By: Dann Anthony Maurno
Harald Horgen knows business model transformations. The president of Bellevue, Wash.-based The York Group, Horgen has worked with B2B firms since 1993, from small to large, and in recent years has focused on helping companies transition their business models toward cloud-based subscription software and repeatable services.
He will present three sessions at Microsoft Inspire 2017, one of which is Building a repeatable IP business, alongside Microsoft Enterprise Partner Cloud Sales Lead Saurabh Rana. The session is aimed at services partners who want to build out an IP business model that leverages their existing strengths. Horgen will present a checklist that partners need to address, including target markets, sales organization compensation, customer support, and the overall organizational impact of incorporating repeatable IP.
He spoke to MSDynamicsWorld about the strategy, and a few companies that have made the leap successfully.
MSDynamicsWorld.com: Partners seem interested in repeatable IP, but Microsoft seems adamant about it. What’s behind that?
Harold Horgen: Microsoft’s big push is to drive Azure consumption, and they’re implementing lots of strategic initiatives to do that. One is to drive systems integrators and IT consultants to productize their custom IP. If they’ve done something for one company on a custom basis and if they retain the IP, there are probably other companies that have a similar problem. So, if systems integrators package their IP as a standalone product, and if the application is built on Azure, that will drive Azure consumption.
Where that ties in with Dynamics specifically is that Dynamics 365 is designed to be optimized as a development platform for third-party applications. And those applications could be vertical, specific to an industry; they could be horizontal; or they could be a specific function. But Microsoft is really positioning Dynamics 365 as a development platform as well as a standalone application.
IP goes beyond software, does it not?
Absolutely. There are a number of ways of defining IP, and we break it into three buckets based on how productization-ready they are.
If they built a custom application, then they’re one step away from having a productized solution.
The next [bucket] is business processes. I did some work with Luxoft, which is the largest outsourcing company in Russia, which does a lot of work in the US. They built an internal project management tool that they used on 60 or 70 deployments. It became standardized, effectively productized, and they built out user documentation for consultants. That’s the second bucket, where a documented business process is converted into a technology.
And the third bucket is very specific domain expertise that may not have been documented at the process; but they’ve got very deep expertise in a specific area. But then they have to go through documenting what that expertise is and developing a product.
Just about every services company that has done well did something different from the competition. And that’s the underlying message: find a way to productize that so that you can get scale and sell that on a repeatable basis, instead of having to customize that process or your domain expertise or that application for every customer.
You describe both “opportunistic” and “strategic” IP; what is the difference?
To begin with, there’s a new Microsoft initiative for their national systems integrators called “Partner Crossover.” It’s a three-phased program to help systems integrators move into a product-focused business model. I come in at the end of that where they’ve gone through scoping out and looking at the technology and deciding what can be productized. [I then] work through the business model issues if they want to now build an IP-focused business.
And we look at it from two perspectives: do they want the repeatable IP to be opportunistic, or to be strategic to their business?
If it’s opportunistic, they don’t fundamentally re-engineer their business to be focused on that IP. They put it up on a marketplace with very low-cost sales and marketing initiatives; they do some advertising, some LinkedIn stuff and other social marketing, and follow up on any leads that come in. But it’s kind of a “nice-to-have”; they don’t dedicate a lot of resources to drive volume for that product.
If it’s strategic, then they have sales people focused on it. They invest in a market program, and change their customer support to support those customers at scale.
Either way is OK. Some companies use the opportunistic approach to test the marketplace, and if they get traction, make a more committed investment in building out the repeatable IP business.
But IP revenues aren’t “funny money” – the valuation of an IP company is significantly higher than for traditional services companies, isn’t it?
In traditional services, they’re doing a traditional on-premise implementation with some customization, and bill for it as a project. That’s where you get the four- to seven-times [earnings before interest, tax, depreciation and amortization] EBITDA.
An example of the managed services business model is Avanade, which completely changed its business model from custom programming on a project basis. Most of their business today is provisioning those applications as a service. Instead of charging for the development work up front, they say “We will build the application, we will provision this cloud-based application from our data center or from Azure, and we will support it, and we will do all of this on a monthly contract.” So, they sign maybe a five-year contract at a six-month or maybe quarterly rate, rather than progress payments.
This is a fairly fundamental move for services companies, finding a way to provide managed services rather than project-based services. That greatly increases the value as a company, because an acquirer is buying an ongoing revenue stream that is almost independent of an ongoing sales process, or in many cases, of keeping the entire staff. If you sell a traditional services company, what you are selling are your client relationships and the people who maintain those relationships. If those people leave, the value of those businesses go down very quickly.
But the really big difference in valuation is in IP versus services, because IP is based on a multiple of revenues, not on earnings. In very few cases are ISVs or IP-based companies with recurring revenue models purchased based on the earnings; the acquirer is typically a larger company that’s going to feed that into their distribution channel, so it’s almost always bought as a multiple of revenues.
Even for the large publicly-held SaaS-based companies, their valuation is typically a multiple of revenues. In the case of Salesforce, it’s running six, seven to eight or ten times revenues, depending on the quarter.
Walk us through the IP maturity model that you’ll describe at Inspire. Is it that unless a company is willing to dedicate a business unit to IP, the effort may be worthless?
That’s the decision companies need to make, about productizing IP, which is something that services companies often underestimate.
They build something on a custom basis for one customer, and many services companies will lead with the IP; but each time they [implement it] they still have to customize it for the new client.
Iif they want to go to the third phase, they have to go through a product management function and become more programmatic around rebuilding the product, and then go to market around the rebuilt product.
That’s a chasm that many don’t cross, where they take something that needs a high level of services to customize and integrate each time, to something that can be sold on a repeatable basis by third parties. That requires rebuilding the product.
Nintex [a provider of workflow automation] went through all four phases of that maturity model. Nintex started off as a SharePoint systems integrator in Australia, a small services company with 10 or 15 employees. They built some cool [business process management] BPM functionality on top of SharePoint and realized they had something there. They moved to Seattle to start selling the product, and ultimately that product became so successful that they sold off the services business.
Blue Rooster did the same thing. They were a services company with 70 people, then built some standardized templates around SharePoint and ultimately shut down the services and ended up as a products company with 12 or 15 people.
I’m reminded of Harley Davidson, which famously makes more from apparel than from motorcycles. One day, they had to realize, “We’re a T-shirt company that makes motorcycles on the side.”
That is a huge issue and trend in the software industry as well. Software is becoming devalued and commoditized. The price of software in general is declining, and a lot of the existing ISVs have to find other ways of making money in the same way that Harley Davidson makes money from T-shirts and all the branded stuff.
This is what is propelling the move into big data, data analytics and IoT, as a way of monetizing data they collect from applications, because they had to find another source of revenues because there will be a steady decline of margins from the sale of software. That’s a topic for another day, but that’s exactly the Harley Davidson model; you’ve got a customer base and a core IP, but how do you customize it and not rely solely on the margins of a core product?