Jan Brass Takes a Hard Look at the Cloud

Does the Cloud Also Mean Lower Profits?

Does the Cloud Also Mean Lower Profits?Cloud computing means various things to people. Consumers love the convenience of having apps automatically sync data across multiple devices. Software developers do not need to struggle to build up server or storage infrastructure before launching innovative new services such as Netflix or Dropbox. Enterprises are discovering that moving internal applications to the cloud results in significant cost savings and improved collaboration between employees.

One of the biggest reasons for the quick adoption of cloud computing is that it reduces costs for everyone involved: end-users, developers, service providers and organizations. Providers such as Amazon, Google and Microsoft are able to leverage economies of scale and their expertise in building the massive infrastructure required for delivering cloud services for profit.

Nevertheless cloud computing has also disrupted the existing business models for many technology companies. Oracle, SAP, Microsoft and others had built multibillion-dollar businesses on the old software licensing model. Now practically every company is moving towards providing Software as a Service instead. While it may be convenient for users and businesses, the move towards the cloud has been a significant overhaul for the software makers involved.

For some of the major players, moving their software to the cloud was driven by the realization that the technology market is drastically different than a decade ago. However, making software available as a service has necessitated changes in how revenues are realized and profits booked, especially in the B2B enterprise market.

Software was previously sold on the basis of number of licenses or on a per seat basis. This meant that revenue would be recorded in the books at the point of sale itself. If the company now provides the same software as a service, clients would be paying subscription costs on a per month or annual basis. This means that the revenue from one contract would be spread over a period of years.

For instance, SAP recently revised downward the company’s profit outlook for 2014 because of the shift in business model1. While financial analysts and other industry watchers may be disappointed by the news, it was likely not a surprise to those companies who had already shifted to the cloud. Nevertheless, it doesn’t mean that the company will be making less profits than before (although profits will still depend on demand and sales). It only means that profits which would earlier have been recorded for the year 2014 will now be deferred to 2015/2016. The news may appear disastrous in the short-term but augurs well for the company’s long-term growth prospects which might have been bad if SAP had not embraced the SaaS model.

The same will hold true for other companies in the midst of switching to a new business model. When an entire industry is changing the way it works, odds are that some companies will miss the boat. In this case, those businesses that do not adapt to the cloud will quickly lose profits and customers. For others, cloud services will serve them well as long as they can effectively cater to the demand from organizations.

1. Reported by The Financial Times, October 2014

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