'Tis the season of giving, and today our gift to you is the ninth day of our annual 12 Days of Insights blog series. Enjoy!
If there was any doubt that the technology industry is undergoing a major transformation, this year has produced even more compelling evidence that we are nearing the end of the first great era of tech. There are no tea leaves involved here; the story is playing out in the publicly reported financial data from traditional technology companies. Collectively, tech company revenues have declined steeply in 2015, with tens of billions of dollars coming off the table quarter after quarter.
And it’s not just the top line that is suffering. These same companies are reporting downward pressure on both gross margins and operating income. Perhaps more telling is that for the first time in many years, revenue from product-attach services is down, and blended service margins appear to be flattening out, indicating that the ability of services to buffer softness in the product side of the business is weakening. This does not bode well for legacy technology providers. For more details behind these assertions, you can view the TSIA Q3 2015 Technology & Services 50 webinar.
The Impact of the Cloud
Offsetting the decline in traditional CapEx model tech businesses are the rising stars of the industry–the cloud companies. (Tweet this!) While it’s true that these companies are seeing healthy revenue growth and market share gains, it is not enough to make up for what has been lost in the legacy CapEx model. In aggregate, there are still tens of billions of dollars that are no longer flowing from customers to tech suppliers.
Does this mean that the appetite and need for technology solutions is diminishing? Far from it. What it does mean is that customers have gotten savvy about how to procure technology in the most cost-effective, low-risk way. They have effectively shifted the high costs and complexity of managing technology infrastructure back to their suppliers. Customers now reap the rewards of great technology with none of the messy and expensive strings attached.
Given these new buyer dynamics, it’s not surprising that the cloud is where all the revenue growth is taking place, but it is still not where the profits are being made. Looking at the 2015 data from the largest cloud technology companies tracked in the TSIA Cloud 20 Index (you can watch the latest Cloud 20 webinar here), cloud companies are still collectively delivering negative operating income with an average NOI of -2.7% through the end of Q2. This is due largely to the high costs to operate and support a cloud offer, as well as the high costs of acquiring and retaining customers. In fact, on average, these companies are spending 38% of revenues on sales and marketing. As these companies grow larger, they are spending even more, yet the data reveals that it is not showing up in top line growth.
So what is the way forward in the new era of tech? Clearly, legacy providers need to continue on their path of migrating to a cloud model. (Tweet this!) For these companies as well as the pure play cloud companies, there needs to be a relentless focus on the core fundamentals that will produce profitable growth. Here are my top three recommendations for where companies should invest time and resources in 2016 to position themselves for future growth and profits in the new era of tech.
#1: Continue to Invest in Customer Success
2015 was the year that Customer Success became a mainstream function across both traditional enterprise and technology-as-a-service companies, and for good reason. Customer Success organizations play a critical role in ensuring that customers are on-boarded quickly and effectively so they can immediately begin to use and get value from their new solution. For SaaS companies, it is the antidote to shelfware.
Beyond this, a critical, and arguably more important function performed by customer success is driving customer adoption of the solution. This includes everything from monitoring and reporting usage, to proactively helping customers leverage key features and functions that will accelerate their ability to realize a positive ROI on their technology investment. The premise here is that successful customers are happy customers, and happy customers are more likely to renew their subscription–a sales motion that is increasingly part of the charter of customer success organizations. (Tweet this!) In subscription-based businesses, it is all about customer retention and churn avoidance, and this is the critical role played by customer success. A strong customer success function also creates an important foundation for account expansion.
For 2016, TSIA recommends continued investment in developing and maturing critical Customer Success capabilities, including practices around how to leverage data analytics to yield actionable insights about customer health.
#2: Develop a Systematic Approach to Delivering Business Outcomes Through Outcome Engineering
Helping customers achieve desired business outcomes unlocks margin potential and encourages customers to put new budget dollars on the table. Instead of being beaten down into market-based pricing for a “me too” offer, technology providers that are able to deliver business outcomes can leverage a value-based pricing model. The dwindling economics of legacy technology models is creating not just an interest in, but an urgent need for outcome-based offers.
Equally exciting is that many tech companies are discovering that improving the business outcomes existing customers get from existing technologies creates significant increases in customer spending. We’re happy to report that a number of TSIA members are beginning to engage with customers in outcome engineering efforts. Once these engagements are complete, most companies report that subsequent customer spending and vendor “share of wallet” increases dramatically. TSIA member companies are reporting customer spending increases that range from 2X to 3X.
In 2016, TSIA recommends that companies accelerate the development of Outcome Engineering capabilities. To learn more, read TSIA’s Primer on Outcome Engineering, or watch my keynote video from the TSW 2015 Service Transformations conference.
#3: Exploit Your Most Cost-Effective Sales Channel – Services!
One of the key levers to improve profitability–an imperative for tech companies of all varieties–is to reduce sales costs. Amongst the tactics that can be used is to redistribute sales activities to lower-cost sales resources, and specifically, those that reside within your services organization.
Whether you’re a traditional tech company or a cloud provider, your front line service resources are optimally positioned to surface new revenue expansion opportunities with existing customers. Not only do they have 15 to 20 times more interactions with your customers, they have a unique understanding of how your customer is using your solution and where there is fertile ground for product and revenue expansion.
When you combine this approach with outcome engineering capabilities and a finely tuned customer success function, you create the perfect set of conditions to begin a virtuous cycle of value delivery to the customer that rewards the solution provider with not just renewal revenue, but customer revenue expansion. (Tweet this!) This is a double-positive scenario as it not only positions you to capture incremental revenue but to do so with a lower cost of sales.
In summary, TSIA recommends that technology services leaders focus on optimizing three key motions from the TSIA Customer Engagement Model: Adopting, Expanding & Renewing customers.
In 2016, you can expect to see more cutting-edge research and best practices published by TSIA on these topics. We’ll also be introducing an exciting new application to enable members to more easily consume TSIA research and data to help accelerate your own business outcomes. Here’s to a great year ahead!
- Funding Customer Success
- The Customer Engagement Lifecycle
- Primer for Outcome Engineering
- Generating Leads with Existing Customers
About the Author
Thomas Lah is executive director of TSIA. Since 1996, he has used his incisive analysis, strategic thinking, and creative solutions to help some of the world’s largest technology companies improve the efficiency of their daily operations. He has authored several books, including Bridging the Services Chasm (2009), Consumption Economics (2011), and B4B (2013).