloud” speech hundreds of times, while I was evangelizing the cloud for Google in 2007-2013. In these troubling times, it’s worth revisiting my old notes, which are more true and relevant today.
Cloud Computing has four incredible, mind-blowing benefits over the traditional on premise hardware and software model. I will list them in order of importance: 1) Speed of deployment 2) Elasticity, 3)Security and 4)Cost.
Speed of Deployment
On premise hardware and software programs are unbelievably slow to write, deploy and update. And by unbelievable slow, I mean we measure cycles in increments of decades!!! No, I am not sh*ting you here. It is highly typical for companies to take 5-10 years to deploy new applications or even new functionality on existing applications. Don’t believe me. Read on!
The best software company in the world is undoubtedly Microsoft. There are other great software and hardware companies, but none is a good as Microsoft. They have ~$100B in Annual revenue, Earnings of ~$25B; Market Cap of $400B. There is a reason Gates is the richest man in the world. His company has the undisputed king of the on premise software world.
Now how fast was Microsoft with on premise software? Fortunately we can easily track how fast they developed software because they did us a favor my naming their products by years. Here are the major release cycles of the world’s most popular application program, Microsoft Office:
- Office 95
- Office 97.
- Office 2000,
- Office 2003,
- Office 2007,
- Office 2010,
- Office 2013,
- Office 2016
So, on average they release software every 3 years. Every 3 years!!! And that’s from the best software company that the planet has ever known
Worse than that, customers would not or could not easily deploy new software, and they would often be years behind those release cycle.
When we launched Google Apps in 2007, I went to see General Electric. This company is the hallmark of management practice, an example for all of how to run companies. GE bragged that it spent $4B on IT. Surely they were faster. Nope. When I went to see them in 2007, they were using Office 2000 products and would do so for another 3 years. GE users were forced to use software that was 7 years old. Can you imagine using technology that is seven years old? Can you imagine a mobile phone that is seven years old? Would you buy from Amazon if you were using their website from 7 years ago!!!!
Ever wonder why, it takes the United agent, 500 keystrokes to change your flight or your seat. Its not the agent’s fault, he is using on premise reservation software that was originally written in the Nixon Administration!!!
The cloud allows massive improvements in speed of development, deployment and end users get functionality quickly and seamlessly. Applications design and development is less monolithic. Cloud applications can be updated in real time, you don’t’ batch up features and release them every three years; you introduce them as they are developed. At Google we could put new features in every day or every week. Secondly, because true cloud applications are essentially centralized version NOW, multi-tenant instances, they are orders of magnitude less complex to deploy.
I could go on, but you get the point. End users are now accustomed to constantly updated cloud applications liked Facebook, Google, Amazon, Snapchat, etcetera, they are not going to put up with using enterprise software that is a freaking decade old!!!!
Cloud applications, at least properly architected applications ones offer the ability to cheaply and easily build applications at scale that can withstand heavy loads without significant performance degradations. Better yet, you can rent the computers and software stack from cloud vendors and only pay for what you use. If your application is a flop and there is not much usage, you don’t pay much. If you application is a hit, you application won’t crash while you are ordering hardware and installing software.
This is especially important for your most crucial applications, your customer facing applications. These applications might need to scale to hundreds of thousands or millions of users and have very spiky workloads. On premise hardware and software model was largely designed for internal applications – those used by company employees. In the pre-cloud days, only GE, Wal-Mart and GM type companies had to worry about scale on applications. But when the cloud age hit, many companies delivered computing to their customers where scaling is paramount, and performance is critical. Further the Internet age was accompanied by globalization, so for the first time IT departments had to build globally scalable applications. Most modern cloud applications come with built in global scalability, if you build on premise applications, you will be building data center capability globally.
In the on premise world, we would estimate workloads, build capacity for peak demand, deploy hardware and software into multiple datacenters and hope the application was a hit. If it was a hit, our servers crashed and we scrambled to build more expensive infrastructure. If the application was not a hit our software and servers sat idly by, burning up cash by the minute.
In the cloud, you can let others worry about this. Hardware and software infrastructure are much more elastic. Build the application, run it in cloud and forget about estimating workloads, determining server capacity and factoring in lead times for hardware and software deployment.
It is still sacrilege to say this. But I said it in 2007 and I will keep saying it. The public cloud is much more secure than traditional on premise software and hardware. Security is a benefit of the cloud, not a liability.
I am not saying that you should not do deep security due diligence on your cloud vendor. You should. You can build crappy cloud apps, but most people don’t and securing cloud applications is much easier than securing on premise applications.
The reason that cloud applications are more secure than premise applications is that security for on premise applications is a virtually impossible task. Let me explain how impossible it is for even the richest and most competent IT organizations.
Everyone will agree that all software is vulnerable. It must be continually patched. We are now paying outsiders to continually hack our software, identify vulnerabilities and then quickly issue fixes and parches for that software.
So the key to secure applications is the ability to patch quickly.
Traditional on premise applications are highly decentralized. They exist on many servers. We are talking 10’s to 100’s here. And software is deployed to desktops where there are 100’s to 1000’s of those computers. So even with virtualization and automated patch systems the task is massive. If you are Fortune 1000 company, you may be able to cobble the resources together to be half way decent at this. But if you are a mid sized organization, you cannot hope to be able to handle this. (I have a great story from an old customer on this, but that’s another blog post)
Secondly, the application stack that most companies deploy is incredibly complex. Operating systems, database, application servers, countless layers of middleware. It is very complex. And those layers don’t typically come from one vendor, so when one vendor identifies a security vulnerability and sends you a patch there is no guarantee that you can deploy that patch because it may not work with the other layers of software. They will likely need to wait until other vendors catch up before they can deploy the patches. And patches are further delayed because IT departments need to do testing on the application to ensure that the patch does not break something.
Lastly, most on premise software applications are not designed to be patched and updated without “taking the system down”. This is mind boggling to young people. They can’t believe this. Amazon updates it software without closing its store, Google updates it software without taking search down, You never go to Facebook and see a message that says “the system is down for routine maintenance”. But that is how we live in the on premise world. We have to take applications offline to patch them, but our maintenance windows are getting very tight. Business is 24/7 globally, and applications are now critical to the functioning of the business. No applications, no business. So many organizations, just batch up their patches and roll them our periodically in order to ensure application stability and reduce downtime.
But that means your systems have known vulnerabilities for extended periods of time. Forget about zero day exploits, the bad guys can hack systems by using known vulnerabilities.
With on premise hardware and software, deployed in the traditional fashion, it is virtually impossible to keep your systems highly secure. We know this in IT we just don’t like to talk about it.
Cloud based systems are highly centralized, easier to patch and typically designed to be patched and updated with no downtime.
Cloud based vendors also have extremely large and competent security teams. I am not saying they are perfect, but they are usually larger and better than the IT security teams that non–IT companies can build. Security specialists are in short supply and do not come cheap. You can do your best at building a great IT security team, but in the end, on premise IT systems are like storing money in your mattress. You might feel good because your data is at your location, but its only safe if you can vigilantly protect your house. Might be better to store your money at the bank where they have professional security.
Everyone talks about this as he the main benefit of cloud. It is a benefit, but it is fourth of my list because you should do cloud, because of speed, flexibility and security. Lower cost just happens to be a side benefit of cloud and a pretty damn nice one at that.
When we introduced, Google Apps in 2007, we charged $50 per user per year. The average loaded cost of a Microsoft Exchange email box was $500 per user per year. Our systems were 1/10th the cost of on- premise software! And much of that $500 expense was not going to Microsoft license or maintenance fees. It was the cost of hardware and an increasingly large IT staff that are need to deploy, maintain , and secure internal IT systems.
Its not just Google Apps, Workday is cheaper than PeopleSoft or SAP, Salesforce is cheaper than Siebel, Netsuite is cheaper than Great Plains software. ZenDesk is cheaper than Remedy
It is not only less expensive to buy and run cloud software, but it is less risky to procure. Price entry points of traditional software are very high as large perpetual licenses need to be bought, followed by 20%-25% maintenance fees. On premise software is so expensive and risky because of its high upfront costs. On top of that, large deployment and customization charges are typical in the on premise world. And once you have deployed software, switching costs are very high. So the vendor has a lot of power in price negotiations. Maintenance fees were about 12% when I got in the business in the mid eighties. They are now 20-25%.
Cloud based software is purchased annually with no exorbitant upfront costs. If you don’t like the software or your needs change, you simply don’t renew. You don’t need to marry your cloud software, you can just date it.
The cloud will win. It is a simple matter of fact. I don’t know what is going to happen with valuations, but I do know who is going to win this battle.
So if you are an investor, entrepreneur or employee of a B2B cloud company it is ok to hyperventilate or puke on your shoes. But take a deep breathe because the cloud wins!