Understanding Vendor Incentives To Get the Best Value for Your Business
And so if you're in a position where you are purchasing or contracting IT services or technology in any sense of the word, you know, you need to understand the incentives of the of the vendor, you know, and and what you're up against as a buyer. So, you know, the simplest way of looking at this is, you know, people think about, you know, public companies in their quarters. You know, where is the vendor at in their in their cycle? Are they getting close to the end of quarter? Well, what happened close to the end of the quarter?
Speaker 1:All of a sudden, discounting comes out like crazy because they will do anything to increase the revenue and and their contracts. And, you know, that's because their the sales team is incentivized. You know? You know, this is where it gets into, and also the company gets incentivized. I saw this post on LinkedIn the other day, and I saved it because I wanted to respond to it, but I wanted to do it in a way that wasn't just commenting on the thread.
Speaker 1:And there's there's a few things going on with this post, and and the first one is just a reflection on the state of layoffs in the tech industry and the SaaS industry. And in this case, you know, why is why is, Eric and Zoom getting a pass for laying off a ton of people when others didn't? And, you know, the second part of it is is talking about their sales motion, and and really what this person's writing about is frustration, their frustration over sales tactics that Zoom was employing. So, you know, a few things. Let's talk about sales tactics.
Speaker 1:Let's talk about Zoom sales tactics in particular. Zoom is a very popular meeting application. At this point, everybody knows what Zoom meetings are. But Zoom meetings is one piece of a larger bundle of collaboration product. And when we talk about unified, communications and collaboration today, Really, that bundle is meetings.
Speaker 1:It's, voice. It's video. It's phone. It's chat. It's messaging.
Speaker 1:It's shared work. There's a bunch of things that fit into that bundle. So while Zoom is an extremely popular meeting application, it is not, what's, how do I wanna put this? Zoom needs a moat. And in this case, adding voice or adding chat or adding these other things that comprise the the Zoom one bundle really creates a moat that protects Zoom's core business.
Speaker 1:So while Zoom phone and Zoom 1 is absolutely incremental revenue for Zoom, the goal and the design of selling, you know, Zoom phone and Zoom 1 is as much as about creating a moat and protecting their core business from the competition as it is about incremental revenue. So so think about how you look at, what Zoom is trying to accomplish here with Zoom 1 and Zoom phone a little differently. Yes. They want the incremental revenue, and, yes, the margin on that incremental revenue is is is great, but the value to Zoom in selling that additional license is greater for protecting their core business in Zoom meetings than it is in the actual incremental revenue, you know, of that, of that license. Okay.
Speaker 1:Giving it away, in most cases, discounting by over 50% against the competition. So they they were actually I mean, literally giving it away. The sales motion was incredibly aggressive. And if you push it a little bit, you could kick in just unbelievable concessions. Now the real issue with their sales motion was that they had, you know, weak sellers, you know, and and, you know, really just junior people in the in their AE teams that had not experienced a world.
Speaker 1:So the world changed. Okay? 2020, world changed. 2021, the world changed. 2022, the world changed.
Speaker 1:2023, the world has changed again. So when you have a sales team that comes up in any of those environments, what they're pushed to do and what their incentive to do and what their expectations are changes also as well. So, again, Zoom is incentivizing their sales teams to sign bundled product licenses by any means necessary because, again, the moat is valuable to Zoom. It protects their core business. So now if you're interacting with a Zoom seller and, you know, and this was 2022 and you get on a on a conversation with them and you're saying, you know, we're interested in Zoom phone or we wanna look at it and demo it and think about it and we're considering it, what was happening too much was those sellers were in the first conversation, the first sentence out of their mouth was saying, we'll give you x, and that x was, you know, massive discounting and free service and all these different crazy things that made absolutely no sense because they they were unnecessary for that stage of the sales cycle.
Speaker 1:They're they're just just leaching revenue unnecessarily. Now, again, that was the behavior that was desired because Zoom wanted the moat around the service. Now the second thing I we should talk about a little bit is the actual costs and the margins and the way this business gets made up. So in in any sort of SaaS application, we'll just line this up here because it's easier. You know, you have your average sales price.
Speaker 1:So or, you know, so you can look at this as, like, what's the monthly subscription? What's the average contract value? What's the annual recurring revenue? You know? So let's just say let's just use ARR.
Speaker 1:So annual recurring revenue. And then you have your second big one is what your customer lifetime value is. So if you sign a seat up, if you have one user on Zoom and that user has a, you know, you know, ARR of $240. And their CLV, the average length that they're gonna be a customer is I mean, I don't know. You know?
Speaker 1:What's what's Zoom CLV? Let's just say it's we'll do something that's simple. We'll do, we'll do 4 years. So in this case, you have a $1,000 of value, $960 worth of value from that seat. When you are in control of your stack, in this case, Zoom is, they have cost to deliver the service, but they're not paying licensing to a third party.
Speaker 1:They're they're not paying somebody else to use any of the stack. So so their effective incremental margin per seat is very high. So when you say, okay, if you're gonna if you're gonna bring on a seat and that seat's worth $1,000 to you, what is the acquisition cost of that seat worth it to you? And what you're doing when you when you factor in what this acquisition cost is is you're just eating into your margin. So what's an appropriate acquisition cost in a $1,000, you know, okay, well, let's just assume some other things.
Speaker 1:What what do we think their gross margins? Their gross margin is huge. Right? So Vonage proved this 20 years ago, you can afford to have a incredibly high acquisition cost if you have a long CLV and you have good margins in the business, and Zoom has both of these things. So now if you, you know, are giving away I mean, in this case, let's just let's just say your acquisition cost is half.
Speaker 1:Right? You know, that's not great. But, I mean, if you spent $480 to acquire $960 worth of revenue and that 96, you know, $960 worth of revenue had a 90% margin, I mean, that's good math for you. It's not great math, but it's good math for you. And that's at a 50% acquisition cost.
Speaker 1:If you take that acquisition cost and you discount it, you say, okay. We're gonna give you a year of free service. We're gonna give you $240 worth of free service. You know, that acquisition cost against the actual CLV and against the margin of that business is I mean, it's it's like no brainer. And then when you take and you take a step back and you say, well, the reason why you're doing this in the first place is to defend your moat.
Speaker 1:So in the case of Zoom phone, Zoom phone, you know, at an average seat cost of, like, $10, if you give somebody a $100 worth of free service, and that $100 of free service is protecting a $1,000 worth of customer value with margin. I mean, it it's it's a really easy lever to pull, and that acquisition cost of a $100 is minuscule when you look at the actual alternative acquisition cost that a company has to go through. And this is marketing and sales and and, you know, it's it's a relatively cheap way to acquire the customer, and the CAC is not outsized against what the actual ARR and CLV is for that type of customer. So now, again, 2023, the world has changed again. We've moved from 0% interest rates to inflation, you know, rising interest rates, cost of money is increasing, risk free rate of returns are changing.
Speaker 1:You know, right now, today, you can get a savings account at a 4% return annualized. So the evaluation and the calculus that goes into how money gets allocated changes pretty significantly. And this is why all these companies have had to change their approach and what they're looking at. So, you know, Zoom has done the same thing. Their layoff, percentage wise, hopefully, they don't have to do another one.
Speaker 1:That's that's my position on this. You know? They scaled up very fast to deal with the pandemic and the response to COVID, and and now they're being judged based on what their revenue per headcount is, what the actual what's their actual free cash flow? What's the revenue per employee? And how do they increase and improve, the actual core metrics of the business?
Speaker 1:And for most companies, you know, you can you can look at this from a lot of different ways. It's like, can you address your underlying cost of service and what you're spending and what your what your core cost of goods sold are, or can you make another shift? In this case, layoffs are expensive, but they're a very fast way for a company to influence their financials. And that's what Zoom has done. So, you know, giving it away, discounting by 50% against the competition.
Speaker 1:I mean, you just you know, it seems crazy if you're on the outside of this and you don't understand what's actually going on. But when you spend a little bit of time to actually understand what's going on, what their incentives are, you know, it makes complete and total sense. And so if you're in a position where you are purchasing or contracting IT services or technology in any sense of the word, you know, you need to understand the incentives of the of the vendor, you know, and and what you're up against as a buyer. So, you know, the simplest way of looking at this is, you know, people think about, you know, public companies in their quarters. You know, where is the vendor at in their in their cycle?
Speaker 1:Are they getting close to the end of quarter? Well, what happened close to the end of the quarter? All of a sudden, discounting comes out like crazy because they will do anything to increase the revenue and and their contracts. And, you know, that's because their the sales team is incentivized. You know?
Speaker 1:You know, this is where it gets into, and also the company gets incentivized. So you've got quarterly closes, and you've got annual. You know? End of the year, great time to go out and contract. Right?
Speaker 1:Really simple incentive structure that you can take advantage of. And, you know, anybody that that understood what Zoom's incentive structure here was got a fantastic bargain for them if they're out acquiring these services. And these aren't bad things. I'm not putting this in the position of this being a bad thing. I'm just saying understand the incentive structure of the people that you're working with, and you can understand a lot about what they're going through, what there is valuable to them.
Speaker 1:And then based on that, what's important and valuable to you, and you can put yourself in a really strong position as a buyer to actually do something and get the best value you can for yourself and your business.
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