Actuate: the pain of transitioning to subscription models

actuate stock priceActuate is going through some real pain at the moment.

Its Q1 2014-15 results were grim with a massive fall off of license revenues that precipitated an acceleration of the pivot they were already making towards a subscription rather than perpetual license model.

This discussion is not a critique of Actuate and should not be read as such. Rather, it should be seen as an example of how tough it can be for management to transition from one business model to another (the so-called pivot) and the impact this has on both financial results and stock price. It is particularly relevant in the context of what we see happening in the large enterprise market where every vendor is trying to find an orderly way of shifting from one model to another without upsetting customers or stockholders.

Regardless of your position, this has ramifications for customers who often bet years of their existence upon specific technology plays.

The backdrop

The noise in the consumer market would have us believe that software is almost disposable. Something doesn’t work – junk it. Users don’t like XYZ software – replace it. Fail fast, fail often – that’s the road to success. That’s not the way (most) things work in the enterprise. It is largely true regardless of whether we’re talking a mom and pop shop, the truly global companies and pretty much everything in between. Whether they know it or not, most organizations make bets for the long term for the bulk of their software acquisitions.

For the buyer, IT related costs are often in the range 3-5% of revenue. That’s for everything the business chooses to count towards IT. Therefore, it should not surprise that in most organizations, any particular software acquisition, while important and significant, is often a fraction of the overall business cost.

Nonetheless, this has huge implications for software vendors who have enjoyed many years of upfront licensing combined with the near guaranteed annuity that comes with maintenance. Put bluntly, when you can get the customer to pay twice for the software over a five year period and enjoy 85-95% gross margin while doing so, then who wouldn’t want that model?

That all changed when software as a service (SaaS) providers showed up. Knowing they can save capital expenditure while maintaining a healthy model themselves, it isn’t hard to see how they might creep in under the IT radar. That’s called ‘land and expand,‘ a technique successfully used by many SaaS vendors, with Salesforce and Tableau being the current stand out examples.

The SaaS vendors could look even better, riding on the back of an anticipated consumption model for software rather than being presented with a bundles of ‘stuff’ they’d need to implement over a long time. That has changed somewhat in the last year or so with more deals coming in for three to five years. Even so, SaaS continues to look economically attractive for the new buyer. Enter Actuate.

Reviewing Actuate

Actuate plays in the business intelligence (BI) space which most recently has seen something of a renaissance. Those of us who have followed this market for a long time know BI has something of a Cinderella existence, at one time taking on importance, then fading into the background. With so much current market emphasis placed upon the value of data and its proliferation, now should be a golden period for any vendor with a BI ticket on their software. Some are faring better than others and of course the market remains incredibly competitive. Here, Actuate is hurting.

Actuate, while founded in 1993 is best known for its open source BIRT software that was launched in 2004. Unlike Cognos, Hyperion, BusinessObjects and many other smaller players, it was not consolidated by IBM, Oracle and SAP respectively in the early-mid 2000’s. It has survived but remains a small company by software vendor standards.

Actuate is also a publicly traded entity so is subject to all of the short term thinking that drives management as it tries to satisfy Wall Street analysts who in turn are attempting to forecast a price and value for the companies they cover. Any perceived weakness is always punished and only stellar performance matters. That in turn creates a dynamic where management is often locked into what I perceive as a long term death dance: perform or die.

What happened?

Just like many other vendors, it has to adjust to what the marketplace is saying and that of course starts with customers. Here is what was said during the most recent earnings call:

Question from Greg McDowell, JMP Securities:

It feels like we’re going from a gradual pivot to subscription and now it’s suddenly a very sudden and hard pivot to subscription. So I guess I just want to understand whether the move – the hard pivot is a direct result of sort of the Q1 results or was the Board contemplating more of a hard pivot move at the time you guys had reported Q4 results?

Answer from Pete Cattadini, CEO:

It has nothing to do with Q1. During an orderly transition to subscription was what we intended on doing. But to tell you the truth it almost feels like being sort of a magician with plates on a stick and so that having 20 of them going at once, trying to make everyone happy, customers, shareholders, employees, very difficult to do. So we had a discussion with the board and we said the only thing we should do is the right thing for the business which ultimately is in the best interest of shareholders and they thought going cold turkey to subscription along with management was the right thing to do. So it wasn’t about Q1. It was about doing the right thing for the business.

The follow up question then asked about metrics going forward. This is where the CFO stepped in

Answer from Dan Gaudreau – CFO:

So the going forward obviously our metrics will have to change. We have not concluded exactly what we will be producing. I can tell you seeing that we’re going to be experiencing this over the next nine months, three quarters, I rather kind of keep an eye on what’s important over the next few quarters and then determine in 2015 what metrics are important to the street as well as internally. I mean clearly we’re going to have to report revenues differently.

From what I’ve seen in my analysis of other companies have gone through this transition I’m leaning towards a revenue breakdown that is license which would be the perpetual licenses that we continue to book, recurring revenues which would include subscription transactions as well as perpetual maintenance that exist and that will run-off over the next many, many years and then professional services being the third category. That’s what I’ve seen is a prevalent breakdown of revenues with companies that have made the transition to subscription.

In terms of the metrics I mean I’ve seen it jump very allover the place. And to be quite honest with you we have not concluded what metrics we will publish, but I have clearly seen it go from looking at a company like Advent who publishes just about every metric known to mankind to a company like (Caldes) that effectively publishes no metrics or very few metrics. So I think [we] will fall somewhere in between. We just have not concluded on those metrics yet.

The market was far from satisfied with the answers given and the share price plummeted.

Verdict

Thinking charitably, it is difficult to know what else the CFO could have said. However, this problem has been coming for a long time and in every major category of IT spend. Vendors I speak with are acutely aware of what awaits them if they mis-step in communicating how they will pivot. Actuate clearly needs to do a better job but that’s hard when you’re in the vortex of a changing market, trying to cut deals on a day to day basis.

The good news on the other side and as has been demonstrated by Workday, is that once you have established a pattern of subscription selling, it is remarkably easy to predict revenue in the immediate few quarters. The lumpiness that comes with perpetual licensing goes away. That does not come without problems of its own, not least the insane valuations that are baked into assumed growth rates. But at least there is a level of predictability that is comforting for everyone.

All vendors that need to pivot will be faced with the same dilemmas that Actuate is working through. They are not insurmountable. Adobe is going through it now and looking like it will succeed. Ariba went through it a few years back and managed to continue building a business albeit it was subsequently acquired. Actuate has a slew of its own problems but one can hope that it will successfully transition although much depends on its ability to successfully monetize an open source solution that in some senses looks tired and dated.

Disclosure: Workday and Salesforce are partners at time of writing.

Featured image credit: Businessman Choosing Success or Failure Road © Creativa – Fotolia.com

Den Howlett
Following 20+ years in finance and IT related roles, Den Howlett became a freelance writer/analyst/commenter specialising in enterprise IT. He has been calling the vendors to account ever since.
Den Howlett

@dahowlett

Disruptor, enterprise applications drama critic, BS cleaner, buyer champion and foodie trying to suck less every day.
Den Howlett
Den Howlett

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  • SalComunale says:

    dahowlett diginomica Dennis good reading. Could you add me for further discussion. Thank you!

  • vijayasankarv says:

    aublumberg dahowlett not all subscriptions are that way – especially open source SW like MongoDB :)

  • dahowlett says:

    aublumberg I think the benefits outweigh the risks but that story is for another day.

  • aublumberg says:

    dahowlett Many peers seem to underestimate the lock-in effect of cloud. Plus the fact that, unlike perpetual, if you stop paying it’s over.

  • aublumberg says:

    dahowlett Now, once everything is on the cloud then the pendulum swings again and your basically screwed …

  • dahowlett says:

    aublumberg LOL – well – I don’t often hear *that* said so good for you sir.

  • aublumberg says:

    dahowlett yes Dennis very much so, it’s good being a buyer right now …

  • dahowlett says:

    aublumberg Thx Andre – I believe these things are important as part of buying decisions.

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