Apps Market Is Clouded By Cheap Money

As Customers, Investors Clamor For Cloud Action, Vendors Comply


Flushed with capital, the Cloud applications market has catapulted into one of the key battlegrounds for software companies to redefine corporate functions and business processes on behalf of millions of enterprises.

At the heart of the struggle is how and whether companies should continue to run their own systems to manage common business functions like accounting, benefits administration and order management. By accessing Cloud applications from vendors, companies are practically offloading those functions to a host of technology providers responsible for the upkeep of the systems with continuous updates and product support.

Once companies realize the benefits of doing business in the Cloud – just ask any merchant selling goods on Amazon – the multiplying effects are profound and intoxicating as they search for more and better ways to handle routine but delicate tasks such as team collaboration, risk management and even industry-specific pain points from costing in construction, revenue cycle management in healthcare and compliance in food safety.

For example, Clio, which specializes in practice management applications for law firms, reported that its base of 20,000 customers were using its Cloud apps to enter 4.6 million new contacts, create 6.8 million documents and track 26.6 million hours in 2014.

Similarly, Box Inc., which sells Cloud-based collaboration and file sharing tools, has grown to reach 50,000 customers including some of the biggest organizations in the world since 2005, achieving an annual revenue run rate of nearly $300 million.

Meanwhile, Cloud applications vendors have been able to raise a stupendous amount of capital from investors wanting to profit from the gold rush. Over the past year, hundreds of these Cloud apps vendors have received billions of dollars in new funding. In particular, more than $1 billion has been raised in recent months by five Cloud apps vendors Domo for business intelligence, Medallia for customer experience management, Zenefits for HR benefits, Slack for team collaboration and Chrome River for travel and expense management.

Vendor Cloud Applications Market Amount raised to date, $M
Chrome River Expense & Invoice Management 120
Deem eCommerce 467
Docusign Online Collaboration 440
Domo Business Intelligence 450
Dropbox Online Collaboration 1100
Evernote Online Collaboration 250.5
Medallia Customer Experience Management 255
Slack Team Collaboration 340
Zenefits HR, Benefits 580

Consolidation Wave

Fueled by low interest rates, the 2015 consolidation wave that has spawned a record number of mergers and acquisitions in different industries shook the Cloud applications market in recent months with a number of old-line companies buying into the Cloud space. Notable deals included Cox Automotive, a division of media conglomerate Cox Enterprises, paying $4 billion to buy Dealertrack for its Cloud-based dealer management systems and CRM applications; and Advance/Newhouse, an affiliate of Advance Publications and publisher of the New Yorker magazine, spending $500 million to acquire Cloud Big Data player 1010data. Within the past year, more than 100 deals have been recorded in our database covering a wide range of acquirers and their Cloud targets from Japanese advertising giant Dentsu buying eCommera for eCommerce to online behemoth Amazon investing in Acquia for content management. Amazon competitor recently bought a 10% stake in Kingdee, an ERP vendor in China, for $170 million.

For much of 2014 and first half of 2015, the state of the Cloud applications market exuded euphoria mixed in with a flood of easy money collectively chasing unbridled growth.

There are signs that the Cloud gravy train is likely to continue because of healthy backlog of recurring revenues and bookings, global opportunities as well as a combination of new add-on services and unusual alliances.

A number of enterprise applications vendors have successfully transformed themselves from selling licensed software to Cloud offerings. Adobe, for example, saw its annual recurring revenues from an array of Cloud applications for enterprise customers and design professionals topping $2.3 billion in June 2015, a milestone that was the equivalent of its peak annual product revenues sold on a perpetual license and maintenance basis just four years ago.

Many Cloud applications vendors book anywhere from a quarter or more of their revenues from customers outside the United States. Zendesk, which sells customer service apps in the Cloud to 57,000 customers around the world, now gets 46% of its revenues from non US customers after embarking on a global expansion program just a few years earlier., the granddaddy of Cloud applications, is selling everything from CRM apps to analytics and healthcare-specific apps for improved patient care, in addition to generating incremental revenues through a gamut of alliances with thousands of Cloud developers as well as erstwhile partners such as Microsoft and Sage, both of which at one point or another have directly competed with Now they are partnering to ensure each other’s products is well-integrated in the Cloud. Apple and IBM, another set of strange bedfellows, have recently joined forces to develop new Cloud enterprise applications designed for Apple’s mobile devices.

Meanwhile, SAP is reselling a range of Cloud applications from new partners such as Benefitfocus for benefits administration and Workforce Software for workforce management to augment its SuccessFactors core HR and talent management offerings.

Cloud Only Strategy

What these developments underscore is the fact that the Cloud applications market has grown to a point where growth is almost guaranteed not just because of customer demand, but also an almost universal consensus among vendors that there really aren’t any viable long-term alternatives other than selling via the Cloud.

Ellie Mae, which specializes in Cloud-based mortgage lending applications for brokers and lenders, announced in February 2015 that effective May 2016 it will no longer support its on-premise version of its flagship product Encompass for all aspects of mortgage processing from underwriting to closing. At its peak in 2009, there were more than 58,000 on-premise Encompass users.

Today Ellie Mae is focusing its product development efforts solely on the Cloud version of the product, which now has over 126,000 users generating more than $100 million in annual subscription revenues. In 2009 Ellie Mae had only 1,261 Cloud users with negligible revenues. A year later, it signed 8,704 Cloud users and recognized nearly $5 million in Cloud subscription revenues. Even though Ellie Mae still has about 20,000 on-premise Encompass users, it appears that the vendor has decided to pull the plug on them knowing that they will end up migrating to the Cloud sooner than later.

In June 2015, Pros, which sells revenue management applications, unveiled its Cloud First strategy, essentially placing much of its future on Cloud applications sales. For 2015, the Pros forecast calls for a slight drop in total revenues as it starts dialing down its traditional license and maintenance revenues. Their decline will be offset by increased recurring revenues primarily in the form of subscription fees from its base of 70 Cloud customers. The switchover could be fairly swift over the next few years. The question is whether its existing customers are aggressive enough to migrate to the Cloud and realize the same – if not more – benefits as they do today.

Similarly, major vendors such as financial services developer SunGard, which is in the process of being acquired by Fidelity Information Systems; and data warehouse specialist Teradata, have all started breaking out their Cloud subscription revenues for the first time since the beginning of 2015. That underscores the growing importance of Cloud subscription revenues to the future of these vendors. For years, Oracle and SAP have embraced similar move by breaking out and detailing their Cloud subscription revenues, bookings and any other metric that gives them a more convincing narrative as they start migrating their customers to the Cloud.

The Hangover

Not every part of the Cloud applications market is as rosy as it appears. Beneath the surface, a number of product categories such as Customer Relationship Management and Human Capital Management have already experienced decelerating growth. Vendors such as Constant Contact, LivePerson, NetSuite, TriNet and Workday have seen their stock prices tumbling since the beginning of 2015. The question is whether their performance is a reflection of the general market conditions as the era of easy money may soon come to an end with expected interest rate hikes by the Fed, which could make other investment vehicles more attractive and fool-proof than the boom and bust cycle of high-tech companies.

A more gloomy scenario is when the frenzy to invest in Cloud applications starts to ebb, exacerbated by  an inevitable market shakeout, the ability to weather the storm will be largely based on how some vendors are able to mitigate the risks through product diversification and/or cost cutting. For their customers, the only hope is if they are capable of running a hybrid environment that allows for ready recovery of their business data.