Services weekly preview: Nov. 5-9, 2018

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Well into the third quarter of industry earnings and our periodic assessments of IT services vendors, TBR’s analysts this week will also share their semiannual analysis on vendors in the management consulting space

Monday: In 3Q18 Infosys signed 12 large deals with a total contract value over $2 billion, but the company’s delivery framework remains fragile as Infosys maintains its margin-first culture. In our full report on Infosys, Senior Analyst Boz Hristov notes that open-source solutions will support Infosys’ efforts to compete on price as it morphs its value proposition toward becoming a platform-based company. Returning to sustainable double-digit revenue growth will remain a mirage in the next two years.

Tuesday: Senior Analyst Jen Hamel’s initial take on IBM Services’ 3Q18 earnings performance noted that while internal transformation efforts expanded margins, stalled revenue growth shows the company’s work is far from over. The full report expands upon the implications of IBM’s ongoing transformation, including the recent announcement of plans to acquire Red Hat, for IBM Services’ future as a leading IT services vendor.

Wednesday:

  • Analyst Kevin Collupy’s initial report on DXC Technology’s (DXC) quarterly earnings will explore the company’s approach to software and partnerships and its continued use of acquisitions to fill talent and portfolio gaps. We expect tepid growth through the remainder of the year and likely modest organic year-to-year declines, highlighting the importance of strategic acquisitions.
  • In the last edition of the McKinsey & Co. Management Consulting Benchmark profile, I anticipated a slowdown in the firm’s acquisition pace and questioned whether McKinsey could assimilate new capabilities and roll out new offerings, especially around digital, design and analytics. This profile publishing this week will detail how McKinsey performed through the start of this year and how the firm has positioned itself well to benefit from competitors preparing the market for digital transformation.

Thursday: Analyst John Caucis’ initial response to DXC’s earnings and the fiscal performance of the company’s healthcare IT services (HITS) business will cover a mix of positive and negative developments in the fiscal quarters ended 2Q18 and 3Q18 (semiannual report). DXC continues to execute strongly in APAC, particularly in Australia, but indications of difficulties in Europe began to surface in 3Q18. Meanwhile in DXC’s core U.S. market, disruptions appear to be lingering from the spin-merge with Hewlett Packard Enterprise (HPE) Enterprise Services, delaying a rebound in healthcare IT services growth.

Friday: In this edition of the semiannual look at Accenture’s management consulting practice, Boz will note that the company will rely on patented, artificial intelligence-enhanced solutions to maintain revenue growth momentum and withstand threats from the Big Four and IBM. However, adding tech-centric offerings and engineering-trained resources may pressure its management consulting brand, while a potential large-scale management consulting acquisition could help the company address buyers’ perception.

Oracle implores enterprises to adopt its uniquely architected cloud stack

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Oracle reinforces its cloud stack to accelerate enterprise cloud adoption

Oracle has a strong portfolio of cloud applications that are proving competitive in the market against more narrowly focused or less integrated SaaS competition. Oracle’s core platform and infrastructure businesses, however, are proving a harder sell, implied by financial results and qualitative context, despite significant innovations over recent years. The tone of Oracle OpenWorld 2018 mirrored its overall performance: The company is well positioned and executing in cloud application adoption initiatives, and is well positioned but facing stalling sales in the infrastructure business.

Applications updates were minimal but valuable

As Oracle executives pointed out, Oracle has been able to position itself well in the SaaS market by buying and building applications across both front- and back-office functional areas, leaving few holes in its horizontal applications portfolio. This relatively comprehensive portfolio, particularly across the back office with integrated ERP and Human Capital Management (HCM) suites, positions the company well as more customers look to adopt cloud applications — both voluntarily to achieve efficiencies, and under duress to plan migrations as other vendors’ on-premises products are given end-of-support deadlines. Strengthening the value of its applications at the annual event, Oracle announced artificial intelligence (AI)-based capability additions to its ERP and HCM portfolios, including chatbots, recommendation engines and process automation. Oracle also enhanced select supply chain management applications with blockchain-enabled tracking and controls to increase value for customers. These advancements add value for customers but do not significantly alter Oracle’s back-office portfolio.

 

 

Oracle’s (NYSE: ORCL) annual conference, Oracle OpenWorld 2018, took a different tone than in recent years. With corporate focus narrowed around the cloud portfolio, and key product foundations already in place, keynotes and announcements were more focused on improvements to existing applications and the database and infrastructure architecture underpinning all cloud services. This year’s event doubled down on themes of past years, including Oracle CEO Mark Hurd’s previous keynotes concerning macroeconomic trends and predictions for the cloud market, and introduced a panel of distinguished U.S. and U.K. security personnel that painted a bleak cybersecurity picture, subtextually in support of a secure, single-vendor cloud stack that Oracle is positioning itself to best address.

Specialized industry expertise and agile service delivery position NIIT Technologies to disrupt incumbents

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The rising tide of digital transformation demand continues to lift all boats, particularly small, intensely industry-focused IT services players, such as NIIT Technologies, that aggressively and tactically align their portfolio offerings and go-to-market strategies with the evolving needs of their clients and target markets. Though the long-term sustainability of NIIT Technologies’ rapid revenue growth and margin expansion remains to be seen, its strong performance in a services arena nearing saturation deserves the attention of global technology and IT services peers.

Strong financial performance highlights the success of NIIT Technologies’ pivot toward digital

CEO Sudhir Singh kicked off the event with a summary of NIIT Technologies’ recently reported FY2Q19 earnings results:

  • Revenue for the quarter ending Sept. 30, 2018, grew 23.1% year-to-year and 10% sequentially, in local currency, to Rs. 907.4 crores ($129.5 million U.S. dollars [USD]).
  • Operating margin expanded 186 basis points year-to-year to 18%.
  • Fresh order intake increased for the sixth consecutive quarter to $160 million USD, including 10 new logos.
  • Digital revenue reached 28% of total revenue, expanding 11.6% sequentially in local currency.
  • Headcount crossed the 10,000 mark, with 261 additions during the quarter. During 2018 NIIT Technologies has added 1,000 employees, with 499 in digital areas. Despite double-digit headcount expansion, utilization has also increased (80.4% in FY2Q19) while attrition has stayed well below that of Tier 1 India-centric peers, hovering between 10% and 11%.

Though relatively smaller in scale compared to Tier 1 India-centric peers, NIIT Technologies prided itself on its relatively balanced geographical mix for a company its size (e.g., only about 49% of revenue comes from the U.S., about 34% from Europe and the remainder from Rest of World), on par with Tata Consultancy Services [TCS]). The company also touted its culture, built upon a heritage of learning and research, that empowers employees with both technology skills and design thinking expertise to create business-relevant solutions for clients.

 

 

TBR attended NIIT Technologies’ U.S. Analyst & Advisor Forum in Boston, where the company’s executive leadership team presented on the company’s recent financial performance, strategy and portfolio offerings with an overarching theme of “Engage with the Emerging.” The event’s agenda was organized in line with NIIT Technologies’ recent restructuring around three core verticals ― travel and transportation (T&T), banking and financial services (BFS), and insurance ― and five service lines ― Intelligent Automation, Digital, Data and Analytics, Cloud, and Cybersecurity ― which the company brings together in matrixed offerings. Leaders from each of the three industry verticals and several of the service lines presented individual sessions on their areas, in some cases with clients. TBR also interacted one-on-one with executives throughout the event.

BearingPoint offers collaborative transformation that integrates advisory services and solutions

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BearingPoint is transforming from a consulting company that delivers services in a traditional way into a company that is flexible in the way it works with clients and values innovation, collaboration and entrepreneurship. In a discussion, BearingPoint’s new Managing Partner Kiumars Hamidian stated, “We try to reduce the use of PowerPoint with clients,” which essentially leads to increased interactions during the proposal and solution development phases. On the other hand, BearingPoint is increasing its use of collaborative activities with clients and encouraging people to bring their best ideas, often using design thinking and agile-based methodologies. BearingPoint places innovation at the center of its activities across its three business pillars — Consulting, Solutions and Ventures — utilizing its “Be an Innovator” process to generate ideas for new services. The company uses IP assets such as accelerators, as well as incubators and ventures, to drive innovation.

BearingPoint is a European consulting company with global market reach

Executing on its three priorities — markets, portfolio and people — and utilizing its three business pillars will enable BearingPoint to continue to grow revenues and reach its 2020 overall revenue goal of €1 billion (or $1.2 billion). On the markets side, BearingPoint positions as an independent and partner-owned management and technology consulting company that has European roots and global reach and enables clients predominantly in its core European territory to become global leaders. Utilizing its European market reach and a new design and brand profile that emphasizes creativity, innovation, and a collaborative, agency-like approach, BearingPoint is set to attract such clients. As BearingPoint updates its brand profile to represent the company’s diversity, its bold, fresh and modern character will likely lead to growth opportunities, especially in new digital segments. To serve clients outside its core territory, BearingPoint utilizes its Global Reach Offices in Dallas and Shanghai and expands its global market reach through consulting and technology partnerships, such as with West Monroe Partners in North America, ABeam Consulting in APAC and Grupo ASSA in LATAM.

 

 

BearingPoint selected Lisbon, Portugal, as the host city for its Analyst Summit 2018. The event, which was held on Oct. 11, was not a traditional analyst day, as it was held at a former needle manufacturing facility, rather than in a conference room, and the vendor refrained from using PowerPoints to display its capabilities. Instead, the vendor transformed the facility to use personalized setups and spark attendees’ imaginations, and it relied on engaging conversations to gain the attention of the audience. The agenda was rich in topics, ranging from strategic and business overviews to five client case representatives talking onstage about their work with BearingPoint. The company also used a mobile app that was specifically developed for the event to provide personalized information about the event, share files and take live polls of the audience, which further enhanced engagement with the audience.

Voice assistant volume is increasing

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A survey conducted by Adobe Analytics found that 32% of U.S. consumers owned a smart speaker in September 2018, compared to 28% in December 2017. The report also projected that near half of the U.S. consumer base could own one by the end of December 2018, supported by Adobe Analytics’ finding that nearly 80% of smart speaker sales occur during the holiday season. It is just one study, and there are more conservative studies out there ― but even if the data isn’t completely on the mark, it does uncover the trend of voice-controlled devices gaining ground inside consumers’ households despite use cases and monetization still being blurry.

I own four Amazon Alexa-enabled devices myself: two Echo Dot smart speakers and two Fire TVs. Of the Echo Dots, one was given to me by a colleague to play around with, and another I bought for about one-third the list price from acquaintances who had received it as a gift from their extended family and left it unopened because they felt it was “too creepy.” In our household, the Echo Dots have been used as glorified hands-free music players in our kitchen and one of our bathrooms. The Fire TVs are used as media players first and foremost. Sometimes, we try some of the new skills Amazon sends along in update emails as a fun diversion, but usually that is a one-off activity. I am deeply invested in the Amazon ecosystem, having been a Prime member since its debut and a fan of Prime Video, but it is still challenging to find ways to use Alexa smart-home devices to enhance my other Prime benefits or drive me to Amazon’s e-commerce business.

Adobe’s research seems to align with my anecdotal experience, noting that among the most common voice activities* are asking for music (70% of respondents) and asking fun questions (53% of respondents). The only other activity above 50% is asking about the weather (64% of respondents). So yes, people are using them, but these are not skills that require much depth or complexity or that drive additional revenue for Amazon.

Therein lies the problem for voice-platform providers such as Amazon and Google (Microsoft and Apple are also players, but I don’t believe they are as developed as Amazon and Google are in the smart speaker and voice assistant space). In an ideal world, voice assistants would provide platform companies with a wealth of consumer data as users query the devices about their everyday needs. Also, voice assistants can be a new conduit to monetization through new applications or — especially in Amazon’s case — to lowering barriers to the purchase of goods. However, most complex tasks, such as ordering a ticket for the movie you’d like to see tonight, finding out when the beach is open, or buying an outfit for an upcoming wedding, are still much easier via a smartphone or laptop interface. The Adobe study found that of the 32% of respondents with a smart speaker, only 35% and 30% used voice interfaces for basic research or shopping, respectively.

Improving the use cases, or “skills,” of voice assistants will be critical for platform vendors to increase the use of these devices for complex tasks and to elevate smart speakers from smart radios and novelties to gleaming data gems. TBR expects this to be the major battleground between voice assistant and smart speaker providers moving forward as the form factor has been relatively proved. TBR believes Google has a slight advantage due to its heritage in data mining behind the façade of services as well as its Android and Chrome cross-platform tie-ins (a lot of relevant user data is already in Google, such as contacts, schedules, and often email). Amazon is no slouch either due to its investment spend, growing media empire and robust e-commerce platform, which Google lacks. Apple could be a dark horse; however, its Siri is still weaker on an artificial intelligence (AI) basis and the HomePod’s pricing makes it an unlikely easy gift.

The next frontier for all of these platform providers is in the commercial space, an area we may see Microsoft put much of its effort into while leaving the consumer space for better-suited peers. In fact, collaboration between Microsoft and Amazon on voice and smart speakers may confirm this. Using voice assistants and smart speakers to query analytics or gain business insights or employing them as a “smart secretary” in conference rooms are areas TBR sees as avenues for commercial expansion. TBR has seen slightly different approaches from Amazon and Google in the commercial space. Amazon, likely with Microsoft support, focuses on the office with Alexa for Business, while Google seems to be positioning its voice AI and smart speaker technology to serve as an interface for a business’s customers.

However, as with the consumer space, the use case must be proved, the skills must be ironed out, and existing commercial infrastructure must be modified to support voice assistants and smart speakers. And despite furious investment in these possibilities by the major platform players, TBR doesn’t expect to see Alexa widely adopted in the boardroom for at least another two to three years. For now, I believe smart speakers will continue to find their way into homes as a novelty or curiosity for tech-excited people and early adopters, contributing to slow but steady growth, or as an easy, cost-effective tech-based gift, driving additional bursts of increased unit sales during the holidays.

*Voice activity data includes devices that are not smart speakers, such as smartphones.

2018 5G Americas Analyst Forum

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5G will provide network efficiencies for telcos as they anticipate next-generation use cases

Given the introduction of Verizon’s (NYSE: VZ) 5G Home fixed wireless service in October, as well as the upcoming launch of AT&T’s and T-Mobile’s mobile 5G networks by the end of 2018, the 5G era is edging closer to reality after years of industry speculation regarding the technology’s capabilities. Similar to prior network eras, such as the transition from 3G to LTE, the 5G era will be a gradual evolution of existing network capabilities and will not immediately yield its full benefits or dramatically alter the global wireless market during its inception.

A resounding theme at the 2018 5G Americas Analyst Forum was that the 5G era will essentially be “more of the same” initially. LTE will remain the predominant source of connectivity for most wireless subscribers in the Americas over the next several years until 5G coverage becomes nationwide and customers transition to 5G-capable devices. The accelerated speeds offered by LTE-Advanced services, as well as the cost savings offered by IoT network technologies such as Narrowband IoT (NB-IoT) and LTE-M, are currently more than sufficient to support the demands of most consumers and enterprises.

The wireless industry is anticipating 5G will foster IoT innovations in areas including connected car, healthcare, smart cities and augmented reality (AR)/virtual reality (VR). Though advanced IoT use cases that require the precision promised by 5G, such as remote surgery, are being explored, many of these services will not become commercially available until the mid-2020s at the earliest. Additionally, solutions like remote surgery and V2X automotive services will be burdened by significant regulatory challenges as ensuring 100% network reliability and ultra-low latency will be essential to prevent hazardous outcomes.

Although the end-user benefits of 5G will initially be limited, investments in 5G will ultimately be viable due to the network efficiencies operators will gain from the technology. 5G, which is expected to provide between four- and 10-times greater efficiency on a cost-per-gigabyte basis compared to LTE, will enable operators to more cost-effectively add network capacity to support the prevalence of unlimited data plans as well as continued connected device additions. Offering 5G services will also be essential for operators to remain competitive against their rivals as the marketing of accelerated 5G speeds will help to attract subscribers. Lastly, the deployment of 5G networks will prepare operators to support 5G-dependent use cases when they do come to fruition and spur customer demand.

 

 

Around 70 representatives from well-known operators and vendors attended the annual 5G Americas event to talk with more than 70 industry analysts about the state of wireless communications in North America and Latin America as well as discuss challenges and opportunities presented by the rapid development of the mobile ecosystem.

The event kicked off with a presentation from T-Mobile (Nasdaq: TMUS) CTO Neville Ray regarding 5G leadership in the Americas. He discussed topics including projected use cases, the importance of 5G to the U.S. economy, the Americas’ position in the global 5G market, and the different initial approaches U.S. operators are taking to 5G. A panel of network and technology executives from operators including AT&T (NYSE: T), Sprint (NYSE: S), T-Mobile, Telefonica (NYSE: TEF), Cable & Wireless and Shaw (NYSE: SJR) provided additional insights into 5G evolution and activity around 5G by each respective operator.

Day 2 began with panel sessions featuring leaders from top telecom vendors, including Ericsson (Nasdaq: ERIC), Cisco (Nasdaq: CSCO), Nokia (NYSE: NOK), Samsung, Intel (Nasdaq: INTC), Qualcomm (Nasdaq: QCOM) and Commscope (Nasdaq: COMM), to discuss areas such as 5G regulatory challenges, 5G network and technology deployments, and potential 5G go-to-market strategies and use cases. Following these panel sessions, the reminder of the event offered analysts the opportunity to participate in a choice of 34 roundtable discussions focused on key 5G topics, including Internet of Things (IoT), edge computing, artificial intelligence (AI), 5G network infrastructure and technologies, regulatory considerations, and 5G in the automotive industry. 

Big Blue opens its arms, and its wallet, to Red Hat

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Red Hat’s projected growth is enough to justify the hefty purchase price

On Oct. 28, IBM (NYSE: IBM) and Red Hat (NYSE: RHT) executives announced a proposed acquisition ― one that will be the industry’s third-largest acquisition should it gain approval. The deal, valued at $34 billion, would bring Red Hat into IBM’s hybrid cloud team, in its Technology Services and Cloud Platforms (TS&CP) group, where its IaaS (formerly SoftLayer), PaaS (formerly Bluemix) and hybrid management capabilities reside.

While the sheer magnitude of the deal may surprise some, the underlying reasons do not. IBM’s cloud strategy was sorely due for a boost, and Red Hat has been looking for a potential buyer for quite some time. Stefanie Chiras, a 17-year IBM vet, joined Red Hat as the VP and general manager of the Red Hat Enterprise Linux (RHEL) business unit in July, likely to lead that group through the planned acquisition. The potential acquisition would also be aided by portfolio synergies around Linux on IBM hardware and Kubernetes. Additionally, IBM is pervasive in the large enterprise market while much of Red Hat’s revenue is channel-led.

What’s most important is that IBM listened to its stakeholders and the broader market, realizing that while its cloud business was growing consistently at around 20% to 25% year-to-year on a quarterly basis, that was not enough to move the needle materially to more effectively compete in cloud. The company’s recognition that it should not always promote all-IBM solutions is a noteworthy shift. Though IBM has had technology partnerships for some time, there was always the underlying perception that it would push its own solutions ahead of others, regardless of customer needs. Its recent and ongoing focus on hybrid IT enablement has changed this; and now, bringing on an open-source company could change the game for IBM.

Sticker shock fades once you factor in the rest of the numbers

Historically, initial public offerings (IPOs) and sales of more traditional technology and software companies have been valued at around 5x their annual revenue. However, in recent years, as more cloud-native companies with subscription-based business models go public or get acquired, this multiple has steadily shifted upward. As a rather extreme example, Cisco (Nasdaq: CSCO) bought AppDynamics for $3.7 billion, a valuation of nearly 16x AppDynamics’ annual revenue, even though in the week prior to the purchase AppDynamics had been valued at $1.9 billion on an annual revenue of approximately $220 million as the company readied for its IPO.
Much of the speculation around this monstrous deal relates to how IBM can and will fund such a hefty purchase. To put this massive $34 billion figure into perspective, Red Hat’s trailing 12-month revenue for the four quarters ended Aug. 31, 2018, was just shy of $3.1 billion, indicating the deal is valued at 11x Red Hat’s annual revenue. If Red Hat were to stay on its double-digit growth pattern and trajectory*, its revenue and operating income would be projected to more than double by the close of 2021, benefiting from access to IBM’s vast enterprise customer base.

These projections help IBM justify the large purchase price. Additionally, it is likely that the purchase price per share was set at least a few weeks ago, when there were more Red Hat shares available and at a higher price. On Oct. 1, Red Hat was trading at $133 a share, compared to the $117 per share price it was trading at on Oct. 26.

Synergies make the acquisition possible; success will come down to execution

Organizational structure

The proposed acquisition poses significant integration challenges for IBM if approved. Though the company has been successful in the past with integrating software acquisitions, it has yet to make a purchase this large, and this is the first major software acquisition since the company reorganized and brought software subgroups across its various business units a couple of years ago, eliminating a dedicated software business unit. Additionally, none of the formerly acquired companies have run as stand-alone units as Red Hat is expected to be.

Red Hat’s proposed position as a stand-alone unit in TS&CP could have varying results. IBM Services’ culture and cumbersome processes could stifle Red Hat’s software-led mindset, culture and innovation. Alternatively, Red Hat’s products could be pulled through in an unprecedented number of Services engagements the company has yet to see due to its much smaller size and scale. This second scenario, however, would only be possible if IBM Services and consultants can differentiate from Red Hat’s existing systems integration partners to maintain IBM’s status as the largest services provider around Red Hat and Linux. Whether or not those partnerships will stay at the strategic levels they are at today, or at all, remains unclear.

Red Hat CEO Jim Whitehurst would report to IBM CEO Ginni Rometty. While it is very likely he would stay with IBM for the year or so required and then retire, there is the possibility, and this is pure speculation, that IBM could be priming him to be a contender for the position of IBM CEO should Rometty look to retire soon.

Go to market

Undoubtedly, IBM has set its sights on reaching more midmarket customers as its large enterprise customer base is slower and more resistant to move to cloud. Red Hat’s prevalence in the midmarket will surely help open the doors to cross-sell IBM solutions and services to these companies, if pricing is adjusted for smaller companies. Additionally, IBM will gain access to a Red Hat developer community of more than 8 million. On the other side of this, Red Hat also can bring its solutions upmarket to IBM’s largest enterprise customers.

Much of IBM’s focus as of late has been on helping customers link on- and off-premises environments and sharing data across truly hybrid environments. Its large Services arm and broad portfolio set have helped offset some legacy software and services revenue erosion in past quarters. While Linux is already relatively pervasive across the market and OpenStack has yet to garner significant demand or traction, Kubernetes is the open-source solution of choice at the moment and will be in coming quarters. IBM continues to update its IBM Cloud Private portfolio centered on Kubernetes, which can also run on OpenShift, presenting an area of immediate portfolio synergy between the two companies. The incorporation of additional open-source technologies into the mix as well as Red Hat’s interoperability with third-party cloud and software solutions only help position IBM as an increasingly technology-agnostic hybrid enabler.

Peer implications

Despite the size of the acquisition and the attention it is garnering, IBM’s cloud competitors will not face substantially altered challenges should the deal go through. Amazon Web Services (AWS) and Microsoft (Nasdaq: MSFT) will continue to dominate the public cloud IaaS and PaaS market. The two have increasingly embraced open-source technology integrations in their proprietary ecosystems, only enabling them to get bigger as they can also work with RHEL customers.

We believe that if this acquisition were to materially impact any single company, it could be Google (Nasdaq: GOOGL) and/or Oracle (NYSE: ORCL). Google struggles to compete at scale with AWS and Microsoft and does not yet have the same permission to play in the large enterprise segment. With IBM, Red Hat would gain that permission almost immediately. Oracle’s Linux offerings are based on RHEL, which could complicate a competitive relationship between IBM and Oracle. While Oracle may have more pressing areas to focus on and invest in, such as Kubernetes in tandem with its peers, the company could, should it choose not to work closely with IBM when Red Hat is integrated, look to acquire another Red Hat-like company with expertise and capabilities in open source and Linux in particular, such as Canonical or SUSE, which was just sold by Micro Focus (NYSE: MFGP) to private equity firm EQT for $2.5 billion.

Has Red Hat’s Jim Whitehurst set himself up to succeed CEO Rometty at IBM?

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While it is very likely he will stay with IBM for the year or so required and then retire, there is the possibility, and this is pure speculation, that IBM could be priming him to be a contender for the position of IBM CEO should Ginny look to retire soon. — Cassandra Mooshian, Senior Analyst

What Is 5G Technology And When Will It Arrive?

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“With undergoing development, 5G technology is expected to get the show on the road by 2020. That can seem to be a long wait, but it still remains an ambitious timeline. According to Technology Business Research Inc., network operators are expected to spend billions of dollars on 5G capital expenses by 2030.”

Whether by R&D or acquisition, money can’t buy SaaS performance

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The SaaS market appears to provide an easy opportunity for vendors to garner significant revenue and growth. SaaS is the largest segment of the cloud market — bigger than the IaaS space, which draws so much attention due to leaders Amazon Web Services and Microsoft Azure. The SaaS market is also much more fragmented, littered with thousands of providers, which would seem to imply that consolidation is a foregone conclusion. However, even for three of the largest leading SaaS providers, the investment level required to compete in the space remains high, and even spending billions of dollars in R&D and acquisitions does not guarantee success.

This is not to say that these billions of investment dollars are all for naught. Despite being around for more than a decade, the SaaS space remains quite immature. Customers are still figuring out which of their applications can be moved to cloud delivery, and how, when and with which vendors those moves can take place. Until a longer track record exists for making these decisions and vendors consolidate disparate offerings into packages more closely resembling integrated solutions, the market remains very much in flux. It’s not the functionality holding back the adoption of hybrid solutions, it’s the difficulty of integrating and managing the multicloud and multivendor solutions. In the meantime, vendors such as Oracle, SAP and Workday have no other choice but to continue accelerating their investments. Their dollars will not buy SaaS performance in the short term, but this is the only way these vendors have a shot as the SaaS space becomes more predictable.

Oracle is in too far to turn back now

By virtue of its long legacy in a diverse field of software, Oracle finds itself in a unique position with cloud solutions. Aside from databases, Oracle is a company built on acquisitions, and that approach holds true with its expansion in cloud. After first downplaying the overall concept of cloud delivery, even while acquiring cloud assets, the vendor recently quickly shifted its messaging and doubled down on internal- and external-driven innovation. The results from a dollar perspective are laid out in Figure 1, representing a steady and significant stream of acquisitions focused on building out mainly SaaS offerings and R&D that funds cloud solutions across the spectrum of IaaS, PaaS and SaaS. The significant amount of Oracle’s investments is undeniable, but the returns are far from overwhelming. The downfall of Oracle’s SaaS investment plans played out quite publicly, as the company first bet it would become the first SaaS/PaaS vendor to achieve a $10 billion run rate, then recently changed its reporting structure midyear to blur the actual results.

 

Oracle maintains worse performance than SAP and Workday for the return on its acquisition and R&D investments, spending more on these investments than the company generated in total cloud revenue during 2016, 2017 and 2018 (estimated). That does not mean Oracle is without successes, however, as the purchase of NetSuite, reflected in Oracle’s large acquisition expense in 2016, contributes to revenue growth and complements the organic development of Fusion Cloud ERP. A lot of Oracle’s struggles in cloud come from organic initiatives, such as its PaaS and IaaS services, which have not taken root with customers despite aggressive sales tactics. Those categories of services account for a significant portion of Oracle’s R&D investments over the past three years, but still generate relatively small revenue streams for the vendor. Nevertheless, despite the investment outweighing the associated revenue contributions, we believe Oracle will and should remain committed to its current cloud strategy. It may not pay off in the near term, but these investments are the best shot for Oracle to execute a longer-term cloud turnaround.

SAP is making all the right financial decisions, but still falling short

Though still acquisitive, SAP’s cloud strategy has been more focused on internal innovation compared with Oracle. A more even mix of R&D and acquisition investments, combined with an earlier commitment to cloud delivery, is producing a better rate of revenue return for SAP, as shown in the graph below. SAP ranks fairly close to Oracle in total cloud revenue but is achieving those run rates after incurring significantly fewer R&D and acquisition expenses. TBR estimates SAP’s combined R&D and acquisition investments for cloud were $6 billion for the past three years, compared with more than $21 billion for Oracle over the same time period.

Despite the comparatively positive financial returns for SAP in cloud, the vendor is still struggling with multiple elements of its portfolio. After allowing Salesforce to capitalize on the shift to moving front-office apps to cloud, SAP recently started circling back to carve out territory in that domain. Through multiple acquisitions in the customer experience space and new messaging, SAP is making a concerted push, but it faces an uphill battle winning more market share in that space. Furthermore, SAP’s effort with SAP Business Suite 4 HANA is a long-term one, and in the meantime, assets such as SAP Cloud Platform are underrepresented in the platform space. The net is that SAP has managed investments well and grown revenue in cloud but is still not achieving at a scale that ensures the vendor’s leadership in the SaaS space.

Workday is opening its wallet after trying the DIY route

Historically, Workday has been more reliant on internal R&D as the sole means of advancing its cloud strategy compared with Oracle and SAP. That certainly does not mean the company was shy about entering new markets or delivering new products, as Workday has rapidly increased its activities in both regards over the past three years. The addition of student, financial and now platform offerings illustrates how broadly Workday has expanded its portfolio beyond core human capital management (HCM) offerings. Part of Workday’s reliance on R&D comes from its core focus on a “single line of code,” which provides simplicity and consistency in the vendor’s offerings to customers. Integrating multiple offerings and services is part of the challenge with acquisitions, which Oracle and SAP know all too well. Workday’s past acquisitions have always been functionality-focused and intermittent. The company’s three acquisitions in 2Q18, including its $1.55 billion purchase of Adaptive Insights, is a departure from that strategy but is likely not indicative of broader plans to acquire more fully baked applications. Workday Cloud Platform will allow Workday to leverage partner-developed, inherently integrated technology to expand portfolio breadth.

 

The assumption that Workday’s acquisition-lite approach to investment would be advantageous is not necessarily true. Even without significant acquisitions, Workday’s investment ratio (R&D + Acquisitions/Cloud Revenue) is higher than SAP’s for the three years from 2016 to 2018. Workday had a lower ratio than Oracle, which is spending aggressively on acquisitions, but Workday ranked above SAP in internal R&D investment level proportional to revenue. Additionally, Workday’s streamlined “single line of code” approach is not guaranteeing success in new product categories. HCM revenue growth remains strong, but Workday’s new expansions in Financials and Student are not seeing accelerated early revenue growth. The new offerings are certainly growing, but not at the rate one would expect given the strong HCM base into which they can be cross-sold. The large acquisition of Adaptive Insights could be part of a change in strategy to add inorganic revenue and could lead to greater cross-selling possibilities for the Financials business.