Riding on one of the biggest technology shifts in decades, the Cloud applications market is expected to post a 10% growth rate annually over the next five years by reaching as much as $76 billion in Cloud subscription revenues by 2020.
The double-digit growth is likely to materialize as Cloud migration continues unabated despite the adverse effects of a wave of massive consolidation that could undermine organic growth of some of the most promising Cloud vendors. The race to get bigger was striking in 2016 with vendors like Microsoft, Oracle and Salesforce launching audacious and expensive acquisitions in order to capture and expand their market shares. The question is whether the Cloud applications market, when factoring in some ominous signs, could sputter in what economists call a Minsky moment, resulting in a sharp drop in its value when so much of its assets is tied to borrowed money.
Exhibit 1 shows the forecast for the Cloud applications market through 2020.
For the time being, the macro drivers are compelling with increased user demands (millennials prefer flexible cloud delivery over brittle and expensive legacy systems), corporate mandates (airlines routinely give iPhones to their flight attendants and employees for personal use as well as inflight and ground transactions), and improved Cloud reliability and security capabilities (live streaming, ad-blocking and shopping cart technologies are thriving while mission-critical websites like ACA Health Exchanges are racking up more than 12 million enrollees despite early stumbles).
Another key indicator is widespread user satisfaction with Cloud applications. Recently, Bank of America completed a Cloud-based time and attendance system for its 50,000 users (primarily bank tellers) from Infor Workbrain for workforce management. The bank reported 97% satisfaction rate among its users, compared with 47% for its legacy system. That suggests doubling its return on investment from a usability standpoint.
One good measure of Cloud popularity stems from the fact that Cloud subscription revenues exceeded conventional software license sales for the first time in 2015. Given recognition of subscription revenues generally lags behind that of software licenses, it is safe to assume that the overall consumption of Cloud apps is on track of surpassing conventional software implementations over the next few years both in terms of bookings, actual number of end users and perhaps overall spend on new and existing applications projects.
These metrics only tell part of the story. The evolution of the cloud-based enterprise applications is taking on a new shape as incentives of various forms are being extended to help sustain one’s standing in the marketplace.
Cloud Subsidies Multiply
State-sponsored Cloud is probably the most obvious incentive. Consider Entrata, a fast-growing Cloud-based property management apps vendor for real-estate companies. Entrata employs more than 1,400 globally and it has plans to hire up to 191 new employees out of its new headquarters in Salt Lake City as part of its $6 million capital investment program subsidized by the state government.
Similarly, iCIMS, which offers Cloud apps for talent management, announced in July 2016 that it is moving from its current headquarters in Old Bridge, N.J., to a former Bell Labs site in Holmdel, N.J., after the New Jersey Economic Development Authority approved a tax break of up to $38 million over 10 years. With such generous tax breaks, iCIMS, which has nearly 600 employees, could see its headcount rising to 1,000 over the next year or two.
Platform vendors are also doling out hefty subsidies to help boost Cloud applications development. In June 2016, Salesforce announced a $50 million Lightning Fund to help developers write all kinds of enterprise applications on the new platform. That followed Slack’s $80 million fund to help ISVs take advantage of the collaboration and messaging platform from Slack. Because of its mass appeal and ability to supplant common corporate productivity tools like email, Slack has emerged as one of the most closely-watched Cloud startups. Already, Slack has poured $2 million into 11 companies, which receive over $30 million in additional investments from other VCs.
Not to be outdone, SAP has a $405 million fund to help ISVs develop products for SAP HANA, its in-memory database as well as the fast-growing HANA Cloud Platform. Their enthusiasm can only be matched by further VC investments earmarked for Cloud-based enterprise applications.
In July 2016, Sprinklr raised $105 million from VCs, bringing the total funding to $239 million for the enterprise listening apps vendor, which now fetches a valuation of over $1.8 billion. After an extended drought, the warm reception to tech IPOs from Talend for Big Data integration and Twilio for Web Real-Time Communications software highlighted the fact that the era of ultralow interest rates is a vacuum that nature abhors.
Not surprisingly, the Cloud apps market is music to the ears of many investors. Despite the heightened concern over the high valuation of these Cloud startups and their inability to generate a profit in the long run, few investors want to pass up on the opportunity of hitting another homerun by backing successful Cloud developers like Workday.
Never mind that for every Workday or Salesforce there are thousands of failures. Even with temporary setbacks like the one facing Cloud HCM apps vendor Zenefits, which lost over half of its value in June 2016 after a wave of bad publicity as well as execution miscues, the long-term potential of the Cloud applications market outweighs short-term risks.
Cloud Market Forecast By Geography
Across the region, the Cloud applications market has been trending up fairly predictably with the biggest market North America gaining the critical mass the earliest. With that comes a bigger base for the whole Americas, which means that it will trail the other two regions in actual growth year after year. However, recent developments have dampened the outlook for EMEA, the second largest region. Last year, we predicted that the EMEA region would grow 14.7% on a CAGR basis through 2019. Today, we expect the annual growth of the European region to drop to 9.3%, compared with 10.1% for Americas, which is more than twice the size of EMEA, as shown in the following table.
Exhibit 2: Cloud Applications Market Forecast 2016-2020, By Region, $M
|Region||2015||2016||2017||2018||2019||2020||2016-2020 CAGR, %|
Source: Apps Run The World, August 2016
Asia Pacific remains the fastest-growing region as Cloud adoptions have not skipped a beat. In the second quarter of 2016, SAP reported that Japan, China and India posted double-digit growth in Cloud sales contributing to a 47% jump in constant currency – the highest across all regions – in Cloud subscriptions and support revenues for the Asia Pacific region. In the fourth quarter of 2015, SAP Cloud sales in Asia Pacific was equally robust by chalking up a 48% jump.
For EMEA, the UK voters’ decision in June 2016 to leave the European Union certainly played into our revised forecast. For one thing, a less integrated European Union could raise costs for vendors that are faced with the prospects of needing to put in additional infrastructure support at the country level. Adding to the uncertainty is a possible reduction of globalization activities from trade to immigration, which have manifested as the crux of the issue behind the Brexit vote. Regardless of the outcome, the UK market is expected to see increased volatility over the next year or two as many of the big banks and multinationals may have no choice but to move some of their UK operations elsewhere to mitigate any unforeseen risks. All of these could lead to a more expensive, less scalable Cloud with greater tendency for gyration over integration in Europe than previously thought.
Market gyration may spur marriages of convenience. In July 2016, UK-based Bond International rebuffed Toronto-based Constellation Software’s plan to buy the Cloud HR apps vendor. Instead of selling itself to CSI for £44 million, Bond divested its HR and Payroll unit to FMP Global Bidco Ltd, a UK-based HR and payroll firm backed by Tenzing Private Equity. FMP is paying £27.4 million and the assumption of £2 million net debt for Bond’s HR and Payroll unit. After the sale, Bond, insisting that the offer from CSI was undervaluing the company, is expected to mull over future of its remaining assets including recruiting apps and real-estate holdings. CSI may end up contesting the sale with a counter offer because it already owns 30% of Bond.
Increased volatility in the United Kingdom will have considerable implications on how UK-headquartered companies and other multinationals extend their enterprise applications investments, which could put the future of vendors like Bond at risk. As such, Cloud-based applications vendors with heavy exposure to the UK market could find themselves in the same boat as Bond.
Cloud Market Forecast By Revenue Type
The Cloud apps market is expected to outpace the conventional method for enterprise applications implementation as vendors and their customers are replatforming their systems in order to take advantage of a more flexible software delivery model.
As shown in the following exhibit, the Cloud apps market is expected to grow 10% through 2020, while the other two revenue types are projected to show little or negative growth during the forecast period. After investing tens of billions of dollars in Cloud acquisitions, product development and infrastructure support, enterprise applications vendors are keen on optimizing their returns. Increasingly license sales have been supplanted by Cloud subscription revenues, albeit at a reduced replenishment rate given the lag effect of recognizing Cloud subscription revenues over a longer period of time than registering perpetual license sales upfront.
Exhibit 3: Worldwide Enterprise Applications Market Forecast 2015-2020, By Revenue Type, $M Revenue Type, $M
|Revenue Type, $M||2015||2020||CAGR, %|
Source: Apps Run The World, August 2016
Another reason behind the expected steep drop in license sales has to do with the pickup among vendors to convert their license sales into term-based recurring revenues. If that trend continues, the question is whether license sales could see their days numbered, not too different from the way cars are being leased or rented out in a utility model as services like ride-hailing and autonomous vehicles render car ownership obsolete.
The following exhibit shows the depth of contraction projected for license and maintenance revenues as a percentage of enterprise applications sales across the 16 functional markets through 2020.
Functional markets such as Analytics, Content Management, Enterprise Performance Management, Product Lifecycle Management, as well as Treasury and Risk Management are expected to see at least the doubling of Cloud subscription contributions to the makeup of the revenue type in their markets over the next five years, largely as a result of massive Cloud migration already transforming their customers.
Exhibit 4: Worldwide Enterprise Applications 2015-2020 Market Forecast By Revenue Type And By Functional Area, in percentage
Through aggressive trade-in credits, discounts and conversion tools, EPM vendors such as IBM, Oracle and SAP are making it easier than ever for long-time customers of Cognos, Hyperion, and BusinessObjects, respectively, to migrate their on-premise software to the Cloud and not ceding any part of their recurring revenues to Cloud-based developers like Anaplan, Host Analytics, Tidemark and others.
That is expected to propel Cloud-based EPM market to post one of the biggest growth rates among the 16 functional markets based on the projected spend and replacement rates among existing EPM customers in our Buyer Insight Customer Database.
Cloud subscription revenues in nine out of the 16 functional markets are expected to post solid double-digit growth rates through 2020 as many are still at a nascent stage of Cloud migration. On the other hand, Customer Relationship Management applications market is considered a more mature space as it’s harder than ever to find companies without using some kind of sales force, marketing or customer service automation tools in the Cloud. Hence, our five-year projection for Cloud-based CRM applications now stands a little shy of 4%, six points below the industry average. In dollar terms, the 3.9% growth expected for the Cloud CRM apps market still amounts to a net gain of almost $3.2 billion.
Timing of CRM Turbulence
The projected gain does not erase the fact that the CRM apps market is currently in a state of flux as valuation has slipped while debt levels have soared.
In July 2016, Interactive Intelligence became the latest CRM apps vendor putting itself on the block despite a 13% growth in its revenues for the second quarter in another sign of a rapidly consolidating market. inContact was acquired by NICE Systems for $940 million in May 2016 after it bought intellectual property around advanced analytics from Attensity and AC2 for workforce optimization.
Additionally, Teradata sold Aprimo, its marketing automation apps division, to Marlin Equity Partners for $90 million in April 2016, after paying $525 million for it in 2011. Meanwhile, CRM vendors such as Aspect Software slashed its debt by $320 million as it filed for Chapter 11 in March 2016 and quickly exited from bankruptcy protection two months later after financial restructuring and finding replacement of its existing credit facilities.
Even Salesforce, the CRM market leader, is diversifying itself into eCommerce by acquiring Demandware, while actively pursuing platform business by moving aggressively into other functional markets like ERP, HCM and others either through outright acquisitions or the help of its partners. Exhibit 5 shows the Cloud applications market by functional area and their growth projections through 2020.
Exhibit 5: Cloud Applications Market Forecast 2015-2020, In $Billions, By Functional Market and Their CAGR, %
|Functional Market||2015 Revenues, $B||2020 Revenues, $B||2015-2020 CAGR, %|
|Analytics and BI||2.1||5.3||20.2|
|Customer Relationship Management||15.0||18.2||3.9|
|Enterprise Performance Management||0.5||1.4||23.9|
|ERP Financial Management||2.0||3.0||8.4|
|ERP Services and Operations Management||4.0||6.0||8.4|
|Human Capital Management||7.0||10.6||8.7|
|IT Service Management||0.8||1.6||14.9|
|Product LifeCycle Management/Engineering||2.0||5.2||21.1|
|Project Portfolio Management||1.1||1.7||9.1|
|Sales Performance Management||0.4||0.8||14.3|
|Supply Chain Management||1.9||3.2||11|
|Treasury and Risk Management||0.7||2.0||23|
Source: Apps Run The World, August 2016
Cloud Market Meets Minsky Moment
Last year we wrote that a brutal shakeout could be imminent. With the mergers hitting the technology market in full force in the first half of 2016, our prognostication was prescient. However, it was easy to predict the consolidation wave would ensue because that has been the prevailing trend – a locomotive doesn’t stop until it reaches its destination.
What’s more difficult to predict is how the market will evolve amid seismic shifts that could portend the creation of multiple Clouds. A case in point is the pending purchase of NetSuite by Oracle in July 2016 with the former announcing its support of Microsoft Azure as part of an extensive alliance announced in May 2015. The latter, however, has invested billions of dollars to build out its Cloud Infrastructure As A Service and Platform As A Service offerings to accommodate the type of ISVs just like NetSuite. It’s not clear how and to what extent NetSuite will support both the Cloud platforms from Microsoft and Oracle.
NetSuite is not alone in having to support both. A growing number of customers in our database reported that they use both Amazon Web Services and Azure to run their Cloud applications, citing the need to have a back-up Cloud especially in cases where one of these platforms does not have any presence in certain countries. In other cases, the back-up Cloud acts as an insurance policy. The problem with such insurance policies is that it masks actual demand especially for forecasters. It’s as if figuring out actual demand for car tires if the spare ones were included as well.
Similar to the state-subsidized Cloud, the ease of use and affordability of a Cloud platform like AWS, which has been cutting prices regularly since 2011, is in fact a manifestation of the Amazon subsidy at work as much as its attempts to thwart competitors like Google and Microsoft. Regardless of their intentions, subsidies sometimes distort actual demand.
For the Cloud applications market to continue to grow in a sustainable fashion, one is tempted to consider the long-term implications of such subsidies including government handouts, vendor incentives, drastic price cuts, not to mention indiscriminate VC investments.
One possible scenario is the Minsky moment, which calls for anyone to equate a sudden collapse of asset values with how the Cloud applications market could behave upon the abrupt withdrawal of the above Cloud subsidies.
What’s clear is that the tech industry is notorious for its short memory given the fact that the Dot Com bust in 2000 and the collapse of Lehman Brothers eight years later have not deterred anyone from engaging in another round of risky financing.
It’s also plausible to paint the turmoil in the CRM apps market as the precursor of the Minsky moment in the Cloud, perhaps giving more credence to the fact that the Cloud applications market is on the cusp of a contraction.
What’s less clear is whether the Cloud apps market is mature enough to handle such a collapse and whether we should treat the Minsky moment in the Cloud as an aberration, a warning shot or perhaps a massacre to come.
Our advice is simple. In order to prevail in the cloud apps market, one must improve their game in digital marketing and demand generation. Despite their history in the tech marketplace, many on-premise software companies still operate like old-line manufacturers paying little attention to social media, mobility delivery and even the demographic shifts within their customers. In addition, they must be more savvy when it comes to identifying the market segments and the customers that they target by gaining buyer insight. Only by doing so can vendors fortify themselves with the right ingredients to succeed in the long run.
Our latest market-sizing reports profile the top 10 vendors in each of the 37 markets (see Taxonomy here), offering in-depth analysis of the market dynamics, vendors’ Strengths, Customers, Opportunities, Risks and Ecosystems as well as their ability to gain Shares (SCORES) within their respective space. We also track their successes in the Cloud by breaking down their latest on-premise and Cloud applications revenues. Another metric that we use is win-loss analysis of the quarterly wins of these top vendors and whether incumbents and Cloud upstarts pose any real threat to their standing amid shifting market requirements and user preferences.
Each year our global team of researchers conduct an annual survey of thousands of enterprise software vendors by contacting them directly on their latest quarterly and annual revenues by country, functional area, and vertical market. We supplement their written responses with our own primary research to determine quarterly and yearly growth rates, In addition to customer wins to ascertain whether these are net new purchases or expansions of existing implementations.
Another dimension of our proactive research process is through continuous improvement of our customer database, which stores more than one million records on the enterprise software landscape of over 100,000 organizations around the world. The database provides customer insight and contextual information on what types of enterprise software systems and other relevant technologies are they running and their propensity to invest further with their current or new suppliers as part of their overall IT transformation projects to stay competitive, fend off threats from disruptive forces, or comply with internal mandates to improve overall enterprise efficiency.
The result is a combination of supply-side data and demand-generation customer insight that allows our clients to better position themselves in anticipation of the next wave that will reshape the enterprise software marketplace for years to come.