Model N exploits ERP giants’ blindspot

Profile picture for user kmaciver By Kenny MacIver August 15, 2013
SAP and Oracle leave $5bn revenue management segment wide open for stock market debutant.

Barcode-iStock© johan63
Revenue management: the puppet mastery behind pricing, discounts, rebates, channel incentives, chargebacks, deals and contracting designed to squeeze every possible dollar, euro or pound from a sales cycle. On that basis, it sounds like a fundamental business activity, one that should be a critical part of any integrated business applications suite. So how come a little-known group of companies, led by Redwood Shores, CA-based Model N, has stolen a segment reckoned to have a $5 billion potential from under the noses of SAP and Oracle?

For Model N’s CEO, Zack Rinat (no new face in Silicon Valley, having lead application server company NetDynamics to a lucrative acquisition by Sun in the late 1990s), the reason is clear. SAP and Oracle have simply been looking at the complex problem of optimizing revenue flow through the wrong end of the telescope.

“We’re about managing every dollar that impacts the top line. Our customers need a way to better manage how revenue is collected and accounted for. And that ultimately allows them to recoup billions of dollars annually that would otherwise be left on the table,” says Rinat.

The ERP sector giants, on the other hand, have spend 25 years focused in a single proposition, with software that cuts costs by helping to reengineer processes and automate the back office, he argues. “If you think about the focus of CIOs and their ERP software partners, it has all been about the lower part of the income statement. They automated sales and marketing with CRM, automated G&A with ERP, and so on.”

That lack of focus on the management of the top line as a strategic business process has been good news for Rinat and Model N. It has left the market wide open —  and underserved — with most enterprises still entrusting the management of their top lines to spreadsheets, home-grown systems and, in many cases, plain old paper and pen, he says.

Last uncharted territory

Two calculations underscore that potential. Consultants at McKinsey have calculated that a 1% improvement in price – itself just only one part of the revenue lifecycle – equates to an 11% rise in operating profit. And, more tellingly, an IDC study into pharmaceutical industry practices shows that participants leave “$11 billion a year on the table” by mismanaging pricing, incentives and rebates. “The upper part of the income statement remains the last uncharted territory for automation,” as Rinat has repeated during much of the company’s 14-year history.

Revenue in its simplest form is, of course, volume multiplied by price. But in many companies, Rinat argues, the matrix of financial settlements that are applied throughout the sales cycles and across a company’s channels are often poorly tracked, mismanaged and badly understood.

ON Semiconductor used to be a case in point. When it first signed up to Model N’s revenue management software it was in a situation that will be all too familiar to the kinds of CFOs and sales executives who are Model ‘s primary targets. ON was taking two to three weeks to secure quotes; it had a patchwork of discount structures that it struggled to impose on the sales network; it had open competition between the salesforce and its distribution channels that created unnecessary conflict and price erosion; and where it had contracts in place it didn’t always enforced their pricing terms.

“We did not have any kind of magic wand to wave, but we did provided them with the tools to change much of that,” says Rinat. In a matter of months, Model N helped to install a global pricing and contracting system to coordinate ON’s direct and indirect business operations — with not insignificant paybacks. In the first five years of using the software, ON increased its gross margins from 28% to over 40%, says Rinat — although clearly not all of that was its doing.

From bowling alley to tornado?

The opportunity to affect such change has certainly resulted in a barnstorming year for Rinat and Model N. First the company, whose annual sales are on target to hit $100-$105 million in its fiscal 2013 to the end of September, was lauded as the first enterprise software company to IPO in 2013, debuting on the NYSE in March and raising $103 million in the process. Since then it has been a “highly performant IPO”, suggests Rinat, with its market cap rising 30% to $560 million by late July — not hindered by a strong set of 3Q13 numbers which showed steady, profitable growth of 20%.

In recognition of his achievements, Rinat was summoned to the White House in May to receive a ‘Champions of Change’ award. And, against this backdrop, revenue continued to flow from a stellar customer roster that includes Johnson & Johnson, Novartis, Merck, Bristol-Myers Squibb, Abbott Labs, Boston Scientific, Dell, Nokia and STMicroelectronics (all, of course, SAP and/or Oracle reference sites) where the average deal size has floated around $1.5 million and high-end transactions can run to eight figures.

Rinat-lowresIPO day
Rinat is only too aware of the arc that Silicon Valley’s more successful companies have traced, and that shows in the fact that Model N is following a classic ‘bowling alley’ strategy, as advocated by business author and partner at Mohr Davidow Ventures, Geoffrey Moore (of Crossing the Chasm fame). As its customer list betrays, it is closely targeting just two industries — pharmaceuticals and tech component manufacturing.

To outsiders, that tight focus might also suggest that its brand of revenue management is only applicable to specific markets, those plagued by price volatility and discount-incentivized channels, making it too niche for the ERP majors. After all, it’s taken Model N a full 14 years to reach this stage.

Cloud balance

But Rinat, who left his native Israel for the US at the age of 30 to do an MBA at Harvard before a grounding at Silicon Graphics prepared him to lead NetDynamics and its successful $180 million sale, is not suggesting that these are the only pins that Model N could topple. Neither is he daunted by the prospect of existing in an enterprise space dominated by the ERP giants. (After all, he knows a bit about battle tactics: in his 20s, he was a company commander and captain in the Special Forces of the Israeli army.)

The obvious question, though, is this: as the Model N IPO has shone a spotlight on the market potential — and how it might arguably be a natural extension to any enterprise application portfolio — the market leaders of business applicarions will be under pressure to play an acquisition card or perhaps develop stronger alternatives than their existing revenue management offerings that might limit Model N’s prospects.

A purchase, however, would be expensive. With a market cap hovering between $400 and $560 million, and a record of steady financial performance, any suitor would be looking at a $2 billion-plus price tag for Model N – hefty for a company with revenues of around $100 million. But highlighted growth opportunity might make such a move irresistible.

“Revenue management is a relatively new space that augments both ERP and CRM. With its acceptance as a strategic initiative, there’s tremendous momentum in this market,” claims Rinat. It’s also a market where the shift to cloud is well underway.

As it has ramped up its cloud offerings over the last three years, Model N has grown the revenues derived from subscriptions to 40% of total. “SaaS is a growing competent of our business,” says Rinat, not just because customers see the cost benefits but also because, in may cases, they find it is the only effective way to provide high visibility into distributed pricing activity. For example, the company’s International Reference Pricing product targets pharmaceutical and life sciences companies who deal with the complex task of managing global pricing. “The global nature of the offering means we run it on a multi-tenant SaaS platform to enable greater collaboration,” he says.

The third pin

Such indusries, Rinat argues, have an acute need to manage prices, deals and contracts. But there are others with similar characteristics that Model N might consider going after. “Our go-to-market strategy was focusing on pharma/medical devices and high-tech manufacturing. These are two very large sectors, so we don't have any immediate plans to go to other verticals. The only caveat to that, he says, is that between high-tech manufacturing and medical devices, Model N has the opportunity to approach “a broader manufacturing space — that is the one we may decide to pursue.”

That makes Model N a very different property from his high-end competition. “We do see Oracle and SAP trying to sell something into our target markets but they don't really offer the same kind of products. Their strategy of selling one type of software to dozens of different industries is not ours. However, I would love them come into the market,” he says, arguing that such high-profile attention would add real legitimacy to the nascent sector.

Other competitors today are usually horizontal vendors addressing discrete parts of the revenue management cycle for contracting, pricing or rebates.

This is a company that itself puts a lot of value on the efficient use of capital. Its last round of VC money came in 2003, and in the 10 years since it has grown both its revenues and employee numbers by a factor of 10, in the last two years alone doubling staff numbers from 300 to 600.

So isn't Rinat simply setting Model N up as a tasty snack for SAP, Oracle or another ERP company. “I’ve been asked if we are an acquisition prospect many time in the last 14 years,” Rinat says. But he's is no fan of life within the campuses of Oracle Redwood Shores or SAP Walldorf. “I believe innovation comes from smaller companies not larger groups,” he says. Now with public shareholders ultimately driving Model N future, such opinions might have to be reassessed some day in the future.

Image: iStockphoto © johan63