Archive for the 'Strategy' Category

A response to Telco’s and Disintermediation

A guest response to this post, written by Paul

Ok I confess, I’m the other party Ben is referring to and yes I work for a Telco. I’m posting this because Ben kind of got the gist of my argument a bit wrong.

So in order to clarify here’s my starting position.  I really like SaaS. I believe that SaaS and Telcos go really well together. I believe that SaaS providers underestimate their reliance on Telcos (and I’m not the only one - see this from Gigaom and the unreasonablemen.net). I believe that Telcos don’t really understand the internet that well in general.

The starting point of my discussion with Ben was that I was reading this report from Heavy Reading - Reinventing the Telco. I personally hate the document, I think it asks all the wrong questions, having said that it has some interesting facts within it.

I was discussing implications of Telcos and SaaS with Ben, and Ben then asked me what would happen if the Telco got disintermediated at the transmission layer by an application provider.  This hypothetical application provider would swoop in, change the game and everything would be cheaper and paid for by the services on top of the network.

I told Ben that it won’t happen for a  lot of technical and commercial reasons. He replied with his standard response of mass disintermediation and the services ruling the world. I told him he doesn’t really understand the dynamics at action here. (with IM one gets quite blunt!)

This is my reasoning .

First some scene setting. A direct quote from Heavy Reading.

Microsoft & Google bestride the internet like twin colossi, yet between them earn less than a single large incumbent Telco

Added to that MS and Google are global entities, incumbents are normally based in one nation. Bingo - perspective.

It would take a lot more money that either of these companies have to build a global network (what’s the point of a regional one?). That means they would have to either borrow, or convince their shareholders that they will get a fantastically good return on the capital invested if they got into the network game.

Either way, it means that the application provider who moves into the network game HAS to get a good return on its investments. (That is operate at super-normal margins or “telco margins”)

Let that hang for a second…  What that effectively means is that if Google did this they COULD NOT tank the network margins…they need them to repay the debt they owe to the shareholders. It doesn’t actually matter if you use either of Ben’s formulae for making money.

Total cost = (Telco pipe price + Margin) + (Web Service Cost + Margin)

Total cost = (Network Cost + Web Service Cost) * Margin

Because if you are Google in the network game, and do the second option, your pricing is going to be so high (to get the return on capital invested) you will effectively price yourselves out of the application game.

As a working example, you could get hosted email for $2 per seat from Zoho, but Google with its network cost and associated margins (and its need to repay the faith its shareholders put in it to invest in networks) would be $5 or 10 per seat, the actual numbers are irrelevant.  The fact is they would be an order of magnitude out… and that means no game. If you do the first option, well then you are a Telco…

For Google things are even more desperate. Eric Schmidt (Google CEO) has the unenviable job of trying to deliver on market expectations that are quite simply unreasonable. Google’s PE ratio is 40, Microsoft’s is 17, BT’s is 11. That means that the market out there is paying $40 dollars for every dollar of earnings from Google. Essentially Google’s shareholders are expecting growth in profits, lots and lots of growth, twice as much growth as MS and 4x as much as BT.  This doesn’t leave Eric and the boys a lot of room for being egalitarian. What it does point to is a company that will try and maximise the margins on any industry it enters… in fact they could be worse than the incumbents!

My final point with Ben was that if Google or MS did play this way, eventually the titans would respond and they’ve got deep pockets. If the Telcos (many who still own directories or have massive databases of users) wanted to get into the online advertising market…lets say for free (ie keep your internet with us and we’ll give you free ads) then Goggle is in trouble. I’m saying that the threat response such a move would illicit would (over time admittedly) be very very serious for Google (by the way, this isn’t a post about Google - similar moves could be done for CRM, hosted desktop applications etc).

The answer I think lies somewhere in the middle. Telcos don’t get the internet and generally speaking aren’t good at innovation, applications providers don’t understand the network but are good at innovation and services. I think a symbiotic approach would work best because as the diagram from the unreasonablemen.net points out, the service experience of SaaS customers is dependant on both elements working.

I would say that Ben is fundamentally wrong in his assertion that Telcos don’t understand the long tail. Its what they do, they make a little bit from a lot of people. Think about it, the average subscription to a Telco is less than a SaaS seat cost. They do this on top of massive infrastructure costs and are still successful. I’d argue that in fact, SaaS providers could learn a lot from Telcos in that respect…

Disclosure, I work for Gen-i the ICT division of Telecom.

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On telcos and disintermediation…

A friend of mine works for a Telco and of late we’ve been debating the prognosis for Telcos in the face of threats from internet businesses. He gave me some figures detailing the revenue of some internet businesses versus some large Telcos (obviously the Telco’s revenue was massively bigger than the internet companies), and reminded me that al these web services we love to use rely on a Telco providing the network layer.

His perspective then was that all the SaaS businesses in the world are mere leeches, wholly dependant on Telcos to earn their dollars.

Given the current status quo of course he’s right - but in this age of mass disintermediation, there has to be another alternative.

What’s to stop a massive internet player from disintermediating the network layer - building massively scaled wireless networks that obviate the necessity of using the current Telco’s networks. Forget for a minute the arguments about the efficiency of DSL vs Fibre vs WiMax and think about the concept here.

Currently Telcos make their money from network provision - sure they talk abut being service companies and selling value added products - but essentially it’s about providing pipes. As such you have the following equation for a web service;

Total cost = (Telco pipe price + Margin) + (Web Service Cost + Margin)

So let’s, in the words of Tony Blair, find a third way. Imagine a world where (for want of a better example) Google owned an alternative network. The equation in that instance would look like this;

Total cost = (Network Cost + Web Service Cost) * Margin

In recent days we’ve seen rumours of a plot by global Telcos to create some sort of Skype rival, surely this (if it’s true) proves my contention. The Telcos are trying to disintermediate the disintermediaters, creating a point to point offering that is vertically integrated.

My friend pointed out that, given the wildly higher revenue and market capitalisations of the telcos, compared to the internet players, it’d be more viable for them to do the integrating. While I agree that it would be easier from a capital point of view for the process to work this way, we come to some cultural roadblocks that, in my mind, make it more plausible for the internet players to win.

Telcos have grown accustomed to mega-profits and and large ARPUs, it’s hard to take that model and morph it into a long tail one where you make billions a penny at a time. Yet this is the very model that long tail providers are used to - they’re more likely to be able to stomach a lower ARPU, a lower margin and a more aggregative revenue stream than Telcos. Add to this the fact that Telcos have fixed infrastructures they wish to protect and the result is quite some barrier to Telcos winning the war.

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It’s about collaboration, not service transition

I posted last night about Zoho allowing logins with Yahoo and Google user details. This morning my feedreader has been inundated with posts about this very topic. Most see the wood for the trees and identify this as a major step for collaboration.

On a post over on Zdnet however I read something a little disquieting when it was suggested that the main feature needed was the ability to import documents en masse into Zoho.

In my opinion this comment misses the point - it’s not about trying to facilitate users to make the shift into another walled garden, it’s about breaking down the walls and allowing people to play, no matter which garden they’re hanging out it. Zoli has it right when he says;

Why not just make all documents available to online users, no matter where they were created? You should be able to list your Google and Zoho documents, open them, edit them, and save to whichever format (and storage) you want to.

Maybe it’s Zoho’s private ownership that allows them to chart a path that seems more in tune with this open garden approach - time will tell how that strategy pans out for them.

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Xero year end results…

Hot of the press are the Xero year end (at 31 March 2008) financial reports. Key highlights include (with my comments in italics);

  • Revenue from subscriptions of $134,000 less than expected - key will be the figures to the end of May 2008 - projected  revenue from the prospectus is $550000
  • Operating expenses of $5,146,000 that’s a significant burn rate which is fine if revenue ramps up significantly
  • A net loss for the year of $4,310,000
  • Cash and bank balances of $9,517,000

An interesting read is the unaudited comparison between the results and the projections detailed in the prospectus - again with my comments in italics;

  • In the 12 months since Xero’s Offer Document was issued Xero achieved 1406 customers. 1300 were forecast. but at a lower subscription rate than forecast - is this what Chris Anderson meant about the “trend towards free”?
  • Generated revenue in the United Kingdom while no revenue was forecast from either the UK or Australia in the first year. awesome - it’d be interesting to know what those revenue figures actually are
  • Receipts from customers of $213,000 was lower than the updated (February 1 2008) forecast of $250,000 - $350,000 for three main reasons not sure why receipts from customers figure is different from the revenue from subscriptions figure - perhaps Rod can advise?

the assumed average pricing is $75 (plus GST) per customer per month, based on Xero’s current level of functionality. There will be no significant change in pricing during the prospective period.

  • The customer growth curve Xero experienced was weighted towards the end of the period as sales accelerated at the commencement of the 2008/2009 financial year hmmmm - but it’s hard not to think that anyone contemplating signing up for the 2008/2009 would have done so prior to 1 Aprl and would therefore be included in these figures
  • Greater focus on accountants in the first year, and their request for Xero to spend more time on the core accounting engine rather than value added services. Therefore average revenue per customer was less than the assumption included in Xero’s Offer Document which can only but suggest that either the focus on accountants strategy was wrong or the prospectus projections were flawed
  • Less new customers than expected took advantage of the option for a one year in advance payment discount, preferring to pay monthly
  • arguably the primary reason for the lower revenue than projection  (especially given the higher than expected customer count) is the fact that Xero had to drop it’s subscription rate from that indicated in the prospectus. The following is a direct quote from the prospectus;
  • Costs were less than forecast and interest income was greater than forecast resulting in a better closing cash position by $613,000. Closing cash balance at 10 May was $8,991,000 compared to $8,378,000 contained in the Offer Document
  • So overall an interesting result, nothing o shout from the rooftops but not completely off track either. Bottom line is that Xero needs to ramp things up - fast!

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    SAP and SaaS again…

    Recent announcements by SAP that its long awaited BusinessByDesign SaaS product would be significantly delayed has got the commentators buzzing about the issues facing SAP. It’s been said a number of times in the past that there is a big difference between the business model, revenue stream and development cycle of SaaS versus traditional software. These differences are such that it becomes very difficult for traditional software businesses to reinvent themselves into SaaS businesses.

    An interesting post over on this blog looks at the particular issues facing SAP in its quest to introduce a SaaS offering. Specific takeaways include;

    • SaaS is designed to reduce complexity, but SAP spent nearly four years developing Business ByDesign — and precious little of that time apparently went to coming up with a workable license model (read big ugly expensive offering)
    • SAP doesn’t seem to understand that SMBs don’t necessarily want an entire software stack from the same vendor (read SMBs like the aggregation of multiple services - they’re generally not looking for an all-in-one deal)

    Bottom line is that reinventing a big bloatware producing ISV into a slim SaaS provider is a big ask - as much culturally as technologically - can SAP do it? I’m not putting any mney on it

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    And more on Datacentres

    Microsoft acknowledges that it is adding 10000 servers per month to its existing datacentre capacity. It’s new Chicago server farm alone will be able to pack in 300000srvers. MS has the scale to justify this sort of expenditure and infrastructure build, it’s busness model is after all based around software+services, that combination needs lots of storage capacity.

    So why on earth does Facebook not source a hosting deal from Microsoft (who after all are a partial owner of FB)? The details of Microsoft’s datacentre-in-a-container interesting for those with an engineering bent. Here follows a couple of videos detailing what Microsoft s up to.


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    On why Facebook borrowed to buy hardware

    Yesterday I queried the Facebook strategy of owning it’s own datacentre infrastructrue - especially given it’s (hoped for) growth and the prevalence of other scalable, cloud based third party hosting solutions.

    Henry Blodget asks another question in this post this morning. The main thrust of his post is that the MS deal last year valued Facebook at $15bill. The easiest for them to pay for the hardware they need would be to flip off a little more stock in return for cash. Henry contends that the reason they’re borrowing (which puts all the shareholders at risk if Facebook ever loses value) is that they’re not able to sell equity at the sort of valuation they need to to avoid people getting fearful that the entire business was over-hyped.

    Short term it’s no big deal, but at some stage the shareholder will start to squirm that debt keps being taken on to fund growth. Very soon the wolves will start baying demanding either;

    • A clear monetisation path (and at the sort of rates that are commensurate with the valuation)
    • An equity sell down (which needs to realistically be at least at the most recent sell down valuation

    Both of these options are hard to envisage in the current climate.

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    Why would you do it?????

    I’ve just read that Facebook have just raised USD100mill all to “invest” in new servers. Apparently they’re going to move from the 10k current to 50k servers. Questions;

    1. 40k servers costing $100 million. That’s UD2500 per server. Sure there are some related real estate and infrastructure costs but this seems pretty excessive (especially at the sort of deals FB must get for hardware)
    2. Given that they’re spending this sort of money, why don’t they just move to a cloud computing model? Fact is if they’re to continue to grow (and they don’t seem to share my scepticism abut that), they’ll need to be able to scale their infrastructure. They need something elastic, self hosting doesn’t give that degree of elasticity
    3. Seems like a bit of a strategy straight out of legacy business models to me
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    Telecom - talking and listening…

    A comment on an earlier post seemed worthy of it’s own discussion. Relating to some earlier posting about Telecom’s plans re SMEs and SaaS, I’m stoked to see that Victoria Crone from Telecom has both read the original post, and fronted up and replied.

    In my opinion it shows a willingness on Telecom’s part to move away from its closed non-communicative ways of old, and to enter into dialogue, be it positive or critical.

    Victoria’s post is copied here for those interested in where these projects are at;

    Victoria here from Telecom. Thanks for the comments here everyone, it’s great to see the level of interest in what we’re trying to achieve. Here’s an update on where we’re at.

    The new Telecom Business site has gone live, with information on all our services in a much easier to use format and can be found here http://www.telecombusinesshub.co.nz. We’ve had good feedback on this and are always keen for more. This is just the start. We’re in testing now for the next update which includes the domain and web services mentioned above and that will go live soon (sorry, can’t give exact dates and as you’ll know not everything goes smoothly in large scale technology projects!!) We have a lot more planned for this site. Concerns have been raised about our ability to understand and be relevant to business. We’ve been working with many smaller sized businesses over the past year, and have just confirmed 100 or so across the country that we’re working with directly on developing our services. So I guess what I’m saying is we want your feedback and if you’re interested in working more directly with us we’re keen as mustard.

    It’s clear that bloggers are critical and sceptical of our ability to deliver this and we’re held to a high standard. So we’re working very hard to make sure what is put out is robust and won’t disappoint therefore we’ve been testing, trialling and in beta for a whole lot of stuff. A couple of examples, not enough space to go through them all (!) - we’ve trialed a new approach to the broadband help desk for business customers and we’re hearing it’s way better so we’re working through moving it from trial to launch - we’ve also been in trials for Managed Desktop services and are learning heaps about how we bring this service to the NZ businesses.

    Re: SaaS, I’ve had a number of SaaS companies in NZ and internationally approach me based on March announcements. Personally, I’m conscious that this market has been tried before so taking learnings from the past, spending time internationally to see what’s driving success and working out how we support and make this market successful in NZ is critical. I continue to be blown away by the talent and entrepreneurship in this space.

    On a closing note, as they say proof of the pudding is in the eating and hopefully the fact that we’re watching and taking part in the conversation in the blogososphere space indicates our openess.

    Disclosure - Diversity Limited is a consultant to Telecom New Zealand and its subsidiaries.

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    Another SaaS accounting player following Xero’s lead

    Freeagentcentral is a nice little accounting application out of the UK. It’s a similar offering to Xero but as Xero themselves would be quick to point out, doesn’t offer the automated bank feeds (at this time) that Xero does.

    As an aside it will be very interesting to see Xero and FAC go head to head in the UK market.

    Anyway, interesting to see that FAC have taken a leaf out of Xero’s book and have begun signing up accountancy firms as partners. You’ll recall that at IPO, Xero strongly pushed it’s strategy of partnering with accountants, seeing them as teh gatekeepers to SME uptake. Xero no doubt also realised just how sticky the incumbent solutions where, and needed to be able to have a neutral voice showing the value to be gained from changing platforms.

    FAC have signed up five accountants thus far and in a really interesting case of Quid Pro Quo, has offered a 10% discount off the cost of FAC when businesses change to one of the partnered accounting firms. The mutual benefit of this is huge;

    • The accountants get new customers and a point of differentiation from their competitors
    • FAC gets more subscribers, a group of well respected evangelists and, to a certain extent, someone else to cover service and support issues
    • Customers get a point to point service and a professional who understands the system they use and can add value beyond basic form-filling
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