Taking One for the Cloud Team

The quarterly earnings announcement season is in full swing for large tech companies. This past week IBM announced its quarterly financial results and SAP issued guidance. Oracle did the same a month ago. Each of these companies is still showing reduced overall revenue due to the shift to cloud computing. On the surface, this would appear to be a big problem. When companies undergo radical changes that drop revenues, everyone has to worry that their favorite supplier may become the next Sun, Palm, or worse, Novell which is only a shadow of its former self.

I, for one, am not worried. Yes, these quintessential IT companies are taking it on the chin revenue-wise owing to the shift to cloud computing. Cloud computing is disrupting the traditional on-premises software businesses and wreaking havoc with vendors’ hardware units. Major shifts in a market can cause these type of short-term effects on any business. Just look at how the introduction of shale oil has effect the otherwise same energy business, dropping oil prices precipitously in a year. The current disorder in the IT industry is, however, over-shadowing the future benefits of cloud computing.

See, the problem lies in short term versus long term expectations. On a quarter to quarter basis, less money is being made by IT companies switching from traditional to cloud models for their products. Yet these cloud businesses are growing rapidly versus stagnating software and hardware businesses. On top of that, cloud business are locking in revenue far into the future. The traditional model of hardware and software requires customers to make big upfront investments which generate a lot of money all at once. Cloud business generate revenue over time but that revenue is stickier. Big upfront investments make it hard for companies to make decisions about a product; Subscriptions ease the worry that a wrong decision will be made. When IT products start to age, especially hardware, responsible IT managers reevaluate vendors opening the door to competitors; With cloud services offering constant updates and incremental cost increases, it’s easier to stay with what is already in place.

Of course, these are the strategies of growth companies in the IT sector. Companies such as Amazon, Salesforce.com, and Netsuite are successful because they reduced resistance to sales and locked in customers for the long haul. They act like media companies, worried about innovation and churn as much as scoring big deals. I suspect this is what is messing with the heads of the financial analysts the most. They see companies that should be acting like lumbering dinosaurs, grazing safely in placid waters free of major predators, acting like nimble up and comers. Stock prices are as much a reflection of perceived future value as present value. Financial analysts are used to viewing companies such as IBM, SAP, Microsoft, and Oracle act in a certain and predictable manner. That major IT companies are taking steps to ensure they don’t become lunch for some upstart should suggest more value in the future. It’s just not foreseeable what that value will be. The outmoded models no longer work well, as is always the case when big changes are in progress.

So, while market analysts (like me) are predicting accelerated growth in the IT market because of the shift to cloud computing, financial markets will continue to punish the major companies that are embracing these changes. Ours is a long-term view based on successfully delivering superior products and services to customers. Theirs are short-term models based on financial metrics from an earlier age.


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