So much time is being spent speculating if we are in a bubble or not, that what’s really important is being overlooked: evaluating companies for the long term. It’s time to change the focus of the discussion to business models. We all know that when companies fail, it always comes down to not enough revenue and/or too many losses. This is a fundamental of business, as well as a pretty obvious statement. Whether it is optimism or misjudgment this is something businesses still fail to grasp.
Planning for future revenue as the savior of a company is not new. In 2000, I had a client who told me once the add-on technology was offered to the public in two or three years, they would be profitable. In the meantime, if they kept a customer for a year, they only lost $10 on that customer. Two additional facts: (1) they had multiple millions of customers, and (2) in hindsight, we can see the technology for which they were planning only started to hit the market in 2007.
Today, some cloud computing companies are embracing business models that are only successfully in their overly optimistic dreams. The problem with this is they are taking their investors, customers and employees along for the ride and turn ugly when anyone questions their assumptions.
Cloud computing executives should invest in two things:
1) an analyst whose job it will be to consistently assess the marketplace and the company. This person is likely to straddle finance and sales/marketing.
2) an honest opinion. You would think this should be the role of everyone on the management team, but too often groupthink, fear or frustration stifles what is sure to be an unpopular question. Ideally, someone on the team will be given this role. If the company cannot do this on their own, a trusted advisor or consultant is essential. Otherwise, you are in danger of engaging in groupthink, which never turns out well.
There are a few versions of cloud computing business models that need to be assessed more closely:
1) trying to make an enterprise software-style sale via cloud computing. There is a class of SaaS company which isn’t truly SaaS. If your company must do tons of custom work for each installation and you only close a handful of deals a year, your company is not a SaaS company. It only happens to be delivered via the cloud. As more true cloud-based offerings are available in your space, it will become more difficult to sell solutions that take months to implement, require significant investment of customers’ IT resources and cost more than other cloud-based offerings.
2) Freemium models that don’t have either a path to Premium or an additional revenue source, such as advertising. High-volume user plays are a good sales plan as long as the “free” users don’t become a drain on the company. Having a model that includes“free” users must at least pay for itself. Companies must also take into account the cost of supporting these users. Free trials or limited functionality are two ways to increase the conversion rate to paid customers.
3) Ridiculously thin margins are the death of many restaurants and will eventually be the death of many cloud companies. This coupled with a “do anything to get the deal done” attitude occasionally results in negative revenue by the time the solution is fully deployed. This goes back to having ongoing analysis of revenue and the cost of sales.
As investors look for what can go wrong in the marketplace, they need to first look to see what could go wrong in each individual company. Only then will there be sound companies that can blossom in sunny times and weather any storm.