Two Cheers for Léo

November 2, 2009

The German Financial Times today took a bead on Léo Apotheker, SAP’s CEO, saying that on his watch, SAP had lost touch with its roots [verlorene Wurzeln]. No longer, as in the days of Hasso Plattner and Dietmar Hopp, is SAP customer-focused, the article says, and as a consequence, customers no longer think the software is worth the money. (The article cites the current customer unhappiness about increased maintenance prices as evidence for this.)

Helmuth Gümbel, no stranger to this blog, is cited frequently in the article; clearly, he was persuasive about the current state of affairs between SAP and its customers. Clearly, too, one disagrees with Helmuth at one’s peril.

Still, I wonder whether it’s really fair to hang all these problems on Léo. Take the infinitely hashed-over introduction and semi-withdrawal of Business By Design. Léo tends to get the blame for this because he was there on the podium claiming that SAP would get $1 billion in revenue from this product by, what is it, next year? But he had nothing to do with the original product. He was working in sales when Peter Zencke was put in charge of Project Vienna, and he was still in sales when Nimish Mehta’s team was developing T-Rex (a great product, no question), and he was still in sales when Hasso was insisting that T-Rex be incorporated into Business by Design, and so on.

Certainly, it was injudicious for him to promise that his organization could sell the heck out of a product that wasn’t ready for prime time. But why does this make him responsible for SAP’s lost roots? If anybody lost their roots, it was the development organization, which somehow or other couldn’t build the product it thought it would be able to build.

Don’t blame Léo for problems that were not of his making.

Now, I have my own issues with Léo, as my readers know. But frankly, when he came in, I think he was right about SAP. Too much time and money was being spent on stuff that wasn’t what the customer needed (or wouldn’t sell), and this had to stop. Hence the acquisition of Business Objects, the downsizing, the restructuring in the development organization. All of these things deserve at least one cheer, and I hereby give it. Hip, hip, hoorah.

Where I criticize Léo–and I’ve told him this to his face–is in his view of SAP’s role vis a vis the customer. He thinks what SAP has always thunk, that it’s up to SAP to make the best possible tools and it’s up to the customer (aided by the SI community) to figure out what to do with them. I think this view is wrong; SAP has to take more responsibility for making sure that the stuff works.

Ten years ago, when the heroes of the FT Deutschland article were fully in charge of the SAP business, I agree, SAP didn’t need to do that. SAP knew about businesses and about software, and they could figure out what they should do next without fretting about the problems customers were then having. (Believe me, there were a lot of them.) Today, though, with so much development time and development effort squandered, they can no longer believe that they can just build the right tools and count on the customers to get the benefit. Instead, they need to find out what went wrong with the tools they’ve been building and what needs to be done in the future. And the only way they can do that is to figure out EXACTLY what is preventing customers from getting the value they think they ought to get.

You can see why this problem is so important if you look at the SAP Solution Manager. This product ought to be what justifies the maintenance price increase. But as Dennis Howlett and Helmuth himself have both said, the product itself does not yet do what SAP needs it to do. If SAP really wants to justify this price increase, it needs to figure out why customers aren’t getting the value that SAP needs them to get. And they need to do it fast.

This is not easy; indeed, when I said this to Hasso late one night at an analyst party, he said, roughly, “We don’t know how to do that.” But let me just say, of all the executives I know at SAP, the one who is most likely to figure it out is Léo.

If he can figure it out, he will be able to get his customer base back again; indeed, I think they’ll be cheering, and when we’re convinced, so will I and so will Dennis and maybe even Helmuth. So, just in case this actually happens, let me give my cheer now, before it is actually deserved, as a way of saying, “I think you can do the right thing.”

Hip, hip, hoorah.

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If you were one of SAP’s biggest customers and you found out that SAP was giving big discounts to another big customer, pretty much because they asked for it, what would you do?

Assuming you have at least a room-temperature IQ, that is.

Wait a minute. Let’s be democratic. If you were one of Oracle’s biggest customers and you found out that SAP was discounting maintenance for the asking, what would you do? I mean, you’re an Oracle customer, you definitely have a room temperature IQ.

Still not sure what to do? Here’s a hint. The phone number at SAP headquarters is 49/6227/7-47474. At Oracle, it’s +1.650.506.7000.

“Wait a minute, wait a minute, wait a minute,” I hear you saying. “SAP didn’t start handing out discounts, did they? They raised maintenance prices; they didn’t lower them?”

Perhaps. But let’s try to apply that IQ of yours.

As I’m sure you know, it’s been an bruited about in the media that Siemens was seriously considering the possibility of dropping its maintenance contract with SAP, starting January 1 of this year. Their plan was to have a third party provide maintenance, possibly either IBM or Rimini Street. (For a representative summary of the situation, as reported in the press, see this Market Watch report.)

So what happened? As all of you big SAP customers realize, Siemens had to make a decision September 30. Well, here’s what we know. About a week ago, SAP issued a press release, saying that Siemens had in fact re-upped its maintenance contract for three years.

Case closed, right? SAP doesn’t ordinarily announce maintenance renewals, but the underlying tone was, “Well, we’ve read the stuff in the press, too, so let’s deal with those scurrilous rumors, and issue a press release. After all, Siemens didn’t just come back. They bought more.” End of story?

Maybe. But you’ll notice that the press release doesn’t actually say anything about how much they paid for the maintenance. Indeed, there’s a funny little line about, “based on SAP’s maintenance standards for large customers,” which seems to demand some explanation.

So, let’s pursue it a little further. Is there any further information anywhere about what Siemens actually paid? About the same time as the press release, a post appeared on the Sapience blog. The post said that Siemens had been paying 30 million euros, pre-deal and was now paying 18 million euros, plus some other concessions. If you value the concessions at zero, this is a roughly 40% discount.

Sapience is written by Helmuth Gümbel, an industry analyst who has been following SAP for longer than I’ve been in the business. Helmuth is not an uninterested party here; he offers consulting on how to pay less in maintenance. But he’s also a well-respected figure, a person who doesn’t just say whatever he feels like saying, true or not.

[Full disclosure: Helmut is also a person I regard as my friend, someone whom I see socially on the rare occasions when he’s in town.]

So what is one supposed to believe? On the one hand, you can say, “Why believe an isolated blogger, especially when he has an axe to grind?” Then, you assume that the press release is giving you basically the right idea about what happened. On the other hand, you can say, “Where there’s smoke, there’s fire,” and assume that Helmuth (and the Enterprise Advocates, a group that discussed the Siemens situation in its recent webcast, have to have roughly the right version of the truth.

Helmuth isn’t the only source of smoke, here. Kash Rangan, an investment analyst at Bank of America/Merrill, estimated, recently, that 20-25% of customers get discounts on their maintenance payments. (The relevant figures are reproduced in the dealarchitectt blog.

No full disclosure required here. I have only a nodding acquaintance with Kash.

Of course, all this can be pretty muddy. American accounting rules tend to make it difficult for companies to give direct discounts on maintenance; basically, if a maintenance agreement is part of the initial license contract and the stated price of maintenance isn’t supported by objective evidence, companies are supposed to recognize the license revenue ratably, not all at once. If you give discounts, then your ability to demonstrate that the stated price is supported by objective evidence, is called into question. So, contra Kash and Helmuth, you could argue that SAP can’t be giving out discounts, because it would screw up their reporting.

But of course there are ways of discounting maintenance without actually charging less than the stated price. There is, for instance, a long, long history in the software business of handing out free seats, instead of cash, when customers are unhappy. (Both Helmuth and a cynical reading of the press release suggest that something of the sort may be going on here.) If pressed, vendors have also been known to reduce the basis for the maintenance charge and also to fiddle around with start and stop dates. I’m not saying that’s going on here–I don’t know–but I’ve been told by reliable sources that it has been done, at least by some companies.

If that were the case here, then Helmuth’s way of characterizing it is really the only sensible way to figure out what’s going on. You look at your outflow before. Then you look at your outflow afterward. The difference gives you a gauge of what the discount is.

So did Siemens get a discount? The plain fact is that we don’t know for sure, even with all that IQ, and won’t know unless SAP and Siemens agree to tell us, and even then we won’t know, because the one thing we can be sure of is that SAP will present the case in a way most favorable to them.

So, if we don’t know for sure, and yet it seems possible that in fact SAP is giving discounts, what should you do? Well, I have a suggestion. It’s 49/6227/7-47474. See what they say.

But don’t hide it. Post what they say right here. If SAP really is holding the line on disounts, well and good. But if they’re giving them out, don’t you think it’s time for you to get in line?

With Siemens asking for and apparently getting a huge break on SAP maintenance costs, it is time to take a look once again to take a look at the whole issue. Understandably, there is a lot of emotion and name-calling and confusion around this; it’s not quite the health-care debate here in the United States, but the real issues have been buried under rhetoric in a strikingly similar way.

SAP Charges for Improved Support

Let me first state SAP’s position as sympathetically as possible. SAP believes (quite correctly) that the customer’s TCO (total cost of ownership) ought to go down, as software and hardware gets better and cheaper. It also believes that if it does something that would help TCO go down, it should get a share of the benefits.

Who would disagree with either point?

Roughly two years ago, therefore, it introduced a series of software and support improvements that it believed would indeed reduce TCO. These improvements largely revolved around a newly improved version of the Solution Manager, a piece of software that is supposed to do what its name implies.

The Solution Manager (or Sol Man, as it is called familiarly) was actually introduced roughly ten years ago. In its original version, it was a separate piece of software (one that ran on its own Windows box) that one used to communicate with SAP support (filing bug reports, etc.) and to monitor the performance of your SAP installation.

In the version introduced two years ago, the Sol Man EE (or enterprise edition), it did considerably more: it allowed you to do more extensive monitoring, test and manage upgrades, and even document your business processes. This new edition also beefed up the connectivity with SAP Support, so that support could use it to troubleshoot your installation more rapidly and effectively.

When SAP introduced its new, higher-priced Enterprise Edition support package, it placed the Solution Manager EE front and center. In every speech and every press release, it wasn’t, “We’re raising prices because Oracle got away with it.” It was, “We’ve developed new tools and support services based on those tools, and we’re increasing the cost of maintenance, because the maintenance has improved.”

The tools it was referring to were the various components of the Sol Man EE, and the improved support services were made possible by and delivered through the Sol Man.

To sum up, SAP’s position is that it is improving enterprise support by providing customers with new and better support tools. It is in the software business. So it is only reasonable for it to charge for those tools. That it charges via a maintenance price increase rather than by charging for the product itself is reasonable, presumably, because many of the benefits involve improved services, which are provided through the maintenance contract.

The Customer Reaction

It’s just a plain fact, of course, that nobody paid much attention to this. It took me, for instance, almost a year (until John Krakowski’s excellent presentation at ASUG last May) to figure out what SAP was getting at when it talked about new tools. (Before that, I wrongly, but honestly believed that the talk about tools was pure hand-waving.)

Other commentators on this, like Vinnie Mirchandani or Ray Wang or Dennis Howlett , may have gotten to a proper understanding of the argument faster than I did, but for the most part, they didn’t try to address its merits.

Today, for instance, the Enterprise Advocates, gave a webinar on Reducing SAP Maintenance Costs. (The Enterprise Advocates include the aforementioned three, plus Frank Scavo and Oliver Marks.) Not once during the main body of the talk did they even mention SAP’s recommendation for reducing maintenance support costs, which is to implement the Solution Manager and use it.

I don’t blame the advocates for this; it’s not their job. But I do blame SAP. If the Sol Man is what justifies the price increase, then SAP need to explain this in clear language.

Once SAP fails to do this, the Advocates and the SAP customer base are entitled to believe what you and I would believe when somebody offers an unclear explanation for something that seems to require some explanation: they dismiss the explanation that’s offered.

At some point, though, it does seem that someone should give SAP the benefit of the doubt and ask the question that SAP wants you to ask, namely, “Can the Sol Man EE deliver so much benefit that it justifies the maintenance price increase?”

If the answer is, “Yes,” that would of course be the best thing all around. Customers would have a clear path to reducing maintenance costs. SAP would have a product that keeps its customers paying maintenance. Total cost of ownership would go down.

And the Answer Is…?

Over the past four months, I’ve spent a fair amount of time finding out what I could about the Sol Man. I don’t have access to the documentation (all 1000 pages of it), but I do have the more public documents that SAP has issued, and I have talked to a number of Sol Man users and consultants.

What I found out is so complicated, and this blog is already too long. So I’ll delay a full report to another post. But here’s the answer in a nutshell:

1. To get the benefits of the Sol Man absolutely requires significant investment on the part of the customer.

2. It does not appear to be the case that the Sol Man was designed with the goal that SAP now has for it top of mind. It appears to be a product that was designed to be one thing that is now being turned to a different purpose.

3. The areas of benefit that the Sol Man promises are indeed important, and it is at least possible that customers can get significant benefit from it, if they put in the work.

4. At the end of the day, though, it appears to this humble observer that SAP needs to put more skin in the game.

Hope all this whets your appetite for the next post on the subject.

“Brittle” design isn’t limited to enterprise application software. You can find brittle design in cars, bridges, buildings, TVs, or even the vegetable bin. (What are those 1/2-pint boxes of $5.00 raspberries, 3/4 of which are moldy, but examples of brittle design?)

What do brittle designs have in common? The designer chose to accentuate high performance at the expense of other reasonable design parameters, like cost, reliability, usability, etc. A Ferrari goes very, very fast, and it feels good when it goes fast, and that’s a design choice. And it’s part of the design choice that the car requires a technician or two to keep it going fast for longer than an afternoon.

So why are most enterprise applications brittle? You can see this coming a mile away. It was a design choice. The enterprise applications in question were designed to be the Ferraris of their particular class of application. They were designed to do the most, have the most functionality, be the most strategic, appeal to the most advanced early adopters, be the most highly differentiated, etc.

To get Ferrari-like performance, they had to make the same design choices Ferrari did. They had to assume the application was perfectly tuned every time the key was turned, and they had to assume that the technicians were there to perform the tuning.

Enterprise applications, you see, were intended to run on the best, the highest-end machines (for their class). They were intended to be set up by experts. They were intended to be maintained by people who had the resources to do what was necessary. They were intended to satisfy the demands of good early-adopter customers who put a lot of pressure on them, with complex pricing schemes or intricate accounting, even if later on, it made setting the thing up complex, increased the chance that there were bugs, and made later upgrades expensive.

This wasn’t bad design; it was good design, especially from the marketing point of view. The applications that put the most pressure on every other design parameter got the highest ratings, attracted the earliest early adopters, recruited the most capable (and highest-cost) implementers, etc., etc. So they won in the marketplace and beat out other applications in their class that made different design choices.

I lived through this when I worked at QAD. At QAD, the founder (Pam Lopker) made different design choices. She built a simple app, one that was pretty easy to understand and pretty easy to set up and did the basics. And for about two years, shortly after I got there, she had the leading application in the marketplace. And then SAP and JDE and PeopleSoft came in and cleaned our clock with applications that promised to do more.

Now, none of the people who actually bought SAP instead of QAD back then or chose (later) to try to replace QAD with SAP did this because they really wanted high performance, per se. They wanted “value” and “flexibility” and “return on investment” and “marketable skills.” They literally didn’t realize that the value and flexibility came at a cost, that the cost was that the application was brittle and that therefore, the value or flexibility or whatever was only achievable if you did everything right.

If they had realized this, would they have made different choices?

I don’t know. I remember a company that made kilns in Pittsburgh that had been using QAD for many years. The company had been taken over by a European company that used SAP, and the CIO had been sent over from Germany to replace the QAD system with the one that was (admittedly) more powerful. He called me in (years after I had worked at QAD) to help him justify the project.

I looked at it pretty carefully, and I shook my head. Admittedly, the QAD product didn’t do what he wanted. But I didn’t like the fit with SAP. I was worried that the product designed for German kiln production just wasn’t going to work. I didn’t want to be right, and I was disappointed to find out that two years later, despite very disciplined and careful efforts, he was back in Germany and QAD was still running the company.

I’m glossing over a lot, of course. There are secondary effects. Very often, the first user of an application dominates its development, so the app will be tuned to the users strengths and weaknesses. It will turn out to be brittle for other users because they don’t have the same strengths. Stuff that was easy for the first user then turns out to be hard for others.

Two final points need to be made. First, when a brittle application works, it’s GREAT. It can make a huge difference to the user. Brian Sommer frequently points out that the first users of an application adopt it for the strategic benefit, but later users don’t. He thinks it’s because the benefit gets commoditized. But I think it’s at least partially because the first users are often the best equipped to get the strategic benefit, whereas later users are not. I think you see something of the same issue, too, in many of Vinnie Mirchandani’s comments about the value that vendors deliver (or don’t deliver).

Second, as to the cause of failure. Michael Krigsman often correctly says that projects are a three-legged stool and that the vendors are often blamed for errors that could just as easily be blamed on the customers. Dennis Moore often voices similar thoughts. With brittle systems, of course, they’re quite right; the failure point can come anywhere. But when they say this, I think they may be overlooking how much the underlying design has contributed.

It may be the technician’s fault that he dropped the beaker of nitrogycerin. But whose brilliant idea was it to move nitroglycerin around in a beaker?

Brittle Applications

August 31, 2009

In a previous post, I said that MRP was a “brittle” application, and a commenter questioned me. What is a “brittle” application? Is this a technical term? What makes MRP brittle? All good questions.

A brittle application is one that doesn’t work at all unless a lot of disparate conditions are met. MRP, for instance, doesn’t work unless all the data is right, people know how to use the program, the demand for the products is stable, purchasing is also committed to minimizing inventory levels, etc., etc.

The notion applies to a lot of other programs besides MRP, though I’ve rarely heard the term used. But notice that it brittleness isn’t so much a feature of the program as it is the purpose to which the program is put.

Let’s take a simple example: a word processing program. For normal purposes, a word processing program in this day and age is not brittle. A rank novice can use it to type and print. But even today, if you want to use, say Microsoft Word, to put out a 16-page brochure, complete with illustrations, well, good luck, is all I can say. You try to get an illustration and have it float and change the size and put in a table, and–well, just try it, it’s a nightmare. So, to put a 16-page brochure together, Microsoft Word is brittle, but to print out a letter, it’s not.

The point about the MRP program that QAD wrote, which follows the APICS standard religiously, is that it’s brittle relative to the purposes for which it was intended. Pam and Karl and Evan (the founders of QAD) really believed that QAD’s could do supply chain management for manufacturing facilities very effectively. My point was that the program is too brittle. To get things right, you have to get all the data right and keep it right, etc., etc. And if you don’t, what you have is an overwrought and overcomplicated Kanban system, without Kanban’s virtues.

Are there other enterprise application systems that are brittle? Lots and lots of them, I think. Almost all the old, Siebel-style CRM systems were simply too brittle; they depended too much on the good-will of the salespeople, the accuracy of the sales model embedded in the system, the reliability of the sales cycle, etc., etc. You wouldn’t think that financial systems are brittle–after all, they have to work–but they often had components that were overly brittle: cash management systems, for instance, and fixed asset systems and budgeting systems.

What do most companies do when they have an overly brittle system? They use the system for lesser purposes. And they feel REALLY bad about it. So, the Microsoft Word user makes a brochure that is far less fancy, but more manageable, and the QAD MRP user uses the product for tracking inventory. And both of them keep on saying, “Well, one of these days, I’ll get around to really making this product sing.”

They shouldn’t. Brittle applications are brittle for a reason. A lot of the time, it’s because they’re really a special-purpose product, but yours is not that purpose. Some of the time, they’re brittle because they’re badly designed. Some of the time, the model they’re using (MRP is a good example) just doesn’t fit the situation you’re in. In any of the cases, the fact is that they really can sing for the right user, but that doesn’t mean it’s your fault if they don’t sing for you.

What do you do if you have a brittle app that isn’t singing? Give up on it. It won’t work for you. Get another app, one that works. Or change the process. Or just accept the fact that it will never work the way you thought it would.

In any case, good luck.

I used to work at QAD, a small manufacturing software vendor. I subscribe to a QAD chat group, and occasionally people ask questions like the one in the title.

It sounds as if the person asking is peddling something–who knows–but it’s an interesting question nonetheless. What kinds of knowledge are necessary (key) for an ERP implementation? If you run a manufacturing company, is APICS (that is, supply chain) knowledge particularly important?

Certainly, QAD used to think so. When I was an employee, you got a bonus for becoming APICS certified. (APICS is the American Production and Inventory Control Society; to get certified, you had to learn how MRP worked and how inventory should be managed.) And certainly, when the product was designed, the focus was on matching supply and demand. The product was built originally for Karl Lopker’s sandal manufacturing business, and the idea was always to have simple, usable product that managed inventory well.

So you would think that the answer, at least for QAD users, is, “Of course APICS knowledge is key. Duh.” But I don’t think so.

You see, while I was at QAD and then for some years afterward, I looked at a fair number of installations. And what I saw was disheartening, at least if you believed in good supply chain practices. The systems weren’t really using good supply chain practices, at least as APICS defined them.

Let me give you an example, which APICS-trained people will understand immediately. One of the ideas of these systems is to reduce the amount of inventory you have on hand at any one time. To do this inside the system, there are two parameters that you have to set, lead time (which is the amount of time it takes for an order to be fulfilled) and safety stock (the amount you want to have on hand at all times). The longer the lead time or the higher the amount of the safety stock, the greater your inventory expense.

So what would you say if discovered that in not one or even two installations, but many, the safety stock and lead time numbers for most of the inventory were set once, en masse, and then never set again? Well, I’ll tell you what to think. These figures, which are key to making the system work, are not being used.

Now this was not just true of QAD Software; it was equally true wherever I went, no matter what software was installed.

So doesn’t this say that supply chain knowledge is key, after all? If they had supply chain knowledge, wouldn’t they have paid more attention? At first, I thought so. But then after a while, I realized that more supply chain knowledge would have made very little difference.

You see, that’s not why they were using the software. All these companies, it turns out, didn’t really care about getting supply chain stuff right. They managed the supply chain fairly sloppily–tolerated a lot of inaccuracy and suboptimal behavior–and they got along (in their minds) just fine doing that. They didn’t want to put in the kind of care and rigor that is the sine qua non for doing with these systems what they were designed to do.

What were they using the software for? Well, mostly to manage the paperwork virtually. Please don’t cringe, Pam, if you happen to be reading this. This is not a hack on you. The plain fact is that the companies needed to keep track of their commitments (orders), their inventory, and their money, and that’s what they used the system for. They needed a piece of paper that told people what inventory to move that day and where to move it to. And the system gave it to them.

To do this, though, you didn’t need much APICS knowledge or, if you didn’t believe in APICS’s recipes for inventory management, other supply chain knowledge. All you really needed was to be able to count, which most of the users could do without being APICS-certified.

So is supply chain knowledge key for an ERP implementation? Not at all. You can have perfectly happy users who have got exactly the nice simple implementation they need without much supply chain knowledge at all.

This answer, of course, raises lots of questions. What is key? Why do these companies tolerate sloppy supply chain practices? Wouldn’t they be better off if they cleaned up their act. Herewith, brief answers.

What is key? At a rudimentary level, the financials. You have to get the basics right, here, or you’ll never close your books. In a system studied recently by a grad student at Harvard Business School, 65% of the inventory records were inaccurate. Can you imagine the upset if 65% of your account balances were incorrect?

Why do they tolerate sloppy supply chain practices? I think it’s largely because more finely tuned systems are much more brittle. They take a large amount of care and feeding and their ability to take hard, rude, unexpected shocks is limited.

And wouldn’t they do much better using the systems? In many cases, no. You see, at most of the companies I’ve run into, the MRP/APICS model that QAD (and every other software vendor) provided is not actually all that accurate. To make a really significant difference, you need more sophisticated tools that are better suited to the specifics of your supply chain.

Comments welcome.

Brian Sommer just posted a very funny piece on how SaaS CEOs can prepare for an earnings call. If anything, he understates the problem.

We have learned over the years how to respond to software company earnings calls. We look at license revenues; we look at revenues; we look at margin; and we decide whether the company is doing what it “should” do at its level of maturity.

What few people realize is that the rules governing SaaS vendors are different, so comparing SaaS vendors and perpetual license vendors is like comparing–oh, let’s try to avoid a cliche–elephants and rabbits.

This gives these guys so much opportunity to obfuscate that frankly, they don’t even need to practice.

To understand how this works, you need to understand the differences between the rules. I’ll stick with the basics. The key difference is that when a perpetual license vendor sells something on the last day of the month, they report the total amount of the contract as revenue; when a SaaS vendor sells the same software, they don’t.

With the perpetual license vendor, the idea of the accounting powers that be is that selling a software license is like selling a piece of packaged software over the counter. You sign the contract; they invoice; ka-ching. With the SaaS vendor, the idea is that they’re not selling an over-the-counter product, they’re selling a promise to deliver a service. And, since there’s always a risk that they won’t deliver, they can’t recognize revenue until they actually do that delivery.

Let’s see how this works in an example. What we’re trying to do is evaluate how sales are going. With a perpetual license vendor, at the end of the quarter, we can look at their reports and be able to tell, basically, what they sold, and how sales are going. If SAP sells a $1 million contract on June 30 (and ship and invoice), they report $1 million in license revenue, and we know that’s what the sales force did.

Now imagine that a SaaS vendor is working equally effectively. At the end of a quarter, they sign a $1 million contract that is effectively equivalent in the customer’s eyes. (Who knows, maybe SAP and Salesforce were competing and Salesforce won.) If we look at their revenues, we’ll have no idea that this is the case. Almost none of that $1 million will appear as revenue, because they are only allowed to report revenue for the days of SaaS that were actually delivered. For that $1 million contract signed on the last day of the quarter, SAP will report $1 million in license revenue, but Salesforce will only report $1,000, assuming they turned the product on that day and so delivered one day of a 1,000-day (3-year) contract.

This makes Salesforce look bad. But later on, things reverse. Imagine there’s a quarter when both SAP and Salesforce reps sell bupkes in a quarter. That quarter SAP reports $0 license revenue, but Salesforce reports the $90,000 that it earned from the 90 days of delivery on that old contract.

Two companies. Identical performance. Completely different-looking results. Now, we’re not completely trapped. We can get some idea of what’s going on, by looking at what are called the “bookings” numbers. (The booking is the amount of money invoiced during the quarter for the contracts that are signed.) Most financial analysts just use a quick and dirty rule of thumb for comparison purposes; bookings for SaaS companies are roughly equivalent to sales revenues for perpetual license companies.

if SaaS companies booked revenues the same way that perpetual license companies bill for revenues, this would be fine. But in fact, SaaS companies don’t necessarily book all the revenue from contracts like that $1 million contract that I’m using as an example. Very often, they don’t invoice for the product until it actually starts being used. So on that last day of the month, it’s reasonably likely that the bookings will be, say, $299,000 and the revenues $1,000 for that contract. But the rest of that $1 million won’t appear anywhere. It will be booked in the fullness of time, but by that time, we won’t really care.

So how do you compare the elephants and the rabbits? You don’t. To compare the two, you would have to know the value of the contracts that the SaaS companies signed And they have no responsibility whatsoever to tell you what that value is. In fact, they can say anything they want to about that imaginary $1 million contract; they can announce it, hide it, whatever. If this quarter, they want you to believe that they’re selling as much as SAP is, well, they can release figures that make it seem that way. And if this quarter, they want you to believe something else, well, OK. All perfectly legal. In our example, Salesforce and SAP are “actually” doing equally well. But there is no way of knowing this.

Oh, it gets worse. It turns out that the accounting standards that govern SaaS companies make margins worse than they “actually” are. So even if you did get data that let you compare sales accurately, the accounting standards would automatically make the SaaS company look less profitable than the on-premise company.

Awful, right? Not even close. You see, very soon, it’s going to get even worse. The accounting standards are changing. But hey, that’s material for another blog.