Why ISVs do not have the choice besides going to the cloud

Transitioning to the cloudMany of us have now travelled the cloud journey one way or the other. Some of us have worked with software vendors, some have been responsible for implementing cloud solutions in enterprises and yes, there as still some that do not think cloud will happen. What we have also seen during the recent months is that many companies and management teams have come out with a strong message that the transformation to the cloud model will have an impact on quarterly and annual financial results. A good example of this was Intuit that stated to have a “transition year” when moving to the cloud but this move will create a stronger Intuit as a result. Intuit concludes that small businesses are shifting to the cloud en masse.

The problem that traditional software business model has always had is the unpredictability. When we are chasing the next large deal, it is hard to predict when we get it closed. With a subscription-based model, we know exactly what is coming next month, next quarter and year. If our solution sucks, we need to calculate the churn which is one of the biggest fears that software leadership teams should have…. building products that nobody wants to continue to use. The move towards a subscription-based model will always have an impact on results, even if many boards and management teams do not accept this. I have also been surprised that some boards with venture capital executives have given guidance to management teams to make a change towards a subscription-based model but that it can not impact on the financial numbers. That is something that is both unrealistic and not doable. You can’t possibly serve to different models at the same time and make a transition to a new model. It just does not happen.

CEOs and boards do not have a choice in the long run. It is clear that valuations of cloud businesses is much higher than valuations on traditional software businesses. A recent study by Software Equity Group SaaS software revenues will represent about 25 percent of the overall software market in the next 5 years. According to Gartner, the estimated spending on SaaS will reach $22.1 billion by 2015. The problem that many established software vendors are experiencing is that most of their software revenue is still from the traditional perpetual license revenues and maintenance revenues. The valuations of these companies compared with SaaS companies with same revenue numbers is twice that of traditional software companies. This is causing an increased pressure on both ISV management and boards. The enterprise value of SaaS companies compared with traditional SaaS companies is 6.5 times higher. Those are significant numbers, no question about it.

I have seen an accelerated trend within traditional software companies to have a discussion how to make the transition to the cloud. The move does not happen overnight and there are many different models to do this from business and technology perspective. If the management decides to late to start the change, it might be too late for them as new market entrants might already have “good enough” solutions in that space. We have also seen this during the past 2 years. In my upcoming blog entries I will be discussing of the main themes that we have seen ISVs to focus on in this transition. Stay tuned for more blog entries!

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