Struggling Sun Microsystems Opts for Subscription Model
Bill Snyder
06/01/04 - 12:15 AM EDT
Hoping to revive its flagging performance,
Sun Microsystems(SUNW) is moving away from its traditional sales model -- selling hardware and software and collecting revenue upfront -- and turning to pay-as-you-go services.
The plan,
a variation on the subscription model used with mixed results by companies such as
Microsoft(MSFT),
Computer Associates,
(CA) and
Siebel Systems(SEBL) has some appeal because it will provide a smoother, more predictable revenue stream.
But the risks are high: even Sun admits that margins will suffer and it is not at all clear that customers will be willing to do business so differently.
Jonathan Schwartz, Sun's newly appointed president and chief operating officer, was scheduled to unveil the strategy at a conference in Shanghai on Tuesday morning, where Sun also announced 30 new products. "Servers, software, storage and networking...will be reconstituted as services -- such as CRM [customer relationship management software], collaboration tools, Voice over [internet protocol] and video-on-demand -- that will translate into business value and competitive edge," he said in a statement released prior to the conference.
Stripped of the marketing hype, Sun hopes to sell services, rather than simply pushing hardware and software at its customers, and have them pay as they use those services.
The biggest advantage from Sun's point of view, Senior Vice President Larry Singer said, is recurring, predictable revenue.
"Right now we are being punished by stock market. It's not confident that we can keep unit [sales] numbers up. This gives us renewable revenue," he said during an interview last week. (Sun shares entered Tuesday's session down nearly 30% from their 52-week high of $5.93.)
Roughly 20% of Sun's current revenue is recurring, mostly derived from software maintenance; the other 80% is produced by conventional sales revenue.
"We'd like to reverse that ratio," Singer said. How long that will take is unclear, but Sun is implementing the strategy immediately. In any case, it's unlikely that Sun will ever be out of the business of selling hardware and software.
Actually, unit sales of Sun servers have been strong, but the market has focused on the problem of falling revenue. In the first quarter of 2004, for example, sales of units increased year over year by 26.5%, according to market research firm Gartner. But
revenue from server sales decreased by 12.5% in the same period, while the entire server market grew revenue by 9.3%, Gartner found.
Shifting to a subscription model will lower margins and initially lower revenue since revenue from large subscription-based sales will be booked over a period of time instead of upfront. "I'm not worried about margin points; I'm thinking about margin dollars," Singer said. He expects that increased volume will ultimately more than make up the loss of upfront cash.
Also on the plus side of the financial equation are lower sales costs. It's cheaper to make one sale that includes servers, software, storage and services, than to sell the same items separately, Singer said.
Of course, the argument will be entirely academic of customers don't play ball. "In theory, this sounds great. But IT people are very conservative. It's asking a lot to get them to change in mid-stream," said Dana Gardner, a senior analyst at the Yankee Group, an information technology consultancy. Gardner, who was briefed in advance of Sun's announcement, found some skepticism in her survey of IT customers. "They said it was a leap."
Sun's new sales model is complex, and will vary from service to service and market to market. But a deal cut with
ACS(ACS) is something of a template, Singer said.
ACS, itself an outsourcer of information technology services, will get its computing infrastructure -- that is servers, storage, and software -- from Sun. In turn, ACS provides information technology services for a variety of clients, adding value and reselling what it buys from Sun at a markup.
In a traditional sale, ACS would buy the products either separately, or more likely as part of package deal, but would own them and carry them on the balance sheet. Instead, Sun owns the products and collects revenue at intervals depending on usage by ACS.
Large customers may instead opt to skip the service provider and deal directly with Sun, Singer noted.
How the market will treat Sun's new strategy is unclear, of course. But lower sales revenue won't be popular. On the other hand, "Sun's business is already troubled," Gardner noted. "Taking a hit immediately and getting the bad news out of the way could make sense."
