T-Systems’ latest reporting has made me think about one more impact the cloud trend has on the IT industry:

For the third quarter of 2012, the provider reported a decline in order entry compared with the prior-year quarter. There is nothing extraordinary about this fact per se but the reason given is worth having a closer look at: “This reflects the ongoing trend towards smaller, cloud-based deals where the calculation of volumes is based on minimum purchase quantities.” Already in the Q4 2011 report, the company had added: “The actual order volume per corporate customer is usually significantly greater.”

In other words, while some years ago, an outsourcing contract would have had a fixed total contract volume (TCV) of, let’s say, several million Euros over 5 years, the same contract today would probably have a significantly smaller TCV (= “order entry”) due to firstly a shorter contract duration and secondly a smaller base charge (fixed price basis). Parts of newer, “cloudified” services contracts are increasingly usage-based, i.e., future payments are variable, and the providers’ revenues no longer secure.

And this is not only true for the IT services sector; the same applies for ICT product suppliers that are increasingly marketing their hardware and software “as a service”.

What does this mean for the IT industry, especially for cloud providers’ planning and reporting?

Will cloud computing make established forward-looking KPIs obsolete?

“Order entry” refers to the sum of all orders received during a defined period, which will impact revenue and profit in the future, as delivery will take place in the following time period(s). It is thus an important indicator for the evaluation of a company’s future revenue and profit development, and thus also of its “economic health”.

The capital markets normally immediately punish a company that reports a negative trend in order entry.

What’s more, order entry is not only a business KPI for the assessment of an individual company’s situation. It is also used as an indicator for entire economies or sectors (i.e., the total of all companies’ order entries).

Moreover, the “book-to-bill ratio”, usually a major KPI for technology companies and outsourcing providers, is equally affected, as it shows the ratio between order entry and revenue within a defined period. A book-to-bill ratio higher than 1 – i.e., order entry is bigger than revenue – indicates a growing company or market, as it promises rising revenues in the future. Just a few weeks ago, at an advisory event, a major outsourcing provider proudly reported a positive book-to-bill ratio, stressing its big deal capabilities. However, this provider is also making efforts to reposition as a cloud provider.

So what if order entry reflects future revenue development only to a limited extent, as is the case with T-Systems? Or what if there was even no more order entry at all in a “cloud world”, where pay-as-you-use payment models allow a view on actually generated revenue, but no longer on future revenue? What if customers can – in an (admittedly visionary) perfect cloud world with established standards and interfaces – switch from one supplier to the other, from one day to the next?

Will the basis for the planning of future revenues and profit be limited to the sales pipeline?

Uncertainty means risk, and risk means costs. But given a fiercely competitive environment – will providers actually be able to pass on these costs to their customers? Or will customers be understanding enough to no longer follow the cloud trend and instead continue to accept long-term contracts, base charges and minimum purchase volumes?

When it comes to “hosted private cloud” models that are still close to traditional outsourcing, normally “only” the pay-per-use portion of the total contract is affected. Usually there still is a significant base charge and a long-term framework contract.

Even in the “public cloud” area, the impact remains limited so far. At least software as a service (SaaS) is usually marketed in a pay-per-user rather than in a pay-per-usage model. And providers like Salesforce.com normally close contracts running for at least 12 months, which still leaves some planning security for the provider and transparency for its shareholders, and which means that order entry remains a valid KPI.

But the trend towards a further decrease in long-term commitments, and thus predictable payment, is pretty obvious.

Just recently, for instance, Amazon Web Services announced that it had been certified by SAP to run the SAP Business Suite software (including ERP, CRM, PLM, SCM and SRM) in production on the AWS cloud. Of course it remains to be seen to what extent this offering will be able to compete with traditional SAP hosting business, i.e. often hosted private cloud. But nevertheless, it is expected to further increase the pressure on traditional providers to “cloudify” their offerings and to flexibilize their contract design.

So what will planning and reporting look like if there are hardly any hard fact-based, forward-looking KPIs? Will financial markets really have to deal with statements like “the actual order volume is usually greater”?

Post by Karsten Leclerque