Top 10 predictions for cloud financials and accounting for 2010

It's that time again - below find your humble swami's top 10 cloud computing and SaaS predictions for 2010.

1. One or more US states will sue over the sales tax treatment of SaaS / Cloud computing
Revenue for SaaS and cloud computing services will exceed $10 billion in revenue in 2010. Given the financial crisis, governments are hungry for revenue and $10 billion is a big cookie jar. From a sales tax perspective, software licenses are clearly taxable, but for SaaS / Cloud subscriptions things are not so obvious. Is SaaS taxable business software or is it a non-taxable service? Or is SaaS like e-commerce where sales taxes only apply to locations in which the vendor has a physical presence? I only know of one SaaS / cloud computing vendors that broadly charges and pays sales tax on their subscription services today. In 2008 and 2009 states like New York began filing lawsuits to collect sales tax from online retailers and music download services – can the $10 billion SaaS / cloud market be far behind?

Prediction: 2010 we will see the first US states filing legal action against SaaS and Cloud Computing providers to compel them to collect and pay sales taxes.

2. 2010 will separate the cloud winners from the losers as pre-recession funding runs out
As cloud enthusiasm built in 2007 and 2008, major waves of venture funding created and re-capitalized a huge number of cloud computing and SaaS companies. After the recession and downturn hit in earnest began in the summer of 2008, this funding dried up. Beginning in the second half of 2008 and throughout 2009 (remember the infamous confidential Sequoia Capital tombstone presentation), companies that couldn’t continue growth in the recession hunkered down and tried to reduce their burn – but two years is really an outer limit for this. The classes of 2007 and 2008 will face the need to raise cash in 2010 – and those that haven’t been able to prove their business value and show growth will face liquidation.

Prediction: This is really the easiest prediction on this list – because the shakeout has already started – in the second half of 2009 we began to see an acceleration of business failures amongst the second and third tiers of venture backed SaaS and cloud firms. 2010 will complete this shakeout as the venture firms won’t fund or re-fund their investments that haven’t proven business viability – the strong will thrive and emerge from the recession poised for even more rapid growth, the weak will go out of business or be acquired. The recession will prove to be a great demonstration of the old line – what doesn’t kill you makes you stronger.

3. Net CMRR and the CAC ratio will become entrenched as the key metrics for measuring SaaS and cloud computing businesses
Or as our friends at Bessemer Venture Partners like to say: “Bookings is for suckers.” CMRR is Committed Monthly Recurring Revenue, and it reflects recurring revenues from customers as well as signed contracts going into production, reduced by anticipated churn. This is the most important key metric for measuring the ongoing health of any SaaS / cloud business.
CAC stands for “Customer Acquisition Costs.” The CAC ratio is key for understanding whether a SaaS / cloud company has a scalable, cost-effective sales and marketing model – so it’s a key forward looking indicator for profitable growth. To calculate the CAC ratio for a given quarter, divide (annualized gross new CMRR x average Gross Margin %) by (total sales and marketing costs of the previous quarter.) The result is a single percentage that measures sales and marketing efficiency – than the close the number is to one the better you are doing as an organization.

Prediction: In 2010 that Net CMRR and the CAC Ratio will be among the first things the boards of Cloud and SaaS companies will want to see (and so will investors) to evaluate the effectiveness of management.

4. As buyers become more savvy and adopt multiple cloud applications, Service Level Agreements and expectations will standardize and broaden
Cloud software service level agreements have been an evolving topic, with both vendors and purchasers exploring what needs to be included to ensure that over the long term both parties have a successful relationship. There continues to be a wide spectrum of service level guarantees out in the wild – from no guarantees at all, to best efforts (aka meaningless) guarantees to hardened three nines to five nines availability commitments. Historically, most SLA’s have focused on availability / uptime – but more and more SLAs are now starting to also include guarantees for system performance, security, data ownership, error resolution time and much more. They key insight is that with cloud applications, the vendor and not your own IT department is responsible for everything to do with operating your applications – so the SLA needs to guarantee that the vendor will comprehensively perform as well as or better than your own IT department would have done across the board.

Prediction: In 2010 as buyers become more and more experienced contracting for cloud services, they will begin to demand far more comprehensive cloud SLAs from their vendors. They will require a broad range of iron-clad commitments beyond simple availability guarantees – spanning issues ranging from control to operational risk and business risk. Inevitably, as buyers acquire multiple cloud systems, they will expect service level agreements to align across their systems, and standard benchmarks such as 99.99% availability, 500 millisecond end-user response time and guaranteed annual SAS 70 type II audits and external penetration testing will become expected across applications and vendors.

5. Savvy cloud vendors will begin offering offer money-back guarantees
Unlike vendors of on-premises software applications, cloud computing vendors have a great deal of control over the operating environment in which their applications run. They don’t have to contend with different combinations of hardware, operating systems, databases, infrastructure technology and other uncontrollable variables that lead to implementation failure. They have well defined web services to connect to other systems and customization is accomplished through flexible configuration rather than altering of source code. With fewer variables to content with, the odds of a successful implementation greatly improve. As cloud vendors gain experience on-boarding thousands or tens of thousands of clients and develop prescriptive methodologies for implementation, their ability to deliver a successful implementation for a given client with well documented requirements converges toward 100%.

Prediction: In 2010 cloud vendors will begin using money-back guarantees both as a tool to reduce the buyer’s perception of risk in moving to the cloud as well as a competitive weapon against on-premises software vendors who are unable to make such guarantees. In return for a client agreeing to thoroughly document their business requirements, savvy vendors will recognize they can guarantee successful implementations and offer money back guarantees. This is a nice synergy driven by the cloud model – it’s a great deal for both the vendor and the client.

6 .2010 will see financial and political backlashes against offshoring by SaaS and cloud companies
For SaaS and Cloud companies, offshoring development, QA, customer support and implementation consulting to India, China, the Philippines or other developing regions of the world seemed like a “no-brainer” in the early and mid-2000’s – you could build your business leveraging smart people in these countries at a fifth to a third of the cost of US-based employees. But in 2010, the economics make less and less sense as salaries have risen rapidly in these markets and as fast growing, innovative firms have recognized the friction and resultant drop in productivity of managing offshore development teams. Plus US-based customers have never liked talking to support people in India or the Philippines. Politicians can't be far behind - President Obama was clearly on this point when he said "I will stop giving tax breaks to companies that ship job overseas and I will start giving them to companies that create good jobs right here in America."

Prediction: 2010 will see a backlash against offshoring. Boards will scrutinize whether offshore investments in development and QA really do make sense and are more productive and cost effective than onshore. Customers have always preferred in-country support but now this will also be tinged with resentment about support jobs being shifted overseas. I think more importantly, in a time of 10% plus reported unemployment, reflecting near 20% real unemployment and underemployment in the United States, offshoring will also become a real political issue in 2010 – I expect politicians won’t be able to resist demonizing offshoring and penalizing offshorers, as the focus in Washington finally shifts from healthcare and global warming to jobs.

7. SAP, Workday and NetSuite will battle to push cloud ERP up-market
While cloud computing / SaaS applications for the finance department have historically been largely SMB focused, 2009 marked the beginning of an up-market shift to the enterprise. Workday was founded with the premise of bringing cloud computing based applications starting with HR to the large enterprise. In 2009, NetSuite began moving upmarket to take on SAP in divisions of large corporations as part of an explicit upmarket strategy. And, rumor has it, that SAP will be re-re-re-entering the market (for the third time now) with Business by Design in the summer of 2010.

Why will the upmarket push happen - two reasons – first, CAC ratio for selling cloud-based full ERP suites just can’t be financially justified for the SMB market. These vendors will be forced to do bigger deals to compensate for the inevitably high up-front cost of selling ERP suites – and since it doesn’t cost that much more to do a $250,000 sale than a $50,000 transaction they will inexorably be driven up-market by the need to align revenue with cost of sales and marketing. Second, monolithic ERP has never really been that appealing to the SMB – there are no central IT committees in place to force single vendor solutions onto the entire organization and the economies of scale aren’t great enough in the SMB to justify the lack of departmental productivity from being forced to use the “not best of breed” applications that are part of every ERP suite.

Prediction: NetSuite, Workday and SAP Business by Designwill compete to push cloud computing based ERP upmarket in 2010.

8. Microsoft, Sage, Deltek, Epicor, Infor, Lawson etc have very hard cloud computing decisions to make – most will sit on the cloud sidelines.
The mid-market ERP players face hard decisions when it comes to cloud-computing / SaaS for their financial applications. While Microsoft clearly has the resources to build out cloud-based versions of their Dynamics applications, they have a major case of innovator’s dilemma made worse by their explicit strategy of using their applications to sell their technology infrastructure stack. What I hear from the Microsoft VAR community is that most of what is selling today is in fact infrastructure software attached to old installations – and not new Dynamics licenses. The success of Salesforce.com has forced Microsoft to dabble in SaaS CRM – but moving to the cloud for the rest of the Dynamics product line is a whole different ball game and would have a major negative impact on sales of SQL Server, Sharepoint, Windows Server and the rest of the Microsoft infrastructure stack.

The challenges are different for the other mid-market accounting vendors – I don’t think they have the financial resources to both continue with their legacy product lines and to develop new cloud-based products at the same time – so I think they are facing much harder choices – do nothing and position the cloud is a fad (see the famous Harry Debes, CEO of Lawson quote), do they take the Microsoft approach and position hosting as the same as cloud computing, do they acquire, or burn their bridges and take a scorched earth strategy by retooling the whole company for the cloud.

Prediction: Microsoft will continue to sit on the sidelines of the cloud computing game as far as Dynamics ERP is concerned – their main strategy in this market will be to convince the market that hosted Dynamics GP is the same thing as cloud computing. Most of the rest will be unwilling or unable to act and will fall further and further behind. However at least one of today’s mid-market ERP players – Sage, Deltek, Epicor, Infor or Lawson - will seize the opportunity and enter the cloud market in a big way in 2010.

9. 2010 will be the year of the VAR for cloud financials
I’ve been writing about it on my blog for a while, and I feel it every day in my interactions with the mid-market VAR community. 2010 will be the year that the VAR community begins to embrace cloud computing in a big way. In 2009 they fulfilled customer demand by hosting on-premises software on their own – but they all know this is a major Band-Aid and none of them relish being in the data center business. There is still a lot for the VARs to learn, and the traditional software publishers are still spreading FUD about the cloud – but I can feel the momentum and from a business perspective moving to the cloud just makes too much sense for both the VAR and their clients.

Prediction: Half of the top 20 North American mid-market ERP VARS will add cloud computing based offerings to their portfolios in 2010.

10. Cloud computing adoption by the CPA profession will dramatically accelerate, the larger the firm the higher the adoption
This is another easy prediction to make since it’s already happening. All of the major players in the CPA technology ecosystem made major shifts toward cloud computing in 2009, and the AICPA itself weighed in during the year by announcing partnerships with Intacct, Bill.com and Copanion and throwing its weight behind cloud computing for the profession. Intuit, CCH and Thomson Reuters all delivered major new cloud-based product lines for CPAs and in just about every communication with the profession are extolling the benefits of SaaS and cloud computing. The industry gurus are also all part of the act – with organizations like Rootworks, K2 Enterprises, Sleeter and many more delivering training, guidance and practical tips to help the profession move to the cloud. The momentum is just palpable and the value proposition is huge.

Prediction: 50% of the large firms and more than 20% of the multi-partner small and midsized firms will adopt cloud computing in 2010. That’s right – in just one year cloud computing will go from early adoption to significant penetration – the value proposition to CPA firms and their clients is just that compelling.

Cloud Computing Insights from ITA Fall 2009

This week I had the pleasure to attend the Information Technology Alliance (ITA) Fall collaborative in Palm Springs with give or take 300 very senior business leaders and IT executives from the leading mid-market focused VARs, consultants and CPA firms. A very rare day of rain in the middle of the event had us waking up to unbelievable snow-covered mountains in the desert - it was fantastic.

The ITA is a great group - extremely collaborative and all about sharing best practices and what's working / not working. Some of the best sessions were execs standing up in front of the room sharing their "WOW" ideas with their peers - what's been working well for their businesses over the last few quarters.

For the last several ITA events, there has been a huge amount of interest, excitement and even curiosity and skepticism about cloud computing - remember many of the people that go to this event have been implementing and reselling on-premises software applications for 10 or 20 years - so to them the cloud is both an opportunity and a threat.

Several dynamics that were new this time that I think are worth highlighting:

• More than a few Sage / MSFT / Intuit VARs approached me with first hand stories of losing deals to Intacct partners - my feeling was that they genuinely trying to get their arms around cloud financials now that it's starting to have a personal impact on their business. Many of these wanted to follow up after the conference to evaluate adding Intacct to the product lines they carry.
• I was involved in multiple conversions between CIOs within very large CPA firms - they clearly see cloud computing as a huge opportunity to improve productivity, reduce risk and increase security within their firms. I raised an eyebrow at some of the horror stories they shared with each other - such as a regional office with 100's of rogue connections using Microsoft Remote Desktop so CPAs could connect directly to their client's PCs to create reports out of Quickbooks / Dynamics and place them directly on the desktop of their client.
• I was truly amazed at the hoops some of the VARs are jumping through to get into the cloud computing game by working around Microsoft, Intuit and Sage. The VARs were sharing tips with each other on how to build server racks to host and operate these products - I heard counsel like "make sure to buy servers with two power supplies in case one fails" and lots of discussion on dedicated servers vs. virtualization. There was a great example of one VAR who has totally transformed his business by doing this in a flood-prone area of the Northwest - over the last year he's moved most of his Great Plains clients off of their own hardware and onto his servers. While this is good for the clients, I can't imagine why a VAR would want to burden themselves with the low margin, high cost and high risk of running their own data center and operations.
  

As with the last several ITA meetings, there were multiple panels showcasing firms that are having success with cloud computing. This year two Intacct partners Sererra and BI101 were featured and did a great job talking about how their firms are thriving despite the downturn - both of these firms work with a combination of Intacct, Salesforce.com Google apps and other leading cloud computing applications and having tremendous growth and success.

On the downside, it was clear to me that particularly within the VAR community there still quite a few pieces of misinformation about cloud computing floating around - I expect promoted by their current on-premises software partners. Some of the misconceptions I heard repeated several times:

It takes 36 months or more to break even selling cloud computing vs. on-premises applications.

• Breakeven is within 12-18 months for Intacct partners and after this term it's all very high margin upside. I think this misconception comes from the Microsoft world, as Microsoft offers very low royalty rates on Dynamics CRM on-line thus pushing their partners to the on-premises model.
  

There is no services revenue for the VAR in cloud computing applications.

• Services revenue and the tasks performed for implementation, customization and business process consulting is exactly the same, cloud or on-premises. The main difference is that with cloud applications there is no need to install or maintain infrastructure like databases and operating systems. Further, in the cloud model the cost of support is much much lower for the VAR (for instance no need to go onsite to reinstall FRX when it breaks) - leading to far higher ongoing margins.
  

Cloud-based applications can't be integrated or customized

• This tells me that whomever makes this comment has never actually seen a demo or been hands on with cloud applications - the reality being modern cloud applications they are far more customizable and integratable than their counterparts from MSFT, Sage and Intuit. I think this comes straight from the on-premises publishers since it's the exact opposite of reality.
  

Cloud-based applications are simplistic and immature

• Again I expect someone who says this hasn't actually evaluated cloud-based options - for the industries served there is every bit as much depth of function - and in many areas there is even more depth. As an example, Intacct has built in financial consolidation, multi-entity, multi-currency and revenue management capabilities that are far deeper than anything from Microsoft, Sage or Intuit. That said, there is certainly a larger ecosystem of add-on apps available in the on-premises world, though the list is growing all the time in the cloud world.
  

When I heard these types of comments my advice was simple - try it out - At this point every VAR should have something cloud computing in their toolbox - there are plenty of compelling cloud-based add-ons for VARs to experiment with - beyond getting used to how implementation works for cloud-based systems, VARs also need to understand the impact of subscription-based pricing and ongoing cloud business models on their sales and support processes. Products like Avalara for sales and use tax, Adaptive Planning for budgeting and forecasting and BNA Fixed Assets Web for Fixed Assets come to mind as easy add-ons for a VAR's current business.

Existing on-premises VARs should add products like Intacct to their business as an additional product line - We're finding over and over again that VARs have a huge business opportunity to use exciting new products like Intacct to upgrade old outdated software for their clients who are off maintenance and on very old versions of Sage MAS, Great Plains and QuickBooks - making the clients happier while developing very high margin ongoing subscription revenue streams for the VAR.

I don't think anyone is advising a VAR with 20 years of on-premises experience to switch entirely to the cloud overnight - but I also think it's a huge mistake for VARS to try to get into the data center business to work around their vendors being slow to adopt the cloud computing model. This is a ton of risk and expense for a VAR to take on vs. working with a cloud computing partner who has the expertise and scale to make it a cost-effective and high quality proposition.

At the end of the day I very much enjoyed the ITA conference - very smart people, lots of collaboration and tremendous interest and momentum for cloud computing. I'm already looking forward to the next one.