Enterprise software companies have always made a small fortune from annual maintenance and service contracts. In the go-go-go days of the late 90s, most investors and industry observers paid little attention to maintenance renewals though, because:
A) License revenues were far sexier (and the driver of growth and new business)
B) Virtually every software company enjoyed 90%+ renewal rates
But in the last few years (read: post the bubble), as enterprise software has undergone a period of maturation and consolidation, maintenance revenues have become a focal point for the industry and the investment community.
- M&A valuations are being driven by the expected present value of future maintenance and support revenue streams (because they're annuity-esque)
- Renewal rates, while still quite high, have started to widen making it easier to tell the "haves" from the "have nots" (if you're renewal rates are falling, that means your strategic value as a vendor is probably weakening)
- Ondemand and subscription pricing models are starting to call into question the economics of premium maintenance contracts
- Consolidation (e.g., Oracle+Peoplesoft+J.D.Edwards+Siebel+Retek) has customers wondering about the status of their existing investments and the future technology upgrade path
So it was with great interest that I had the chance to sit down with Lon Fiala, VP of Global Marketing for TomorrowNow, while as SAP Sapphire. As most of you know, TomorrowNow provides 3rd-party maintenance and service for Peoplesoft, J.D. Edwards and Siebel software. 16 months ago, SAP acquired TomorrowNow as part of its competitive initiative against Oracle and its M&A binge.
At the time of the acquisition, many assumed it was simply another arrow in SAP's quiver as it attempted to capitalize on the uncertainty surrounding the Oracle buying spree. I presumed TomorrowNow would go from an independent 3rd party maintenance provider to a funnel for SAP changeover. While that's certainly a long-term goal of the combination, TomorrowNow has, to date, maintained more independence in that regard than one would've otherwise expected.
According to Fiala, TomorrowNow's ability to maintain its autonomy is "essential to how we run the business." From TomorrowNow's perspective, being brought into the SAP fold gave them scale and financial viability that's been critical to scaling the business.
How much runway is left? According to Fiala, TomorrowNow has captured about 1% of the combined J.D. Edwards/Peoplesoft/Oracle maintenance revenue base to date. The value proposition is simple enough: all of the service for 50% of the cost. Certainly if TomorrowNow can continue to provide 3rd party support and maintenance at a high enough level of service, it would be silly to think there isn't significant growth ahead. With the addition of Siebel support, TomorrowNow is attacking a multi-billion revenue source.
- Oracle's trailing 12 month application-related maintenance and support revenues = $2.031 billion
But here's my concern...if SAP's acquisition of TomorrowNow really gave the company scale and legitimacy, was it ultimately worth it? Just as J.D. Edwards, Peoplesoft, Oracle and Siebel users see the appeal of paying less for support and maintenance on older versions, don't SAP users? Considering how much emphasis SAP has placed on Netweaver and ESA (moving to a platform), there are an enormous percentage of SAP R/3 users who might not be eager to move to mySAP apps in the near term; but will be pressured by SAP bag carriers to do so. While TomorrowNow has certainly set the bar high for 3rd party maintenance organizations, what's going to stop other organizations from making the same compelling argument to R/3 customers? SAP has played a huge role in validating the 3rd party maintenance model. Oracle has recently announced a partnership with SYSTIME to offer support for R/3 (at up to 55% discount); and other 3rd party organizations (e.g., Rimini, netCustomer) are starting to scale as the financial model has been proven out.
For now, because SAP is growing much faster than its competitors (in terms of new license sales), the trade-off has been worth it. But what happens in a year or two when their share gains start to slow down (or outright reverse)? While I believe SAP executives and TomorrowNow executives believe the ends justify the means, I'm not sure we'll know the full economic impact of this for years to come. Fiala maintained that SAP customers aren't looking for "legacy support" whereas J.D. Edwards, Siebel and Peoplesoft customers ARE because of the uncertain migration path that Oracle Fusion presents. Yet, moving to Netweaver via mySAP is in and of itself an enormous endeavor for the 70%+ of SAP customers still running on R/3.
This issue falls squarely into the "I don't know the answer" department. I DO know that customers, in a cost constrained environment, will embrace 50% cost savings. I also know that every time TomorrowNow signs a new satisfied customer they are effectively shouting to the world that maintenance and support contracts are overpriced. SAP recently unveiled a premium version of its own maintenance and support (22% annual)...how can the rationalize the value of that pricing model when they're so effectively showing the world the same service levels can be provided for half that price?
There are a lot of avenues to travel down this debate...I would love to hear from people within the industry on all fronts and how they see 3rd party maintenance trends and the pros and cons of going with a different vendor. I look forward to your comments and debate.
Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained long equity positions in SAP and ORCL.