Part 1: Analyzing Ariba’s Quarter — Trends, Numbers and Services

Over the weekend, I spent sometime digging into what transpired on Ariba's analyst call last week. Even though bloggers are not yet allowed to ask questions (I tried in a call a few quarters ago, but to no avail), I still find the calls -- especially the Q&A section -- quite useful for gauging how Ariba and others are performing in the context of the overall market. I've got plenty of notes and analysis from the call worth sharing, but I'll try to limit myself to a post or two on the subject, tackling only the useful findings and observations. On this first post in the series, we'll examine in detail the basic numbers that Ariba presented which customers should be most interested in (e.g., cash-flow, customer growth, solution mix) as well as double-click on the services revenue line-item. Let's begin.

Perhaps first on the list of anyone evaluating vendor viability for Ariba -- let alone other players in the Spend Management sector -- is the ability to generate cash. In this regard, customers and investors should have nothing to worry about. Ariba was able to generate cash flow from operations of $20 million which gave it $177 million in cash and investments on hand (or roughly a cash balance of $2 bucks a share) at the end of June. And software wise, Ariba is continuing to grow, despite some of the challenges impacting SAP's software numbers, among others. In this regard, Ariba closed 226 unique customer transactions in the quarter overall (including software and services) and added 39 new "named accounts" to its customer roster. Over two-thirds of these transactions were for On-Demand or SaaS deals.

However, services continues to be the crux of the revenue challenge for Ariba. On the earning's call, Ariba shared that "services and other revenue" came in at $28.5 million which is "at the low end" of the guidance for the quarter. During the Q&A on the earnings call, one sell-side analyst asked if professional services was up sequentially or whether it was down. Bob responded that Ariba is "not seeing it go up, but it's holding it's own ... kind of flat, but down slightly." In other words, Ariba did hit the numbers it would have liked to from a services perspective. Bob attempted to deflect the situation by later suggesting to the audience that "everywhere I look to external benchmarks, any consulting firm I look at, most are showing pretty significant declines year-over-year". This includes "any type of consultancy, even cost reduction consultants" which are "under a fair amount of pressure".

For most observers' eyes, this probably appears to be a reasonable response. But if you look at the actual situation in the sourcing and supply chain world specifically, a more accurate statement would be to say this year has become a mixed bag depending on firm. Some are doing fine (including some of Ariba's top historic competitors in the area like AT Kearney Procurement Solutions and new turnaround/consulting entrants like Alvarez & Marsal and Alix Partners) while others are having challenges, especially those tied into discrete manufacturing. I personally believe Ariba is underperforming in services -- especially in sourcing consulting -- relative to what they should be doing. For example, if they were able to have taken only 25% of AT Kearney’s Procurement Solutions quarterly revenue (averaged over the past 12 months), they would have blown away services expectations overall (and ATK is but a single competitor). But instead in the past year, Ariba lost at least two of its more senior folks I know of to ATK.

Part of the problem is that the current consulting environment does not favor the type of resources that Ariba's business model has to offer, even from a sourcing consulting perspective. Not only does Ariba lack enough heavy-hitter partner-types to sell and manage large engagements -- they also lack the requisite expert teams underneath. The entire FreeMarkets model that Ariba acquired became predicated on a "sourcing factory" modeled on lean operations that greatly reduced slack-time and drove each possible task to the lowest possible cost resource while maintaining specified quality levels. The highest level subject matter experts had limited time to do anything but manage their own teams and come in and offer talking-head like advice to clients. In contrast today, clients are expecting subject matter experts to stay on the job. And in a number of procurement transformation projects -- which have included large category sourcing and category management components -- that I've been privy to of late, the consulting teams have been somewhat top heavy at the client's request which is the opposite of Ariba's sourcing consulting model.

What can Ariba do to kick-start its consulting revenue? For one, the company should not be in denial about how challenging the environment is. Yes, it's hard, for some firms. But not all. In fact, many of its cost-reduction services competitors are doing quite well even if they've had to adapt their models (e.g., working on contingency vs. a fixed fee basis, a shift I've heard that Ariba is seeing as well, but more on that in another post). Second, Ariba should look to hire both more senior consultants and true category and industry experts that they can staff on projects as part of larger teams as well as maintaining the same resources they've had in the past in the sourcing factory in Pittsburgh (this is one of the models that is making the turnaround firms so successful as consultants in the supply chain and procurement areas of late). And third, Ariba should work more closely with many of the firms who could use their services from an expert subject matter and execution perspective within their client base (e.g., IBM, Accenture, McKinsey, BCG -- yes, BCG, they’re getting into this area as well – PWC, Alvarez & Marsal, etc.)

What's the bottom line? Ariba's consulting revenue (or lack thereof at the level which it needs to be) is holding them back from blowing away revenue expectations. The rest of the business is performing remarkably well given the overall environment despite a number of quibbles any curmudgeon (myself included) could make.

Jason Busch

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