With acquisitions in the air again, how do you tell if an ERP vendor is performing well? For example Lawson is performing well by many accounts, but received an unsolicited takeover bid anyway. Some suggest the cost of shifting to the cloud puts Lawson’s business model in peril – they only have the resources to either serve their on premises customers or develop a cloud alternative. Without a cloud alternative Lawson has no future, in spite of Lawson’s profit and revenue performance. Is this the best way to analyze an ERP vendor?
Several fundamental measures exist for any software company, including ERP vendors: initial license fee growth rate, maintenance renewal rate, services growth rate, and the percentage mix of license fees, maintenance and services.
Initial license fees are easy to track and predict the future of the other revenue streams, without a license there is no maintenance or services. The emphasis on cloud delivery of ERP reflects analyst belief that future growth will favor cloud over on premises delivery of ERP software. Thus a typical analyst would devalue an ERP vendor for a lack of emphasis on cloud, and factor in declining initial license fees in their projection of vendor performance.
The maintenance renewal rate is the most important indicator of ERP vendor performance because maintenance is the biggest revenue category for a software vendor. The maintenance renewal rate reflects how well the vendor is performing at the key task of continuing to deliver new value to its existing customers. Too little value, renewal rates decrease. Major shifts in technology can have big impacts on renewal rates. For example the shift to Windows based client server architectures led to much lower renewal rates of ERP vendors which could not deliver on the new technology. This led to two consequences: a relative unknown got to the new technology first and dominated market share in ERP (SAP); many strong ERP vendors could not make the transition and ended up acquired by industry consolidators. A rule of thumb in software is that a renewal rate of 85% is healthy – initial license fees and maintenance price increases can easily replace 15% of maintenance revenue and still provide for overall growth. An ERP vendor whose maintenance renewal drops to 60% is in very big trouble very quickly (this is what happened to most of the ERP firms acquired in the 90s as the client server trend took its toll). After two years the customer base is only one third the size of the original (60% * 60% leaves 36%), total revenues are falling through the floor and required layoffs eliminate the ability to invest in future products. Thus a typical analyst would devalue an ERP firm’s maintenance revenues as at risk from the lack of direction to the new cloud technology.
Services revenues have a different impact, and here I differ from the analysts. While the typical analysts sees post sale services as a vibrant and desirable revenue stream in the face of changing technology, I see a big services revenue stream as a drag against initial license fees and maintenance renewals. A high services percentage of total revenues tells the ERP customer two things: implementation will be very expensive, and upgrades will be prohibitively expensive. This holds true for both on premises and cloud delivery of ERP systems. Thus a focus on services revenues will make an ERP vendor less competitive in initial sales (implementation estimates often dwarf on premises license fees, let alone cloud rental rates) compared to ERP vendors who successfully reduce the need for services. The focus on system upgrades as a services revenue opportunity will cause fewer customers to upgrade, meaning fewer customers will receive continuing value from the vendor – thus reducing maintenance renewal rates. Thus unlike a typical analyst, I would devalue an ERP firm’s services revenues as destructive to the core revenue streams of license fees and maintenance renewals.
How the to measure services? As an overall benchmark services revenue should be less than 10% of an ERP firm’s revenue base. The effectiveness of the services delivered (and thus key predictor of maintenance renewals) is measured by the percentage of active customers on the current release / refresh of the software. Less than 60% of customers on the current refresh within one year of release suggests upgrade barriers are too high – and too few customers are benefiting from the ERP vendor’s R and D output. (One ERP vendor benefit of the cloud is the vendor controls upgrades, and can drive the associated services revenues whether or not the customer benefits).
How do ERP vendors rate on these metrics? While posting renewal rates is more common, few vendors release any of these key metrics. HarrisData looks pretty good by this view, naturally.