On the morning of Thursday July 28, I received a text message from a former co-worker that currently works for a NetSuite VAR in the Seattle area. The text was just a URL to a NetSuite web page for a press release, without preamble or reaction. Once I clicked the link, I understood why she knew it wouldn't require explanation: NetSuite had been acquired by Oracle.
I'm a strategy nerd, and I love the idea of a business making moves to better their position in the market. Every business believes (and some actually understand) they fit in a particular segment of their ecosystem, and the publicly visible strategic moves they make offer a rare glimpse into the otherwise protected thinking of their management team. Having supported, implemented, designed, and sold many complex NetSuite solutions over the past decade, it was a storyline that really piqued my interest, driven by one, really compelling question:
Why would Oracle acquire NetSuite?
As I'm wont to do, I immediately turned to my friend the internet. After 30 minutes of searching, reading, and following various related links, I was able to distill down the common speculative themes into these three categories:
- Oracle is buying SaaS market share rather than building it on their own (Bloomberg)
- Oracle and NetSuite are complimentary products that will —co-exist forever— (Forbes, and a quote from the joint press release)
- This acquisition will allow Oracle to compete more effectively against competitors like Salesforce.com (Fortune)
As I read through these articles, I couldn't help but think that they were each missing the point and just rehashing the same tired analysis. This lead to more searches, more reading, and many, many numbers. In the end, none of the proffered justifications seem very well supported, or they ignore important details as follows:
1.Oracle did not purchase NetSuite to acquire market share:
Oracle can be grossly simplified and distilled down into three primary business lines: Hardware, Software License, and Cloud. Hardware and Software License have traditionally been the vast majority of Oracle revenues (~92%), and both have been trending downward, with losses of 2% and 7%, respectively, in the last quarter. Oracle SaaS (Cloud) products, on the other hand, grew by 68%, to represent approximately $690 million in revenue in the same period. While representing only 8% of overall revenue for the company, it clearly shows an acceleration in their push into the cloud with a simultaneous decrease in traditional on-premise revenue.
It's important to note: that number is QUARTERLY revenue. Oracle's fiscal calendar doesn't align with NetSuite's, so there isn't an apples-to-apples comparison. But for the last year (which overlaps 50% with Oracle's year), Oracle's SaaS business had approximately $2.2 billion in revenue, compared with NetSuite's $741 million. With projected growth rates of Oracle's cloud software solutions at 75% for the coming year, compared to NetSuite's projected growth around 35%, the argument of a need to acquire market share through purchase or corporate acquisition seems dubious.
With an acquisition price of $9.3 billion, Oracle would need to be betting that NetSuite will continue to significantly increase in value, outpacing their historical growth rates. In addition, Oracle would have to rely on continued NetSuite market share growth coming out of their competitors' share. Oracle otherwise runs the risk of NetSuite's growth being fueled by cannibalizing the existing Oracle customer base, and potentially decreasing the currently high growth rate of Oracle's own cloud business line. Unfortunately, much of NetSuite's growth in the last five years has occurred as a result of moving up-market into traditionally Oracle territory, which makes this scenario very unlikely.
Given the financial facts of the companies' respective annual revenues and growth rates for SaaS products, and because they play increasingly in the same market, it is unlikely Oracle purchased NetSuite for the sake of acquiring market share.
2.Oracle and NetSuite are not merely complementary products that will —co-exist forever.—
An increasing portion of NetSuite's growth has come at the expense of the gray area between the small and mid-sized business (Small Business) market (traditionally NetSuite's bread and butter) and the Enterprise Solutions market (traditionally the purview of Oracle and SAP). As early as three years ago, the frequency with which I competed against Oracle when selling NetSuite started to dramatically increase. NetSuite has made consistent inroads to the Enterprise Solutions market in the past five years, including offering dedicated environments, opening the platform to deeper development, granting better database access, and appealing to larger organizations. Each of these moves is targeted at addressing the traditional arguments of on-premise Oracle Enterprise Solutions clients against the cloud: —I don't want to be on a shared box——I don't have access to customizations——I can't get access to my data——The system isn't sufficiently scalable to meet the needs of my business.— While NetSuite continues to eliminate the arguments of, —Why NOT NetSuite?—, they have slowly eroded the moat that traditionally protected Oracle from competition.
The baseline license fees have begun to price out the —S— clients from the Small Business market as NetSuite has continued to move up-market. Part of this pricing strategy (with the corresponding feature enhancements) was aimed at appealing to more Enterprise Solutions clients, and diligently moving the product upstream.
These improvements have enabled NetSuite to compete directly against Oracle in some scenarios, particularly for those companies on the lower end of the Oracle ecosystem considering the choice of upgrading an existing Oracle implementation or moving to a replacement platform, such as NetSuite, for a fraction of the cost. Ten years ago, very few organizations would have seen this as a viable option. Today, many organizations have to take a hard look, in large part because of the increasing feature parity as each release improves the NetSuite product. A continued dedication to strong investment by Oracle in the NetSuite product would only further erode the protective boundary between the markets, increasing the likelihood that NetSuite would cannibalize Oracle sales by improving feature parity between the two offerings.
As a result, it is highly unlikely that Oracle would continue to invest heavily in both its own offerings as well as those of NetSuite, especially in light of the investment cost of the acquisition and the respective growth rates of the two companies' SaaS offerings. While investment in NetSuite may continue, it is unlikely to be targeted at areas of the product that could lead to the loss of Oracle customers.
3.The acquisition of NetSuite does not seem to give Oracle a particular competitive advantage against other SaaS companies.
Salesforce.com was listed in multiple analyst reviews as a primary motivator of NetSuite acquisition, largely on account of Salesforce being the de facto leader in SaaS CRM software (by comparison to the $9.3 billion NetSuite price tag, Salesforce has a value somewhere north of $50 billion). However, there are few truly competitive advantages Oracle gains through NetSuite to help it better compete against Salesforce. NetSuite includes really strong CRM capabilities, but it is not necessarily a primary competitor to Salesforce. Zach Nelson (NetSuite CEO) has frequently commented that organizations may run both NetSuite and Salesforce concurrently, as the product depth for NetSuite resides in the accounting and ERP features, with CRM to augment, and the strength of Salesforce is purely in CRM, with no accounting or ERP features.
Moreover, it was Oracle's inclusion of CRM features in their own products that led to one of the initial rifts between Larry Ellison and Marc Benioff, in part because the CRM capabilities of Oracle's own products began to keep pace with those of Salesforce.com.
There are no particularly unique characteristics of NetSuite's CRM that Oracle gains through the acquisition to help it compete against Salesforce. Aside from also serving the Small Business market, Salesforce and NetSuite are much closer to complimentary products than, say, NetSuite and Oracle. If an organization were evaluating both Enterprise Solutions and Small Business software, and looking for a combination system to tackle both ERP and CRM functionality, the competition would not be between Oracle to Salesforce, it would be between Oracle and NetSuite.
Oracle's Acquisition of NetSuite Was Defensive
At the end of the day, I think the real motivation behind the Oracle acquisition of NetSuite is the need for, and capability to execute, a defensive maneuver to protect market share.
As mentioned above, much of NetSuite's growth in the past five years has been through an acceleration into the Enterprise Solutions market, while moving away from the lower end of the Small Business market. NetSuite has really successfully transformed themselves from an online Quickbooks alternative (remember when they were NetLedger?), into a legitimate option for large businesses evaluating traditionally Enterprise Solutions software packages. The company has continually grown, showing annual growth in excess of 30% for a number of years, and continuing to demonstrate a capability to effectively serve an increasingly complex segment of the market for ERP and CRM needs via the cloud. They have moved beyond the bleeding edge of technology by proving the model, which makes their platform a compelling option for ever larger businesses who may have been unwilling to take a risk on the cloud five years ago.
At the same time, Oracle is seeing a decline in their traditional business lines due to the competition presented by their cloud services, including NetSuite. The only area of significant growth for Oracle is in their own cloud offerings. In previous years, Oracle could scare Enterprise Solutions customers away from the cloud through doom and gloom predictions of data loss, inflexibility, and performance issues. As NetSuite has continued to prove their model, this tactic has become more challenging for Oracle. More importantly, with Oracle's primary growth coming from their cloud services, they can no longer afford to claim the cloud is an unsuitable alternative to their traditional offerings. When Oracle promotes their own high-growth cloud business, they simultaneously give credence to all other cloud competitors over the traditional model. When you consider that NetSuite projects are only a fraction of the cost of Oracle projects in terms of implementation and licensing, the competitive threat of NetSuite against Oracle's own cloud offerings starts to become very real.
Given Larry Ellison's large stake in NetSuite (approximately 40% at the time the deal was announced), a defensive acquisition by Oracle seems like the much more likely motivation for the purchase. Ellison maintained his fiduciary obligations by having an impartial committee handle the negotiations, but carried sufficient weight and influence to instigate and drive the transaction. By acquiring NetSuite, Oracle ensures they can maintain a protective moat around their fastest growing business line, while also mitigating the risk of market share losses in their traditional business lines to a growing competitor.