October 02, 2012, 3:45 PM — ShoreTel, which made its mark in IP telephony by simplifying unified communications and reducing total cost of ownership, recently broke into the hosted VoIP business with the acquisition of M5. Network World Editor in Chief John Dix caught up with ShoreTel CEO Peter Blackmore to find out how integration of that company is going and where he is taking the company.
You've been CEO for almost two years now and the largest development in that period was the acquisition of hosted VoIP supplier M5. Why did you acquire them and what have you achieved since?
Last year in June we discussed with our board the changes in the market and the growth of voice-over-IP in the cloud, and we agreed that ShoreTel, notwithstanding the continued strong growth in the premise, would need a cloud solution.
The issue was, do we buy or do we build? We knew we could build a cloud platform, but the time it takes to build it, scale it, get the data centers running, get new accounting systems that do very different sorts of billing than we do, it's a three-plus year exercise. So we decided to buy.
The reason we decided to buy is when the market starts accelerating to the extent cloud is, there's a window of opportunity where you can find good targets and you can also afford the target. So we think we got the timing just about right.
There are 80 voice-over-IP cloud companies in the United States alone and we talked to 25 of them, not as targets, but to learn and to understand their business model and understand what worked, what didn't work. Then we talked seriously to nine companies and selected M5 by November. Between November and January we did the term sheet and closed on March 23. So it was a very diligent process.
Why M5 versus anybody else? We wanted a company with their own intellectual property. One of M5's attributes is they can link Salesforce.com in the cloud to their voice-over-IP in the cloud; you can share data. That is a very sticky application and there are many more you can add by building a network of apps and linking it to voice. You cannot do that unless you have your own IP.
The business model in cloud is totally different to premise. You ask a customer to pay monthly one month ahead of their usage. Therefore, it takes about two years to get the return on your investment, and for that to be a good investment you need the lowest churn rate and the highest ARPU [average revenue per user]. M5 has an ARPU in excess of $60, which we believe is the highest in the industry, and a churn rate of 0.2% per month, which we believe is the lowest in the industry. So that was two of the key factors.
We then asked, "Is it a proven business? Do they have a proven management team? Are they ramping?" And they were doing all of the above, so that's why we chose them. We've had our first full quarter with them, which was the June quarter, and their bookings gross was 43% higher than the previous year, which is excellent. And they're doing very well, so we're delighted.
M5 was one of the earliest players in this market. Given they've been around for so long, frankly I'm surprised they are only adding about $15 million in revenue to your books. Have we not turned that corner in the growth curve of this whole hosted VoIP business yet?
Well, if you look at the competitors to M5, you don't have the normal names we associate with the premise. For example, we don't see Cisco and we don't see Avaya. There are smaller player and most of them have been in business for 10 years. So that was my point about when the market starts really taking off, you need to get in at the right time. We think the timing is right.
How many customers do you have on the hosted side now?
About 3,000. The average number of seats is 40.
So the typical hosted user is a smaller shop. Do you see that changing over time?
It's interesting. When we were negotiating with M5 their average seat size was 30. It's now 40, so it's increasing. Our biggest customer is a human resources search agency and they've got 2,000 seats. There's no glass ceiling here. You can have bigger and bigger customers. The profile is steadily increasing, and that's why we think the M5 market is more interesting than competitors such as 8x8 and RingCentral, who have less than 10 seats on average. We're at the 40 level and it's a business customer with lower churn, higher ARPU, so we think it's the right place to be.
Your annual report says your profit margin is lower on the hosted side than on the customer premise side, which seems counterintuitive, no?
Hosted customers have a choice of either a pure Web connection or a T1 connection to improve voice quality. The vast majority ask us to provision T1 and therefore it reduces our overall margin. Over time, I think that will go away because the quality of the Web telco will steadily improve.
Speaking of time, although the hosted business is a fraction of your customer premise business today, looking out five, 10 years, does that flip-flop?
IDC says that by 2015 the voice market for premise and the voice market for cloud will be equal at $15 billion. And then on top of that you've got to add the UC market, which will be split between the two, and that would be an additional $12 billion. So you've got 15 and 15 plus 12. That's the size of the market, and it is split 50-50. So it doesn't flip but that's cloud catching up fairly fast with premise.
Is M5 fully integrated at this point or is there still work to do?
We're on track. The first step was to integrate finance, human resources and information technology. That was done in the first three months. We're now in the process of integrating engineering and we've been public about that with employees on both sides. We'll have a fully integrated roadmap and a fully integrated engineering team by December.
Our plan is to keep go-to-market separate because if you have a SaaS product and a hardware and software product, very rarely can a sales team sell both well, so it's better to keep them separate. We do share lead generation, but everything else will be integrated by December.