Behavioral Economics and Enterprise Software Sales: Who is teaching Whom?

I’m almost done reading Daniel Kahneman’s best-seller “Thinking Fast and Slow“, which is a great book on behavioral economics.  (Thanks to Peter Lugli for the recommendation.)  I try to read most of the popularized literature in this field (e.g., Dan Ariely, Richard Thaler, and Michael Mauboussin) partly because I’m an old Economics major and partly because the work has so much to say about marketing and selling.  The work of behavioral economists seems especially applicable to the marketing and sales of intangibles, including software.

Each time I read about the ways we consumers differ from the rational “automatons” imagined by neo-classical economics, I laugh for two reasons: a) because the “anomalies”, in retrospect, seem so obvious and b) because so many of them are already so well exploited by anyone who sells or markets enterprise software for a living!

Here’s a list of just a few of the behaviors noted by behavioral economists.  In each case, I have tried to identify how they are applied in the enterprise software sales world.

• Behavioral economists note the “irrational” behaviors of procrastination, status quo bias, social conformity, and risk aversion that is greater for losses than it is for gains.  I’ll add to this list a rational behavior: desire to avoid switching costs and, voila, we have a recipe for big ERP success, a rationale for “land and expand” strategies, a pretty good explanation for Geoffrey Moore’s Chasm, and an underlying basis for why no one ever got fired for hiring IBM!  Ask any enterprise start-up and they will tell you that battling these collective forces against change is one of the hardest tasks they encounter.
• Behavioral economists note the amazing power of reciprocity that is ingrained in all of us.  That is, if someone gives us something (even something relatively meaningless) we feel obliged to reciprocate in some way.  All good enterprise salespeople understand this one intuitively.  Every major sales training system teaches the salesperson to ask for something in return when they are providing the prospect with something of value.  In addition, reciprocity makes it entirely rational to initially throw out a very high price.  Upon rejecting the absurdly high price, the prospect will have an urge (albeit small) to reciprocate in some way.  In addition, tossing out a high price is also a form of anchoring, another finding of behavioral economists.
• Mental accounting, or our habit of putting something fungible like money, in separate mental “cubby-holes” is another finding of behavioral economists.  This one is ironic because not only do enterprise salespeople run into this phenomenon, but they run into real accounting!   Enterprise salespeople understand that funding software out of operating expenses is generally easier than trying to get an equivalent capital expenditure approved.  This mental, or real, accounting is one of the accelerants of the SaaS explosion in enterprises.
• Overconfidence, another finding of behavioral economists, is something that SI salespeople rely on when scoping integration and change management engagement.  Best to keep the initial, overconfident integration estimates low and then go for the change order later!  After all, mental accounting, often keeps clients from realizing that “sunk costs are sunk”.  Clients, especially those whose jobs are on the line, will keep throwing money at a project simply to avoid admitting failure.   Behavioral economics teaches us that sooner or later a small probability of success will be viewed as preferable to admitting certain failure.
• Choice architecture is the notion that the small, seemingly inconsequential details of a particular decision situation can be powerful.  Every salesperson knows how critical it is to present choices, pricing, and packaging in a way that will influence the final decision.  Product marketing people spend their time on versioning, bundling, naming, etc. for this reason. (And hopefully because legitimately different customer segments exist.)
• The closely related issue of framing, that is how ideas are conveyed and what language is used to convey them, is also prevalent in enterprise sales.   Simple examples from the world of enterprise software would include:
  • In the old days of perpetual licenses, support was always expressed as a percentage of the initial price, never a dollar fixed amount.  Behavioral economists (and anyone who understands math) understand that percentages are confounding and can sound smaller than large absolute dollars.
  • Ever notice how small, private software companies (I’m calling you out Coupa and OB10!) always report in their press releases only the percentage gains in sales, customers, transactions etc.  Those numbers sound a lot better than disclosing that your company grew  from $4 million to $6 million in sales (50%!).
  • In the SaaS world, products are often priced per user per month.  Salesforce.com knows that $75/month/user sounds a lot better than $900 per year per user, year in/year out!  And now many software companies like to frame their offer relative to Salesforce’s!

When I first set out to write this post, I was going to recommend that a behavioral economist get together with a sales training company and write a book on how to apply behavioral economics to sales and marketing.  But the more I think about it, the more I think behavioral economists should just get out the lab and watch some great enterprise salespeople in action.  From that, they can deduce how little individual, or even organizational, decision-making resembles a rational process!

Who knew that the Surplus Goods Industry in the Cloud Providers were so hot?!

I’m not exactly sure what to call the companies that match buyers and sellers of surplus/used goods–especially of the capital variety.  They really are marketplaces, but having lived through the original “marketplace” era, I find it hard to choke out the “M” word with a straight face these days.

Then there is the issue of what to call the items they sell:  are they “surplus”, “used”, “secondary”, “pre-owned”, “salvage”, “legacy”?  But whatever we decide to call these marketplaces, it has been a busy time in the sector, which is now rapidly consolidating.

Liquidity Services (LQDT), which I have written about previously, acquired a surplus goods (excess retail merchandise, that is, not used stuff) company in September and their stock increased quite a bit.  This week, LQDT announced they acquired one of the early players in the space: Go Industry/Dove Bid, which, believe it or not, was public in the UK.  LQDT’s stock went up again.  Indeed, LQDT stock has been on a tear over the past year, moving from $19.50 to over $65, now sporting a market cap of $2 billion! (No, I don’t own any. I claim to be observant, not smart.)

Ritchie Brothers (NYSE/TSE: RBA), the grand-daddy of offline surplus asset auctions announced, today, it had bought AssetNation a long-time online player in surplus assets, for $64 million.   Capital Asset Exchange, which the all-knowing folks at TCV pointed out to me,  claims on its website that it has grown from $1 million in 2008 to $120 million now.  I’ve also heard good things about Iron Solutions which specializes in the surplus farm capital equipment sector.

There are plenty of other surplus assets marketplaces in IT and elsewhere, but the battle in the capital goods sector is shaping up to be a doozy.  Perhaps Ritchie, Liquidity Services, and CAE will end up being the three eBays of the B2B sector, or will there be only one eBay?

At some point in the future, I’ll dig deeper into these businesses which are fairly easy to study given that they are public and the marketplace model is now well understood.  A critical factor is to look at the growth rate of Gross Merchandise Value transacted and the margin that the marketplace extracts.  eBay extracts about a 9% margin on GMV, for instance.  PayPal is another 3.5%  for the payment piece.

The bottom line is that there is a lot of money in matching buyers and sellers of very unique used B2B goods, just as there is in collectibles!  And just like eBay, or even more so, these marketplaces can add insurance, payment, shipping, escrow, inspection, and financing and make even more!  Treasure from what might otherwise be “trash”.

A Hot Quarter for Enterprise Software (aka B2B)

It’s earnings season and it is starting to feel a little like January of 2000 again, though on a much smaller scale.  If you remember that era, the consumer Internet bubble (B2C) burst around that time and the market briefly decided that there had to be another better bubble somewhere else, eventually settling on B2B.  At that point, the B2B Internet stocks, including the industry consortia, etc. had their twelve months of re-kindled fame until their bubble burst in January 2001.  Right now, the enterprise software providers (as B2B is now called) are riding high again based on strong growth in revenue and earnings, while some of the consumer darlings are starting to fray at the edges.

This past couple of weeks have led to some reduction in the still sky-high valuations in some of the consumer internet stocks (e.g., Groupon, Zynga, Facebook, etc.) while analysts have returned to extolling the virtues of the more slow and steady, yet prolific Enterprise providers (as B2B seems now to be called).  See here, here, and especially here.

Industry in the Cloud (IC) providers that I follow are especially hot right now:

• LinkedIn (not quite an IC, but close) knocked it out of the park and has watched its stock price nearly double since January.  As a consequence, SAI Business Insider ran this chart comparing its performance to Zynga and Groupon.

• Ariba announced its quarter last week and the stock was rewarded with a new high.  The market apparently liked the seemingly accelerating growth rate of the Ariba Network.  Ariba’s stock is up nearly 40% since January. (Disclosure:  I still own some Ariba from the time I worked there.)
• Liquidity Services, which looks like it will be the consolidator in the surplus assets industry, moved up 14% this week on strong earnings and is up 71% on the year.  It is up almost exactly 100% since I wrote about it last September. (I did not buy it, however!)
• Concur also announced this past week and watched its stock jump about 8%.  This one looks like a laggard since the beginning of the year, as it is up only 25%!  (Last August, when the market was swooning, I suggested readers take a look at the stock when it was $38.  It closed this week at $63.36.  (Again, I did not buy any!  I’m better at writing than playing the stock market.)

(Lest you think these stocks are simply being lifted by the rising tech market, the tech heavy NASDAQ index is up about 13% since the beginning of the year–a nice move–but nowhere near like these stocks!)

I could go on, but you get the point: enterprise software is hot and ICs may be even hotter. At least this time, unlike 2000,  the increased valuations are based on growth in real revenue and semi-real earnings (in many cases non-GAAP earnings).  Let’s hope there is not a bubble impending for the Enterprise sector this time as well!

The Big Picture of B2B Commerce Software Providers-Revision 2

A few months ago, I posted a graphic display of my never-ending quest to map B2B commerce providers into their proper vertical and horizontal segments.  At that time, the graphic included over 260 companies.  Below, I’m attaching my latest version of the graphic which has now grown to include over 400 companies–and continues to grow daily.  (One PE firm claims that I am only half way to uncovering their list of 800 such companies, so my work is still cut out for me.)

This graphic is not meant to include all enterprise/B2B software.  It does not include, for instance, pure-play CRM, ERP, and HRM companies.  The graphic and segmentation does seek to include all B2B/enterprise software companies that are engaged in commerce–meaning they connect buyers and sellers, rather than being purely “internal” applications used exclusively within the four walls of a company. Many of these companies are networks, though not all.     Likewise, most, but not all, of the providers are cloud-based. (For the first time in my life, a Venn diagram might have come in handy!)

Besides adding many company names, the major difference in this graphic from the last one is the addition of two segments:  the print vertical and the horizontal Supply Chain Finance category which I just did a post on a few days ago.  I’ve identified about 12 companies in the SCF space alone, not including the banks. I’m sure you will know more.

As usual, if you would like a bigger copy of the graphic, please just fill out the request form on the lower half of the front page of my website www.softwareplatform.net and contribute to the cause by suggesting a couple of companies I may have missed.  This approach allows me to see who is paying attention and add to the database at the same time.  BTW, the graphic has proved quite popular, with at least 10 non-family members asking for copies!

Chicken Little and Supply Chain Finance

Supply Chain Finance is coming! Supply Chain Finance is coming!  Supply Chain Finance is coming!  Many observers, including me, have been saying this for 7 years, so it is hard not to feel like Chicken Little.  But I think SCF may finally be happening–at some point soon.  (Note: I’m still hedging.)

Why has it taken so long for SCF to catch on?

• SCF is easier (and safer) to do when the entire P2P process is electronic.  Unfortunately, we all know how long that has taken to start to be true– more than a decade.  We could ask the same question about B2B electronic payments.  Why have they taken so long to catch on in the US?  Why has E-invoicing taken so long? The list of B2B processes that have been slow to catch on is substantial.  In the spirit of the Passover holiday, why should SCF be any different from all other B2B processes? (Apologies to the gentile readers.)
• The opportunities for SCF to be a win-win for all parties are greatest when the cost of capital differential between buyers and their suppliers are greatest.  However, for most of the past 7 years, one of two odd conditions have persisted:  either there was  a historically low differential between buyer and supplier credit ratings (e.g., AAA-rated buyers and BBB-rated suppliers) as was the case before the 2008 meltdown, or credit was completely unavailable to low-rated suppliers, as was the case after the meltdown.  It would be an understatement to say the last 7 years have been abnormal in the financial sector, credit markets, and in the evaluation of risk.
• For SCF to really take hold, the market for receivables/payables needs to be standardized, securitized, rated, etc.–just like the mortgage market has been along with other debt obligations.  Imagine how eager the financial markets were in 2009 and 2010 to hear that we had come up with another financial market we could make like the mortgage market!  No one wanted to hear about slicing and dicing securities, rating them, putting them into tranches and creating another market that could create another disaster for investors.
• Banks have not been aggressive with their lending to small businesses since 2008 and they will never be good at the technology and supplier enablement part of the SCF process.  Likewise, especially in the economic environment of 2008-2010, no one trusted the small start-ups that were trying to apply the technology and supplier enablement required for the SCF market to develop.  So neither end of the competitive spectrum in the market held an especially strong hand.
• Finally, one could argue that SCF has been making inroads through the likes of many small start-ups (e.g., Prime Revenue, Orbian, Demica, Taulia, Pollenware, etc.) who may not have exactly thrived, but did survive during all of this turmoil.  In addition, growing SCF practices at Citi, Deutsche Bank, JPMC, Standard Charter, and several other banks would suggest that SCF has been “taking off”.  SCF in the logistics space through PowerTrack and CASS has been expanding nicely as well. (In fact, one could argue that p-cards are the original form of supply chain finance and they have grown to cover $200 billion in spend since their advent in the 90s!).  Maybe we just do not know how to define success?

In any case, the time for SCF may be now, or in the near future, as many of the above conditions are abating:

• Some day interest rates and costs of capital will normalize, won’t they?
• E-invoicing really has taken off and the P2P processes really are being automated, so the underlying docs are finally being made electronic.
• The small SCF suppliers have survived and seem to be gaining momentum.  They are also gaining credibility (e.g., the NYSE and The Receivables Exchange).
• As mentioned above, several banks have stayed in the space and had some success.
• Big and machine readable data is enabling the ability to make granular, real-time lending decisions economically, even automatically.
• The consumer and small business space for alternative payment methods and credit sources is starting to grow and pave the way.  (Ever heard of Capital Access Network, Kabbage and OnDeck Capital?) These companies may influence the B2B space from the small business space up.

It’s hard to know when SCF will really take hold, but SCF’s day is coming–it seems inevitable.  I worked in finance for only a very short period of time (though a summer in investment banking is the hourly equivalent of a year in most jobs), but I learned that the capital markets are highly innovative and that capital is like water: it will flow directly to a space that has gaps created by inefficiencies, risk-averaging, or bundling of dissimilar assets, etc. Right now, traditional factoring, letters of credit, and conventional working capital loans involve too many of these compromises. These risks can be better segmented, better evaluated, and better priced, so eventually they will be.  This happened in credit cards, mortgages, and many other securities–it will happen in the receivables/payables market as well.    Having an electronic history of the P2P transactions between two parties, will allow better risk evaluation, better pricing, less fraud, and better granularity.  Mix in financial ingenuity, when everyone is not freaked out any more, and the capital will flow.

Supply Chain Finance is coming.

Source to Settle in Services is Hot

The first decade of the 21st century (2001-2010) ended up being about automating the source-to-settle process for catalog content, this decade seems to be about doing the same for all sorts of services.  (Yes, apparently these things take a decade–though the process does seem to be accelerating a bit thankfully!)

Some examples:

• Fieldglass and IQNavigator, a couple of the original software providers in the temporary labor space are reportedly continuing to grow like weeds.
• Elance and Odesk, which automate the RFQ to settle process, for off-site services (e.g., IT development, marketing, etc) both just raised $16 million and $15 million respectively.
• Crowdsourcing vendors of logos (e.g., 99designs), videos (e.g. Poptent) and others are attracting investments and growing rapidly.  Crowdsourcing providers reported a 75% increase in revenue last year to $376 million, up from $215 million in 2010 and $141 in 2009, according to a report by crowdsourcing.org, a Dallas-based site that tracks the crowd-funding industry.
•  SIM, or supplier credentialing, vendors who specialize in the services that are provided on site–either in oil and gas, mining etc, or even in hospitals–are also growing rapidly and attracting capital and attention.  There are multiple sites that specialize in keeping the credentials of pharma and device reps who visit hospitals.  See a prior post for more on the SIM space.
• Facility related services are being provided by technology-enabled outsourcing providers as well as being enabled through several pure play software vendors.
• Travel and event planning has also seen a lot of activity with StarCite being bought, Cvent raising $100 million, Concur’s stock soaring, and Eved raising $9.5 million.  (Disclosure:  I am a board member of Eved.)
• The entire process of media buying is being automated online and offline by the likes of MediaOcean, Rubicon, DoubleClick (Google) and many others.

I could go on to cover legal, print, logistics, insurance and a bunch of other services.  But you get the point.  All those categories that used to take a back seat in the early days of e-procurement are now coming to the fore.  The low hanging fruit has been “plucked” and the movement is “higher up on tree” where processes are more complex and the value provided to both parties is potentially more substantial.  The SOLOMO convergence of social, local, and mobile adds an entirely new set of catalysts for automating the service supply chain–from verification of service performance to onsite capture of documents.

After a decade of relatively straightforward activity, it is fun to finally see these categories be tackled by customers and vendors.

Vertical Supplier Information Management (SIM)

Horizontal Supplier Information Management gets a lot of attention from the analysts and industry pundits.  There are many reports on the SIM space sponsored by the myriad of horizontal SIM vendors.  Here’s just one example.  At this point, most of the horizontal sourcing and contract management vendors offer a SIM solution which consists basically of a one-to-many portal where suppliers can register and provide the information the “hub” enterprise requires.  Some of the SIM vendors take an A/P oriented approach, instead of a sourcing approach, promising to help customers clean up their vendor master, improve audit recovery, or help effect a check-to-ACH conversion process.  Then, of course, there are the financial data providers like D&B and Experian who have  moved into the SIM space as well.

Whatever the exact sales pitch by the vendor, the high-level notion is usually the same;  the enterprise is told to set up a portal to manage their suppliers and benefit from the vendor’s “network effect” (e.g., database) from having worked with so many other customers.  (There’s no network effect for the suppliers themselves, mind you, but it does make for a nice pitch to the enterprise buyer.)

The IT  (Gartner, etc.) and some of the procurement analysts (who shall remain nameless) seem to like the pitch.  They like the pitch partly because it is an interesting story and partly because they are paid by all of these small SIM vendors!  The analysts are also receptive to the pitch because they are horizontal just like the vendors.  The analysts cover the supply chain software industry broadly, rather than specific industry verticals.

The problem with this analysis is that the most interesting activity in the SIM space seems not to be among the horizontal SIM vendors (who are trying to collect high level information on all suppliers), but among the largely overlooked vertical SIM, or supplier credentialing vendors.  The vertical SIM vendors gather deeper level data on suppliers in a specific industry and sometimes just specific types of suppliers within an industry (e.g., on-site contractors only).  These Vertical SIM providers often interact with multiple buyers in the same industry to get agreement on what information should be collected from vendors and/or establish their own standard for the data to be collected.  In that sense, they do not only SIM, but standards setting and evaluation.  These vendors also often provide a true network effect for vertical suppliers, allowing them to register their information once and use it across multiple buyers within a network. Several of these vertical SIM vendors have replicated this same approach across multiple verticals in a serial fashion.

The most prominent example of this strategy is probably Achilles Group, which started in the oil and gas industry and has expanded beyond oil and gas into several other verticals.  In 2011, Achilles reported about $72 million in revenue–and they are not even really present in the US.  Are any of the horizontal SIM suppliers, besides D&B, in this size range for just their SIM product?  Achilles is just the tip of the iceberg, too.  There are literally 5-10 “Achilles” in the US and Canada working in capital-intensive industries with contractors.. There are also supplier credentialing companies in food, healthcare, and logistics as well.  I’m sure as I spend more time looking for these types of vendors I’ll find many more examples in other industries.

In many of the cases I have looked at, the vertical SIM suppliers seem to be doing a whole lot better than the horizontal ones, who suffer from having to “boil the ocean” across a zillion suppliers, versus going deeper on a hundred thousand vendors or fewer.  For example, Achilles’s 2011 $72 million in revenue comes with about 77k suppliers involved, representing revenue of about $900 per supplier.  Clearly the horizontal SIM vendors who claim to have millions of suppliers in their databases are not yielding revenue anywhere near this per supplier, or they would be $1 billion businesses!  Most of them seem to be well under $30 million in revenue.

Horizontal SIM without a true network effect for the supplier (and/or without a transactional network attached) is really just an example of asking big hub customers to set up another specialized portal for their suppliers to collect a limited amount of information.  This approach offers little value to the supplier and limited value for the buyer as well.  It will work for the very biggest of hubs, especially if it can be integrated with other aspects of their existing portal, but otherwise this approach is like selling “beepers” in the age smartphones–a single-purpose device in a world filled with convergence.  Suppliers already often have to go to multiple portals to deal with some large customers–one for POs, one for invoices, one for payment, another for SIM.  This approach is not sustainable in the long run.

Vertical SIM seems to be where: the action is, the network effect is,  the business model is working, and the vendors are growing and thriving.  Don’t let your attention be diverted.