Software as services

Any veteran of the software industry will tell you that version 2.0 of any product tends to be a shortlived staging post on the way to 3.0, which is where it finally hits the mark. Windows was a classic example. 1.0 was so buggy it was hardly worth using. 2.0 fixed some serious problems but still had a lot of shortcomings. 3.0, launched in May 1990, was an instant success, and the rest of the story, as they say, is history.

Don't be surprised, then, if Web 2.0 also turns out to be just a staging post on the way to a much more mature and durable Web 3.0 is going to deliver a new generation of business applicationsWeb 3.0 era. Over the next couple of weeks I'm going to be writing a series of posts about what I see as the key characteristics of Web 3.0, using a variety of on-demand companies by way of illustration. Of course I'll be mentioning Google, Amazon.com and eBay. But don't assume these companies will inevitably become the dominant players of Web 3.0. I'll also be mentioning some less obvious players, including WebEx, WebSideStory, NetSuite, Jamcracker, Rearden Commerce and Salesforce.com. Each of these companies shed interesting light on how Web 3.0 may develop. As with any shift from one generation to the next, there's plenty of scope for new leaders to emerge — and for established front-runners to stumble — in the battle for supremacy.

I'd like to make one thing is absolutely clear right from the outset: (more…)

I asked several on-demand CEOs for their views on ad-supported applications last week. Everything they said bears out what seems to be the majority opinion of TalkBack posters who've been commenting on my posts (1, 2, 3 and 4), John Carroll's (1 and 2) and ZDNet's news coverage of the topic (1, 2, 3 and others) over the past week or two.

The first person I asked was Zach Nelson, CEO of NetSuite, one of the leading on-demand application vendors. NetSuite targets small and mid-sized businesses with an integrated suite of on-demand business applications. This exactly the type of customer Microsoft is talking about targeting with its promised Office Live! on-demand services. So what does Nelson (pictured) think of the notion of funding these with ads?

"There is no way on God's earth you can fund business applications with advertising."

No mincing of words there. In fact, Nelson was so astonished at the idea that he's convinced there must have been some kind of misinformation or misunderstanding of what Bill Gates and Ray Ozzie were supposed to have said. He can't believe they seriously mean it.

I then asked WebSideStory's CEO Jeff Lunsford. I'll be writing more about his company, which offers a suite of website traffic analysis, search, content management and marketing tools, in a separate post later on. Suffice to say here that it's a leader in its field, posting $34.2 million trailing twelve months (TTM) revenue in its most recent quarter — not a cent of which comes from selling advertising.

But when WebSideStory started out in 1997, its entry-level product was ad-funded, and some low-end players in its field still have ad-funded offerings today. So Lunsford speaks with the benefit of experience.

"We used to give away analytics for three or four years. We changed to subscription because the ad revenues were too volatile," he said, adding that he has no regrets about abandoning the ad-funded model. "There’s not a track record of dramatic success for the ad model. There have been free web analytics ever since we started and we're still doing OK."

My third conversation was with Subrah Iyar, the CEO, chairman and co-founder of WebEx, which with TTM revenues of $292.4 million is arguably the biggest fish (more…)

I can't let John Carroll's latest posting about ad-supported software pass without comment, because he repeats a misconception right in the middle of it that is really central to why I get so steamed up on this topic. Here's the bit that made me fume:

"Ad-funded software already exists, though it's most successful on the web. Google makes stacks of money from ads, as does MSN, MSNBC, CNN … or even ZDNet."

Sorry, John, did you say 'software'? I was not aware that Google advertisers pay for their use of AdWords with money. Now there’s a thought.MSNBC, CNN and ZDNet were software publishers. Surely what you meant to say was 'ad-funded content,' not 'ad-funded software'? I find it simply incredible that otherwise highly intelligent people seem suddenly to be unable to tell the difference between content and applications when they're discussing the Web.

John isn't alone in repeating this canard. It seems to be received wisdom among industry analysts. According to another ZDNet news report last week, George Colony, CEO of Forrester Research, went as far as to write this in a recent column:

"Google's programs are free, funded through advertising and syndication. This is a prescient move. I foresee a world in which even enterprise applications like financials, ERP (enterprise resource planning), and supply chain software will be advertising-funded."

I'm sorry, George, John and everyone else who believes this, it's utter baloney, it really is. You can fund content with advertising (up to a point) but you cannot fund applications with it. Do you not see the difference?

Maybe it's a technology thing — geeks perceive them both as payloads, so they ignore the fundamental differences in the ways users interact with one or the other.

Maybe people get confused by Google, which makes money from advertising in two very distinct but highly sophisticated ways. (more…)

The competition for customers among CRM vendors is getting just as fierce as the fight for subcribers among the cellphone networks a few years back. Old-style phone companies used to count on signing up a customer and then taking them for granted until they moved house. Software vendors have worked on the same principle, assuming customer loyalty at least until the next major hardware upgrade forced evaluation of what was available for the new platform.

Not any more. Selling software is getting a lot more like selling cellphone contracts. As in any pack of wild dogs, the wounded former leaders become the first victimsThe vendors are after your business, and they're offering loss-leading deals to tempt you away from your current supplier. No matter if some of their new customers turn into 'rate tarts' and move on to the next new deal when renewal comes around. Most won't want the hassle of changing again.

As in any pack of wild dogs, the wounded former leaders become the first victims. Hence RightNow's offer this week of a six months' free contract for Siebel users that switch over — provided they sign up for a minimum of two years. RightNow says it has a string of customers who've already made the switch, including one that is said to have "ditched $6 million worth of Siebel software and services."

Another wise old dog is Sage, owner of ACCPAC, SalesLogix, Peachtree, ACT and other venerable SMB accounting and CRM brands. "Stone-age Sage" was how on-demand business suite vendor NetSuite described the company's offerings last week as it launched a free-of-charge service for would-be customers to migrate their Sage data to the NetSuite platform. NetSuite likes to count its "defectors" from rival platforms — take a look at the graphic at the top of this page and you'll see the company already claims to number its QuickBooks defectors in hundreds.

Salesforce.com of course, which released its third-quarter results on Wednesday, has a high enough visibility not to need to indulge in upgrade deals to entice new customers. Its Trailing Twelve Months (TTM) revenues, which I use to compare how publicly quoted on-demand vendors are doing, punched through the quarter-billion-dollar mark this quarter and now stand at just over $273 million. But despite its prowess at gaining new contracts, rivals whisper darkly of a surprisingly high churn rate when customers come to renew. There certainly seems to be no shortage of crumbs falling off the leader's table for the pack to snaffle up.

CRM customers had better get used to the idea of vendors fighting for their business, which at least ought to be good news for the quality of deal they can strike.

There are three three main ways of funding on-demand applications.

Advertising is by far the least effective of the three. It's probably a better option than selling perpetual licences for two bucks a time, but it will rarely produce enough income to fund operation and development of a service that offers real value to customers.

Subscription remains the most popular mechanism among vendors, mainly because it has the advantage of being simple to administer and easy to understand. There are two varieties, plus the option of combining them together:

• Fixed rate, for example, per user per month, per company per year, or other permutations of users and time (per project per month is another example). Customers like this arrangement because they know what their commitment is going to be upfront.
• Variable rate, where customers pay according to usage. This works best where customers can see a direct correlation between what they pay and the service that's delivered. Examples include website traffic analysis, ad serving (Whether it's DoubleClick DART or Google AdWords) and hosted storage. Notice I've cited Google here, because what it sells is more than just ads; it provides an innovative ad-serving infrastructure that has redefined how we think about online advertising. Its profitability comes from the extra value that infrastructure provides rather than simply an ability to place ads.
• Fixed plus variable. There's a strong precedent for this in the cellphone industry, where the concept is well established of paying a monthly subscription for a base level of service and then paying for extra usage above a certain threshold. It hasn't yet taken hold in the on-demand space, but it's likely to become more commonplace.

Transaction commissions are set to become the most important funding mechanism for online applications as time goes on. There are several varieties, but I'll highlight just three of the most important here:

• Trading fees. Ebay's auction service is the most well-known example of an on-demand provider that funds its service by taking a cut of the transactions it enables. Ebay subsidiary PayPal is another example.
• Service commissions. Rearden Commerce is building a business out of providing access to business services, and a significant chunk of its revenues will come from taking a slice of what customers pay for the services they buy. Amazon Mechanical Turk uses the same principle, applied to a single service.
• Aggregation fees. A variation on the above is when a platform or application brings together services and presents them to users, and takes either a commission or a referral fee when users take up the service. The prime example of this today is iTunes, but you can see it working equally well for business services. Where the services offered are highly complementary to the core application, you can imagine that it could become an important source of revenue in certain applications, and I predict this is the mechanism Microsoft is most likely to use to fund 'free' on-demand applications once it's discovered that plain vanilla advertising isn't going to work out.

I see that ZDNet's resident Microsoft apologist, John Carroll, has penned an explanation of why Microsoft will, against all common sense and logic, attempt to (and indeed succeed, he believes, where many others have failed) in funding its promised on-demand applications with advertising. John, it must said, does not in any way represent Microsoft's official viewpoint. He just writes what he thinks.

As ZDNet's resident on-demand software apologist, I too write what I think, and I would like to present the opposite point of view. There are several different ways of funding on-demand applications. Putting ads in them is one, but it's not the basis for building a viable, durable business. Bear with me for a moment while I quickly run through John's alleged reasons why ad-based versions of Windows and Office make sense, and put my counter arguments why they don't.

1. Lower prices. John mentions how some people prefer to use open source software as an alternative to paying Microsoft's extortionate, monopoly-based licence fees, and that ad-funded Microsoft apps would be an alternative source of 'free' software. The flaw in this argument of course is the amount of advertising Microsoft would have to sell to recoup its absurdly high prices. All this advertising would be so intrusive, John ends up admitting, that there would be a strong incentive for customers to subscribe to the ad-free version (or, more to the point, use a reasonably priced, ad-free alternative— probably running on open-source code — from some other vendor).

2. Lower prices. John goes on to explain that Microsoft's unreasonably high prices encourage piracy, and that if well-heeled advertisers instead of impoverished consumers were the ones lining Microsoft's pockets, there would be less incentive for users to turn to pirated copies (he neglects to consider the possibility that the advertisers themselves might choose to go elsewhere).

3. Lower prices. Microsoft wants, John says, to charge lower prices in the developing world, but if it did, this would undermine its extortionate pricing in the developed world. Advertising would neutralize this problem since it would be the developed world's advertisers paying Microsoft instead of third-world consumers (although he neglects to say how advertisers would recoup their outlay).

4. Hidden penalties. In the end, though, John seems to realize that Microsoft might find it difficult to hit its revenue targets through common-or-garden advertising, so instead he comes up with the idea that users of Microsoft's advertising-funded 'free' software will actually have to give Microsoft sensitive, personal information about themselves before they are allowed to use the 'free' applications.

"All in all, I think it's an idea worth considering," John concludes. Well, I can see why Microsoft would find it appealing. But I don't see anything here that is actually in the interest of advertisers and users, who are the people who are supposed to be  the actual customers for this proposition. Having a plausible business plan is one thing. Actually succeeding in the market is quite another. I know that some vendors are convinced of the merits of ad-funded applications, but all the evidence is that they simply don't cut it as a real-world business model.

Who is best qualified to automate a business process? In the past, a software developer was the only available choice, and the qualifications required were technology related. But the only people who really understand what the automation needs to achieve are the people who own and operate the processes — the business users themselves. Shouldn't they be the ones to create and modify the software applications that automate their work?

Nsite certainly believes they should. Last week, the company released version 5.0 of its hosted business process automation service, which uses DHTML and AJAX technologies to put drag-and-drop application building into the hands of business analysts and process owners. Both the application builder and the finished applications are served on-demand by Nsite.

Nsite, who I first mentioned in September, targets smaller businesses who typically can't afford teams of software developers or expensive packaged application solutions. The new release is leading with two ready-made applications designed to appeal to such businesses: Quote Management and Channel Management, both of which are pitched to take advantage of another feature of on-demand delivery; the ease of extending some parts of the application to external users. But the icing on the cake (more…)

Reuters reports that Peter Drucker passed away yesterday morning aged 95. The management guru published his first book in 1939 and has been challenging conventional wisdom ever since. My favorite Drucker interview is in the August 1996 issue of Wired. It begins in typically robust style:

"Will you people at Wired please accept the fact that the computer industry, as an industry, hasn't made a dime? …  Intel and Microsoft make money, but look at all the people who are losing money all the world over. It is doubtful that the industry has yet broken even."

What always impressed me with Drucker is that he ignored short-term fads and took the long view. In that Wired interview, he talks about the early days of the banking industry in fifteenth-century Europe. In an article published by Forbes in 1998, sadly no longer online, he ended by drawing a parallel between today's information technologists and the early printers of the fifteenth and sixteenth centuries:

"The IT people of the printing revolution were the early printers. Nonexistent — and indeed not even imaginable — in 1455, they flourished throughout Europe 25 years later and had become great stars … Printers were courted by kings, princes, the pope and rich merchant cities, and were showered with money and honors … But … by 1580 or so, the printers, with their focus on technology, had become ordinary craftsmen … Their place was soon taken by what we now call publishers (though the term wasn't coined until much later), people and firms whose focus was no longer on the 'T' in IT but on the 'I'."

This is the historical precedent for what we now see happening in IT with the emergence of on-demand services, in which the emphasis passes from those who sell software and the tools to run software (Microsoft, Oracle, IBM) to those who sell new views on data and information (Google, Amazon.com, Salesforce.com and hundreds of other on-demand providers).  It's not the technology that matters, it's what you do with it that counts.

Clayton Christensen's book The Innovator's Dilemma explains in detail why established market leaders get caught out by disruptive innovations. What you might call the incumbent's conundrum is knowing when to flip from supporting your existing successful products to investing in the technologies that will one day make them obsolete.

Most incumbents get this completely wrong. Microsoft has now become the latest example, as its own CTO Ray Ozzie let slip in an internal memo he recently sent to Microsoft employees:

"We should've been leaders with all our web properties in harnessing the potential of Ajax, following our pioneering work in OWA (Outlook Web Access)."

Should've, but didn't. At the time, Microsoft was intent on making sure that as few as possible users deserted the desktop environment in favor of web-based applications. Following up that "pioneering work" would have directly contradicted company strategy. Microsoft had no incentive to do anything that would hasten a switch to web-based interfaces — which is why it ignored a succession of insiders who tried to argue the case. The trouble is, other companies had no such incentive, and Microsoft has ended up following them rather than leading.

Now that Microsoft has got itself on the back foot, things will go from bad to worse for the software giant, I'm afraid. With no track record of serious investment in web-centric business models, the company has no pool of internal expertise in that area that it can draw on. That means its efforts to regain lost ground will continue to be stymied, while it will continue to waste money and resources attempting to defend its established products in areas where they have already lost the initiative (for example, attempting to supplant PDF as a format for document exchange).

Microsoft's decline will be much like IBM's from 1985-1995, when Microsoft itself was the principal agent of disruption. You'd think, given that experience, Microsoft would know better, but maybe no company is strong enough to battle its own incumbency.

If you're going to play follow-my-leader then it's always a good idea to make sure you get behind a winner. Everyone seems to be looking up to Google at the moment, but like I said last week, its reliance on advertising could be a big weakness, especially now that Amazon.com has started experimenting with monetizing the combined brainpower of its entire customer base.

Last month I mentioned that any analysis of top on-demand providers ought to take the likes of Amazon, Google et al into account when calculating who's top dog. This is a theme I'm going to return to frequently but what I'd like to do today is just take a look at where Amazon sits in the on-demand world in revenue terms compared to some of the other players, taking its recent Q3 financials as a starting point.

Most of Amazon's $8 billion-a-year revenues are irrelevant to this exercise. What I'm interested in is the small footnote in the detailed profit-and-loss called "Other revenue." This basically represents Amazon's services revenues, the majority of which come from providing online retailing services to other retailers, but which also include the contributions of Amazon Web Services. Scan down the detailed financial statements and you'll find that the trailing twelve months (TTM) figure for worldwide 'other revenues' reached $211 million in Q3. That's about 2.5 percent of the total, so it's small beer in the context of overall revenue, but it takes on a different dimension when you compare it to some of the more conventional names in the on-demand sector.

That $211 million in on-demand revenue still dwarfs the number 2 hosted CRM vendor, RightNow Technologies, for example, whose Q3 results brought its TTM revenue to $80 million. Salesforce.com's TTM to July 31st, its most recently reported quarter, puts it ahead of Amazon Services at $237 million — but only by a slim margin.

All of this is completely overshadowed, of course, by Google's five-and-a-quarter billion dollars of TTM revenue, pretty much all of which is directly attributable to on-demand advertising services. The problem that Google has to overcome if it's going to maintain that lead, however, is that it's currently a one-trick pony. Advertising is all it does, and while there's a huge amount of scope to make more money out of its unique advertising model, there are plenty of other forms of economic activity that haven't yet been monetized.

That's why Amazon's Mechanical Turk is such an eye-opener, and a reminder that there's still everything to play for in opening up new opportunities for on-demand services. Here's the view from Dion Hinchcliffe's Web 2.0 Blog:

"… the Mechanical Turk service is fundamentally open ended and not tied to any specific product type or service offering, as long as it can be quantified into something they call a HIT (human intelligence task). This makes the Turk a kind of meta long tail that has farther reach than a product specific long tail … Amazon is clearly engaging in radical innovation years after entering the market and isn't afraid to keep taking risks in the market either."

And here's Peter Cashmore's warning not to underestimate Amazon (my emphasis added both above and here):

"While we’re all coming to terms with our Google obsession (apparently their lunches were more interesting than anything else on the web last Friday), companies like Amazon are quietly changing the world - and getting away with it! … If Web 2.0 is about people, peer-production and massive scalability, then by anyone’s standards Amazon has just launched the ultimate Web 2.0 product."

The considered opinion of these observers (and mine) is that Amazon is clearly still a force to reckon with. I would say eBay probably also retains a powerful capacity to surprise us all. And along with Google and a few others, they all have the potential to make a huge impact on the way the on-demand market for conventional applications evolves too.