Ever since I started this weblog the question of whether Sage would ‘get’ saas/on-demand is one that has plagued me. I think I’ve finally worked out the problem courtesy of a chance conversation I had with an ex-Sage senior executive.
For some time, I’ve contended that Sage is more interested in keeping its financial analyst community happy than it is in its customers. If you listen to any of the recent analyst calls it’s all about market share, growth and acquisitions. Rarely if ever do we see stats that talk to customer service. Its most recent release of Line 50 has been viewed by many as a bloatware upgrade that doesn’t add significant value and hasn’t addressed long standing issues. In a sense it typifies a company that has lost its way.
When you look back over Sage’s performance history, it is apparent that organic growth is declining. It is therefore heavily dependent on maintenance revenue, something it signaled at the last earnings call.
When traditional software companies are nearing a level of maturity, they like to think of their business models in terms of (roughly) 40% software sales, 30% services and 30% maintenance. That allows them to spend heavily on sales and marketing to fuel the sales engine because gross margins on software and maintenance are high – often in the 85-95% range – and new sales are competitive. It also allows them to continue R&D investments which were around 15% of gross revenue. In recent years, that model has changed and here, Sage is far from alone. Infor, Oracle, IRIS to name but three are all in the same boat.
As the business software industry has consolidated, there has been a switch in using cash generated to acquisitions. That requires a company maintain or improve its margins because software is highly cash generative and it therefore makes good business sense to do everything it can to increase cash inflows. On the cost side of the equation that has meant a general downward trend in R&D investments and a cutting back on sales and marketing costs. In Sage’s case, R&D is hovering around 10-11% but the company has said that number will decrease. But here’s the crunch.
Sage has made so many investments that it has the equivalent of a knotted ball of string it can neither unravel nor put into a coherent whole. I recall some years back that Sage was endeavouring to rationalise the code base for all applications. This would have been a tough ask at the best of times because developers like to create something that’s unique. When you’ve got acquired code that problem multiplies rapidly. If you are R&D constrained then the problem amplifies further because not only do you have to bring coherence but you also have to continue maintaining the existing code. That squeezes the available resource for developing new products. In Sage’s case, it is not large enough for it to devote significant resource to ‘new’ without that showing up quickly in its numbers. Not large enough? You must be kidding Howlett? Well no. Run the numbers:
In the last half year, Sage turned £748 million. Assuming that around 80% of R&D goes to maintaining the existing code then you end up with £16 million for development which we can double up for the year. That sounds like a handy amount except for two things. That’s got to be spread around the world to many countries because Sage products are mostly country specific. SaaS business solutions take a lot of development and you can eat £1 million with almost the blink of an eye. Given that Sage recorded £139 million PBT on £748 million, it is easy to see how Sage might struggle to get the right amount of resource behind a new direction. Compare that to Oracle which is much larger and has conservatively spent $0.6 billion on just ONE chunk of software and you start to get a sense of the required inputs to build a successful offering.
But what’s more telling is that Sage has been trying to get into this space for about 10 years. If you look back over the history of Sage press announcements then you can see they had the vision at the time of the ASP movement but couldn’t execute. This is a resource issue that refuses to go away without Sage compromising its position.
The crazy part about this is that if Sage could get its development act together, it would signal a new direction from which potential and existing customers could benefit. It would help put to bed the idea that Sage has become dumb, fat and happy and that the only way it can grow is through acquisitions, which in themselves help create the problem with which Sage is faced. But I don’t hold out too much hope. At least not in the short term. The current management has been incumbent for many years and has a certain entitlement mentality about it. That will destroy creativity in a heartbeat.
There are no easy solutions to this problem but there is one that could work. Sage could divert some of its investment into building a startup that is free of current management. It would need to be independent of Sage and be prepared to fail at some point. The investment need not be huge and could be ramped progressively as milestones are reached. It would need to acquire new DNA in the form of people who understand the dynamics of the saas market. All of that is do-able. The question must be, will management see things that way?
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