Software Business Forecast: Cloudy, but Clearing Up

By Rene Bonvanie, Senior Vice-President of Marketing, Information Technology & Serena On Demand, Serena Software |  Software, software

“Cloud computing” may be one of the most aptly descriptive buzzwords to emerge in recent years: when you ask tech or business people what it really means, they generally offer fluffy, foggy responses.

Buzzwords rarely move conversations -- or profits -- forward. So it’s not surprising that many cloud computing companies currently are struggling to make money, as Sarah Lacy recently wrote in Businessweek.com.

Nevertheless, the technologies and businesses that comprise “cloud computing” have indeed become an important trend in modern software. That’s because cloud computing offers users compelling benefits over traditional software

Lacy described these benefits well: “...Low-priced, convenient delivery of applications. Buyers save on consultants, because vendors host the applications and just rent access via the Web. No more obnoxious upgrade cycles, because software is improved and tweaked daily. And if the software doesn’t live up to expectations? Just cancel. Businesses don’t invest in installing and configuring the software, so there is no lock-in. ...On-demand represented a welcome break from the traditional way of doing things in the 1990s, when swaggering, elephant hunter-style salesmen would drive up in their gleaming BMWs to close massive orders in the waning days of the quarter.”

Those benefits are so basic and so significant that any software company which fails to offer them today appears rather backwards. Consequently, most business software vendors have jumped aboard the cloud computing bandwagon. But they’ve done this different ways, which affects their respective profit outlooks.

To clear up this discussion, here are the four “buckets” into which cloud computing businesses currently precipitate:

1. 1. Ad supported. This is the best-established “traditional” model. It’s highly lucrative and has been around for years. Players include Google, Yahoo, Microsoft, and other internet giants.
2. Infrastructure and operations. These companies provide tons of raw computing power. Examples include Amazon, OpSource, Opsware (now HP), telcos, and even Apple (with MobileMe). In the short term, these businesses run at a loss. But in the long term, economies of scale mean there’s lots of money to be made here. To get started in this market, infrastructure cannot be your only business. You must have other robust revenue streams to support it until it matures.
3. Software vendors. These companies piggyback on the companies in bucket 2 above by leasing computing power as needed. Thus, they can control overhead costs, expanding only as demand warrants. This strategy provides global coverage with a much smaller investment -- which in term improves prospects for faster profitability. Serena Software falls into this bucket, as do Business Objects/Crystal Reports.com, Workday, SuccessFactors, NetSuite, and even Intuit (to some extent).
4. Hybrids. These blend buckets 2 and 3, the infrastructure and software vendor approach. SalesForce.com is the classic example of this, since it hosts the software that it provides. Hybrid companies seek to own the whole value chain in order to “win at all costs.” So far, they’re just breaking even because infrastructure is so costly.

This focused, nuanced view more clearly maps out where and when the profits of cloud computing are likely to rain down. It exposes the obvious: Of course not many companies are profiting from the cloud computing business yet! This field is so new that we’re still investing in building the basic infrastructure. Even in the world of high tech, this takes time.

It’s not that different from the evolution of gas stations. When automobiles first hit the market, car owners bought gasoline in buckets -- often from pharmacies. Later innovations like pumps and underground storage tanks improved the gasoline business by making it easier and safer to sell more gasoline in more places. (Which in turn encouraged more automobile sales. Chicken, meet egg.) This helped the business model get more established, and true gas stations began to appear along American roads -- some independent, others franchised by oil companies. Their equipment required a substantial up-front investment, which inevitably depressed station owners’ profits for the first few years.

But once Americans had cars, there was no turning back to the horse-and-buggy era. Fast, independent mobility proved to be such an eminently compelling benefit that it became an inexorable force, driving the development of a major nationwide infrastructure we take for granted today. And in the long run, most of those pioneering gas station owners hung in there and ended up doing pretty well.

The cloud computing approach to delivering software as a service does face some tougher business obstacles than delayed profit gratification. In a comment to Nicholas Carr’s post summarizing Lacy’s article , tech blogger Simon Wardley observed that interoperability and data portability between vendors is a huge current concern for the SaaS market.

“Shifting the mentality of product differentiation into a service world is not only counter to second sourcing -- it makes little sense for [a market that] is becoming ubiquitous and well defined,” Wardley wrote.

Wardley advocated the open-source, “emergent standards” approach to addressing users’ concerns. That’s one possible solution; another ( as IEEE recently noted: ) is the rise of more formal standards for service-oriented architecture (SOA) and web services.

So yes, the road to a viable cloud computing business is bumpy, still under construction, and not all of its amenities and safeguards are fully planned. Nevertheless, more and more users are traveling it every day, to escape the constraints and perceived gouging of traditional license software. They show no signs of turning back. Neither should software companies, infrastructure providers, and other players in this emerging market.

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