Why True Cloud Matters

By Avi Deitcher

2015 Feb 2

In our previous articles, we discussed what cloud is, the types of cloud services, and the difference between true cloud and "market cloud", or hosting.

The big question is, so what?

You are a software provider offering a cloud solution. Does it really matter if it is "true cloud", or just hosted? Isn't it just a difference in architectural design, a matter for your engineers but not your customers or your bottom line?
You are evaluating cloud offerings. Why should you care if the vendor you choose offers "true cloud" or hosted solutions? As long as they hold to the Service Level Agreement (SLA) at the price agreed, why should it matter?

It matters. Greatly.

There two most important reasons why it matter are:

Cloud Margins
Cloud Speed

Cloud Margins

A business lives or dies by its gross margins. The higher your gross margins, the more unit profit you have to contribute to covering your fixed costs, investing in marketing, hiring sales people, improving your product, buying new technology, and returning a profit to your investors.

True cloud businesses have dramatically higher gross margins than non-cloud businesses.

Salesforce.com, the classic SaaS company, had gross margins of 75.6% in FY2014. If you remove the expensive professional services element, the gross margins on the core cloud business itself - listed as "Subscription and support" - are 81.3%! (Salesforce FY2014 10K).

While software is known to have high gross margins but high upfront R&D costs (which are current period expenses and not amortizable), Salesforce - an operations company, has gross margins which exceed Microsoft's 74.0%! Since an operations company like Salesforce must include the cost of purchasing and running all of its infrastructure in its "cost of revenues", those are truly impressive numbers.

How is it that an operations company can have such high margins? Perhaps the more accurate question is, what is it about true cloud that provides such high margins?

We will explain it, but first we need to look at the other benefit.

Cloud Speed

When I work with customers, I ask a simple first question to evaluate how true cloud their offering is: how quickly can you launch a customer?

Today, a $500,000 customer - or $5MM customer - walks in your door. They accept your contract legalese and payment terms as they are. All you need to do is guarantee their service will be up and running by tomorrow morning. Could you do it? If the answer is no, or "yes, with some caveats," or "if everyone works through the night, maybe," then you are not running a cloud service.

What if you could respond that quickly (and without breaking your entire staff's back)? What impact would it have on:

Your ability to launch?
Your ability to recognize revenue?
Your ability to sell smaller deals without hurting your bottom line?
Your ability to enter new markets?
Your cost to launch a new customer and hence your operating margins (and maybe your gross margins)?

I have worked with many companies over the years. Company A would have the first usable customer access within 6-8 weeks of signing. Company B would have a basic customer account up and running within one hour of signing. Which one is true cloud? Which one do you think was growing more quickly?

What is it about true cloud that enables such speed of deployment?

Vive La Différence

Let's work through an example.

Hosted Company

You are a software provider who decided to offer a cloud solution. Your software is built to run inside the customer's environment, and so the fastest way for you to get to market is to install an individual instance for each customer. Of course, you are quite used to dealing with these large customers. You have a well-defined contract negotiation process; your sales team knows how to customize for anyone; your professional services team is well-honed with an entire launch procedure.

When a customer wants to sign up, your sales, legal and finance teams negotiate the contracts until the revisions are done. Then, after the big signing, your professional services team sets up a launch or "kick-off" meeting, and puts together an 8-week schedule. The ProServ team, or possibly an operations deployment team, prepares the servers, launches them, installs the software, configures it, sets up the databases, configures backups, etc. Your quality control team runs a battery of tests to make sure everything works fine. Then, of course, you need to set up the security controls to ensure you have paired with their VPN correctly (a painfully error-filled process), and then you begin the integration.

All in all, it works.

Cloud Company

You have one single contract; over 95% of your customers accept it as is, just sign it digitally using DocuSign. As soon as they are done, your account manager goes to the administration Web page, clicks, "set up new customer", fills in a few pages of a wizard, and hits the "Go" button. 10 minutes later, the customer is ready to go.

The cloud company has eliminated a lot of steps, because their product, organization, metrics and incentives are completely different.

A true cloud company designs its product, technology, organization, metrics, incentives and processes around customer speed.

For a cloud company, the unique unit of a customer is not the application instance, or the database, or the firewall, or the contract, or the professional services. It is the data of the customer. Because of that, a true cloud company does everything it can to get everything else out of the way of the customer.

Customers never have their own servers, databases, firewalls, VPNs, etc. These are all just tools to help the customer manage their data, and so are shared.
Professional services are a tempting source of revenue... and a terrible drag on speed. True cloud companies drive professional services revenue as close to zero as possible without actually losing money. If a cloud company's professional service revenue exceeds 13-15% of total revenue, something is wrong. I once worked with a CEO to divest his professional services arm, even as it made money!
Contracts are a stumbling block. Standardize them, offer terms that everyone can live with, and get them out of the way. You would be surprised how many customers will simply accept what you put out there, if it is reasonable. When was the last time you negotiated new terms with Google, Facebook or Twitter?
Scaling happens when the system as a whole needs it, not when a new customer comes on board. The costs of capacity management - the infrastructure and the team - are amortized across the entire set of customers.

However, there is one very big problem to being true cloud: it is hard and expensive to get there. You need to invest in the organization, metrics, tools, and team that know how to transition you there. The benefit is that once you get there, the margins and speed are yours.

Going back to our example company above, the first company was able to switch from its existing offering to a "cloud" offering in short order. It needed hardware, middleware, data centres, etc., but its engineering, professional services, finance and legal are unchanged, while its product, marketing and sales are only minimally affected.

The second company had to scale down its professional services, build out a shared infrastructure, create management tools, reorganize its teams, change its entire security mindset.. and these are only the first investments it had to make.

But once it did, it swept away the first company on every single competitive engagement.

Summary

Offering a product online does not make an offering "cloud", no matter how many times marketing materials or salespeople repeat it. Without true cloud, it is impossible to get cloud margins, cloud speed, cloud market share and cloud valuation.

Ask yourself my evaluation question. If a $500,000 customer comes to you right now, is willing to accept all of your contract and financial terms and sign today, provided you guarantee their basic service up and running by tomorrow morning. Could you do it?

If the answer is anything other than an unequivocal YES, call us.