by Bernard Golden

Cloud Computing Pushes Vendors to Seek New Roles in IT Value Chain

Oct 11, 20128 mins
Cloud ComputingEnterprise ArchitectureSupply Chain Management Software

Cloud adoption means that companies are increasingly signing pay-as-you-go SLAs and renting servers. This means traditional software and hardware vendors must dramatically reconsider their business models, columnist Bernard Golden says.

It’s obvious that cloud computing imposes vast change within IT organizations. I’ve written repeatedly on this topic, addressing issues such as cost allocation, job opportunities, automation requirements, security and the relationship between application and operations groups.

Cloud computing represents the most profound change in computing that the industry has ever seen. The reason is simple. Cloud computing is not just a platform change implementing a better price/performance capability based on Moore’s Law. It represents, instead, a move to an automated computing capability.

In this sense, it is akin to what mass production brought to automobile manufacturing, a change so profound that our entire society is completely different than it was before Henry Ford married an assembly line to standardized manufacturing.

With the Cloud Comes Small, But Frequent, Purchases

While I’ve written extensively about the big changes that cloud computing brings to end user IT, I haven’t spent much time focusing on vendors’ role in this new world. That doesn’t mean that cloud computing won’t bring equally significant changes to the vendor side of the equation; in fact, the changes will be just as wrenching for vendors, with an equal transformation forced on them by the characteristics associated with the cloud.

The foundation of the change can be summed up simply. Cloud computing substitutes small, frequent, incremental purchases for occasional, large, bulk purchases—and delivering and profiting from the former requires very different skills and organizations than the latter.

The increasing adoption of “pay-as-you-go” or “pay-per-use” by end users has caused this shift. Instead of buying a server to run an app, a user can rent a server to run when he needs it. In many cases, he won’t even need to rent a server, instead paying for just the service and leaving ownership and management of the server to the provider, whether it’s an IaaS cloud service provider such as Amazon Web Services or a SaaS vendor such as Salesforce.

Column: Amazon Faces Commodity Cloud Competition

As should be obvious, this results in much smaller purchases. Moreover, it commonly results in a subscription payment pattern—that is, a monthly payment. While the overall revenue might be significant, it’s going to be realized over a period of time, not in a single payment at time of agreement.

This has several implications. For starters, revenue can be much more predictable. Subscribers typically resubscribe at rates well above 90 percent. Think about how attractive this can be compared to having to find a whole new set of customers each quarter. It’s also much less work to get a customer to agree to a small fee commitment rather than a large one-time payment. While the total fee over the lifetime of the subscription may even be more than a one-time payment would be, the smaller initial payment makes it easier to obtain customer agreement.

4 Features of the New Cloud Computing Business Model

On the other hand, the move to smaller, incremental deals challenges established methods of doing business. Vendors need to develop new operational methods that align with the realities of pay-as-you-go or subscription models. By the way, buyers need to be aware of these implications and be ready to work with vendors following these operational methods.

Analysis: Cloud’s Commodity Pricing Squeezes Service Providers, Creates Opportunities

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Here’s just some elements of the new cloud computing business model:

Standardized offerings. Subscription and pay-as-you-go offerings feature a few, standardized offerings, much like a fast-food restaurant menu. Subscription-oriented offerings need volume to generate significant revenue. That means finding a large number of customers who are satisfied with a standard offering, rather than customizing an offering to suit a few customers. McDonald’s makes money by selling a few types of burgers billions of times, not by offering to cook special meals to a few affluent customers.

Lower-touch sales. Instead of enterprise sales methods that involve lots of interaction, on-site visits, customized plans and consultative selling, cloud vendors expect customers to serve themselves in terms of education, selection and, often, buying.

Sales interaction in this case commonly focuses on telesales driven by Web-based demos. If you want to explore the integration of your cloud offering with your internal systems or processes, you’ll probably need to engage a consultant, either from the provider or a third party. Furthermore, with so much less revenue early in the product or service lifecycle, the provider can’t afford to invest much in the sales process, so don’t be surprised if you, the customer, have to take on more of the assessment effort.

A richer ecosystem. As noted, cloud vendors can’t afford to devote a lot of money to the sales process; crucially, a set of services that used to be provided by the vendor and absorbed as part of the cost of sales can no longer be subsidized by the provider.

From a user perspective, those services will be provided by online sites that offer product or service descriptions and assessments, consultants that provide technical integration and partner providers that offer complementary functionality. (As a customer, you can expect this richer functionality ecosystem to impose additional integration complexity and cost).

A different ecosystem. The current ecosystem will be disrupted, though. Both hardware and software vendors have built up elaborate partner programs to leverage systems integrators (SIs) and value-added resellers (VARs) as channels to bring products to customers.

SIs and VARs are both challenged by cloud computing and need to find new business models to meet the changing market. The vast majority have prospered by taking a cut (margin or points) from the sale of the vendor’s products to customers that the vendor cannot or will not directly sell to. There’s a lot less margin when the sale is a much smaller subscription; consequently, SIs and VARs find their revenue source under attack.

The natural response is to turn to services or consulting to replace the lost revenues, but those require different skills than selling standardized hardware devices. It’s safe to say that “the channel” will undergo significant change over the next few years as the move to cloud computing plays out.

Cloud Computing Gives Hardware Vendors Lemons, Can They Make Lemonade?

Software vendors have been strongly affected by the rise of cloud computing; many see customers adopting SaaS offerings in place of established packaged software offerings. Their current customers or prospects find the pay-as-you-go model more congenial to their wallets.

Just as important, perhaps, is the ease of adoption. Instead of the lengthy, complex and difficult installation and configuration process associated with on-premises packaged software, SaaS offerings allow quick access via a browser, with all the backend headache left to the vendor.

However, of all the affected parties, perhaps the hardest hit are the hardware vendors, who find many of their customers reducing their hardware budgets in favor of SaaS and IaaS cloud offerings. It’s no secret that a number of major hardware vendors are suffering poor financial results as they go through this market downsizing event.

Of course, hardware companies such as EMC and Hewlett-Packard are making lemonade out of their lemons. Several have announced IaaS offerings of their own. If users prefer to access hardware via a cloud offering, they figure, who better to provide the offering than a hardware vendor? This lets vendor find an outlet for their hardware while still providing what the market wants.

Analysis: Dell: Cloud Computing Could Drive Vendor Lock-in

The primary barrier to these vendor cloud initiatives lies within the vendors themselves. Most of their revenue, and all of their historic success, comes from the established products. While everyone can offer lip service to the new, innovative offerings, the reality is that the offerings represent a tiny sliver of revenue compared to the familiar products. Vendors’ entire sales efforts are directed toward their established products, with the sales compensation program designed to reinforce selling those products. It doesn’t take a genius to see that a sales force trained and paid to sell boxes is not going to expend significant effort pushing a lower-price, lower-margin, lower-commission option—even if customers prefer it.

For these companies to succeed, they will need a new go-to-market strategy aligned with the realities of cloud computing. There is vast literature on how to support innovation within an established company, with the majority recommendation coming down on the side of setting up a separate organization, with its own personnel and finances, to pursue innovation. This is much harder in practice than in the textbooks, but this approach, difficult though it is, has been shown to be the only viable one to foster innovation.

These travails will not be the province of hardware vendors alone. When a new technology comes along with a vastly different cost/benefit ratio, it eventually disrupts every segment of a market. No matter what niche of the vendor ecosystem you inhabit, you’ll find change afoot as a result of cloud computing. The only question will be, will you embrace it, try to resist it, or, like Oracle, announce that you’ve been doing it all along?

Bernard Golden is the vice president of Enterprise Solutions for enStratus Networks, a cloud management software company. He is the author of three books on virtualization and cloud computing, including Virtualization for Dummies. Follow Bernard Golden on Twitter @bernardgolden.

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