Hold On To Your Wallet (De-SaaS-ification 1)

On February 17, 2016, in HRExaminer, John Sumser, by John Sumser


A more accurate title might have been, “Why HR Pros should care about software company valuations.”

A more accurate title might have been, “Why HR Pros should care about software company valuations.” Clearer labeling, worse headline. While controversy gets a message heard, it may prevent it from being listened to.

Since so many fortunes have been made in digital technology, the way that software companies are valued on Wall Street is an important topic. It’s not as hard to understand as it might sound at first. It’s a critical bit of learning if you want to understand the behavior of those companies.

Maximizing shareholder value has been the nearly religious heart of modern companies for at least 30 years. (If you want to read the critiques of the idea, check out theses search results.) The complicated relationship between management, employees and stock ownership explains some of the seeming crazy things that software companies do. It’s hard to second guess decisions that make you rich even if they’re stupid and driven by artificial realities.

The stock market makes its major moves based on the risk tolerances and preferences of large institutions (banks, pension funds, hedge funds, trading firms) not on individual investor purchases. That means that the market (both collectively and in the case of individual companies) moves on the decisions of a few individuals who control significant positions. Often, they are junior team members with little or no actual experience in the things they judge.

Spreadsheets and shared assumptions are the coin of the real here.

To the extent that a company’s strategy reflects the views of these powerful players, they continue to invest or increase their stake. To the extent that the two views are at odds, the investors retreat. Not all investors see all things in the same way.

So, a company’s investor relations strategy is usually to try to find a sweet spot  that maximizes institutional investor confidence.

For many years now (since shortly after the first dot com crash), the conventional wisdom about investing in software companies was something like:

  • Software licensing revenue was worth 10X (10 times). If the software licensing revenue in your business was $1Million, that part of your company was worth $10Million at sale.
  • Revenue that came from labor like consulting or other service related things was worth 1x. In that case $1Million in annual revenue from consulting was worth $1Million as a sales price.

Of course, every situation was different and many, many very important spreadsheets must be created to account for those differences. But, at its roots, Licensing revenues were worth 10x and labor was worth 1x.

The ideas was reinforced by the few really big successes (Facebook, Google, SuccessFactors, Salesforce and so on). The rationale was something like, “The real value is in the future somewhere (along with profitability). In the absence of a clear stream of margin, we can safely bet that growing revenues will ultimately lead to big bucks. You could easily imagine a picture of Dr Evil relishing the thought of ‘one beeeelion dollars‘.

Over the years, this has been the foundation of almost all business strategies throughout Silicon Valley.

The basic business model spawned by this theory of valuation (10x – 1x) is the ecosystem that passes labor and consulting work out of the core company to ‘partners’ who execute the most human components of the business. It spawned an army of CEOs who spent their energy chasing labor dollars out of their businesses trimming to ‘agile workflows’ that led to software license revenue.

The good news was that investors were happy. The bad news was that effective customer service and product improvement cannot be done this way. The result is a large number of new companies that couldn’t refine their products adequately or were insulated from real time direct market feedback.

This view seems to be changing as we speak. The major Silicon Valley role models have all taken ‘haircuts’ in the stock market. For example, Linkedin is now trading at half of its price two months ago. It’s held that price long enough to think if it as the new normal. While the customer segments who don’t like and distrust LinkedIn see this as market validation, it’s really a shift in investor perspective.

The emphasis is returning to real profits in real time.

My bet is that you are going to see a number of things in the near future.

  • Older and more established companies (from Ceridian and ADP to Oracle and SAP) will see luster added to their reputations as they demonstrate the way to rejuvenate older operations with insurgent ideas;
  • VCs will start to back companies with real human components. This is the only (and deeply ironic) way to make progress with Artificial Intelligence, Machine Learning, Intelligent Bots and Voiceless Interfaces. They are pieces of the next big thing.
  • Since Human Experience is at the heart of next gen computing, we will see a retrenchment towards customization. (The emphasis on muti-tenant, single instance computing is precisely the way that cloud computing worships the idea of pure software licensing revenue.)
  • Since Marketplaces and App Stores are singularly vulnerable from a security perspective, we will see a contraction in those operations for a while.

Like all things involving institutional investment, this is a swinging pendulum. Extremes in one direction are always balanced by a move to the opposite.

If you are a buyer of HRTechnology, this has huge implications. There will be medium term flux in Solution Providers’ willingness to guarantee levels of customization and customer support.

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