Looking for a Good Buy
Ariba buys FreeMarkets, pays a lot, and gets ... lots of opportunity.
The Bottom Line
Ariba will buy FreeMarkets for cash and stock valued at 3 times revenues. I like the deal, though I have some reservations. The companies are largely complementary. The purchase keeps Ariba well ahead of its ERP competitors. And it could help Ariba accelerate its growth by giving customers more points of entry into the solution.
The reservations? The price, which is high, especially for a company whose brand is fading. The usual feeling that most acquisitions don't work, especially when the acquirer doesn't do this for a living. A feeling that the cultures won't mix well. Vague, admittedly, and certainly far less intense than my doubts about PSFT/JDEC.
The Rationale
This acquisition makes little sense unless you
understand and agree with
Ariba's view of its market. According to this view,
the market (basically the people who do sourcing at the Global 2000)
can't be adequately or profitably served by a conventional software company.
To address this market's needs, the automation and information management
that software brings
is not enough. To use the tools at all effectively, the sourcing groups
must have knowledge about what they're buying which for most companies
is difficult to develop or maintain internally.
Don't consulting companies do that, one might ask, and more effectively
than software companies? Not really. I'm not talking here about traditional
implementation services, which Ariba already does partner for. I'm talking
about a mix of consulting and intellectual capital which, as a practical
matter, is not provided by most implementation services companies, and probably
should be provided by a single source.
I like examples, so let me try one here. Let's say you need forklifts
and want to buy them through an auction process. Software that sets up
auctions is needed; that software can, obviously, be installed by any
competent integrator. But that software isn't really doing much of your work.
You still need to find suppliers, structure the RFP/bid sheet, and figure
out your strategy for accepting bids (single supplier?, single supplier
for each region, etc.) Your success or failure in the auction depends
on this; it doesn't depend on the quality of the software.
Very few people buy forklifts every day. So most people who are
in this situation would like to be able to draw on the
knowledge and experience of others--either other people who have
bought forklifts recently or people who do this for a living.
A natural place to go, of course, is to the company that's in
business to provide this kind of expertise.
FreeMarkets is such a company. But in their model, as I understand
it, if you want a high level of touch from their experts, they hold the
event for you. They are also, by all accounts, expensive. Ariba sees the
need to become such a company, but right now,
their expertise is spotty, and providing expertise
is not what their salespeople are focused on.
So why don't the two companies get together and put on a show?
It is not at all a new idea; I've discussed it with people for
over a year. But, until recently, Ariba was too damaged and
FreeMarkets too confident for the deal to work.
Now that it's working, what do you have? Potentially, a company
that can go to the Global 2000 with a better mousetrap: an end-to-end
software solution for managing the processes and data surrounding sourcing
activity, combined with the expertise to deploy that software effectively
in multiple spend categories, direct and indirect.
Notice that this clearly differentiates them from the ERP vendors. These vendors do offer some of the same software, but they're not in a position to help with the expertise required, nor are their partners. They don't even have the right model, since this expertise is best sold on a subscription basis.
Disclaimers are required, I guess. I have no business relationship with Ariba. I don't take money from them. I don't own any stock.
I just happen, for once, to agree with what the management of a
software company is doing. I think the end-to-end software solution, etc., etc., is a good thing and that customers ought to want it.
So Ariba agrees with me and I agree with Ariba. To make this a real
party, however, we need at least one more group: the customers. So far, this
is a problem. Go out to Sunnyvale. You
just don't see the Global 2000 lined up three deep around the Ariba
headquarters. Yes, there are customers, and according to Ariba marketing, they are getting significant benefit. But those customers are definitely in the vanguard.
What FreeMarkets Could Give Ariba
In a kind, forgiving world, it might be enough for Ariba, the services-based
software company, to buy FreeMarkets, the software-based services company,
and over the next year or two, work hard and make an ideal assimilation
of the two skill sets. We would all applaud and wait for them to execute.
But when you're still trying to create a market for your product,
it isn't enough. The acquisition also has to give Ariba some way
of accelerating its progress. Ariba fails, I believe, if it doesn't
eventually become the dominant provider of solutions to sourcing
groups. But so far, Ariba isn't selling at a rate that will allow
it to dominate.
Clearly, it is possible for the acquisition to speed things up.
FreeMarkets gives Ariba two obvious things here:
- An entry point. Customers who want to move slowly
toward end to end spend management can start by running auctions
with FreeMarkets' help.
- Global reach. FreeMarkets has offices and customers and category
knowledge in areas of the globe that Ariba has never effectively
penetrated, so the acquisition gives them access to more customers.
Both of these are very much in potentio right now. To get and keep
customers that come in via FreeMarkets, Ariba will have to establish
an account management process that is unusually thoughtful and far-reaching.
To take advantage of FreeMarkets' global reach, Ariba will have to invest, and
there are a lot of other places where investment dollars would be a good thing.
At the same time, I don't mean to make this sound far out or unlikely.
Ariba's core sales problem right now is to provide customers with entry
points and then convert them. Today, there are three entry points:
- Customers who have Ariba Buyer (or SAP procurement)
and want to work on supplier relationships with Ariba Contracts or Ariba Invoicing.
- Customers who want to control their spend and have decided that the
analytics solution provides a compelling user interface.
- Customers who have bought some other e-sourcing package that
didn't cut it and are trying to replace it with Ariba.
At the Ariba User Conference, I gained an appreciation of how crucial
the existence of entry points is.
At lunch one day, I grabbed the last empty seat and found myself
with
an Ariba salesman, four people from an aerospace company that
was an Ariba customer and four people from a very similar aerospace
company, not a customer. I was treated to a full hour of Ariba
sales pitch, not from the very quiet salesperson, but from the four
Ariba users.
From their questions, it sounded to me as if Ariba might be
a good buy for them. But they themselves were less certain. I must have heard
"Are you
sure it can work for us?" repeated in slightly different forms at least
ten times. Each time, the current customers said, "Just try it out with
a few events." Clearly, that was the only way this buy was going to happen.
Reservations
The potential gains for Ariba seem clear. They can gain expertise. They
can gain global reach. They can gain access to more customers. They can,
with proper execution, create a compelling product offering. And they can
gain entry points.
So what's not to like? Well, for one thing, there's the price. At three
times revenues, FreeMarkets would be expensive if it had a solid brand,
were profitable, and were completely complementary. But in fact it is
losing money, has a quite negative profile with a good many potential
customers, and has a pair of legacy software packages that need
to be supported or assimilated.
Some of these negatives are just part of the territory. If FreeMarkets
has software and Ariba has (one hopes) better software, good engineering
will eventually allow people to converge.
But others are more worrisome. Take the branding/go-to-market profile.
FreeMarkets' auction services did make
money for people, but I have had more than one customer that never could
work its way through to seeing the value proposition and more than one
customer that eventually was turned off by an overly aggressive sales force
or overly aggressive pricing or both. There were always a lot of rather disingenous
claims about "making money" for people by getting lower prices for commodities
whose base prices were falling anyway. I don't think that any of this
will help Ariba one little bit, but it's not at all clear to me that it
has stopped. If it hasn't, Ariba has some work to do.
There is also the larger question of how you deploy a company
that sells software, intellectual capital, and services. Nobody's
every done this before, and the practical problems are significant.
Take just one example.
On our call, the Ariba people pointed out that the FreeMarkets salespeople
are used to managing an account so that it returns again and again, while
the Ariba salespeople are used to making the sale and going on. It's certainly
possible to end up with the best of both worlds, but it's also possible
to end up with the worst.
And then there are all the normal problems of managing an acquisition.
How do you keep all the smart people while cutting costs significantly? How
do you redeploy skills so that they benefit the whole new company. The usual
stuff.
One thing that is not too daunting is the fact that FreeMarkets is losing money. It seems to me that rapidly-growing software companies build up an enormous quantity of recurring excess costs over time and that almost anybody who comes in with an eye for reform, from Bob Dutkowsky to Craig Conway, can make a real difference to the cost structure in relatively short order. Bob Calderoni, Ariba's president, pays attention to outflow and should be able to make a difference.
Better Hanged for a Sheep
It's a risky move, then. Ariba will have to solve a lot of normal problems
that have defeated most people. And they'll have to improvise and invent their
way into becoming a software and services company with few precedents to
guide it.
But you have to remember, staying still has its risks, too. I don't
need to describe these; Ariba's stock price and the generally doubtful
opinion on the street shows that these are widely appreciated.
Ariba's president makes no secret of the fact that he loves the
Yankess and appreciates the lessons that sports teach. "Be aggressive; better to
try something and fail rather than do nothing and be beat," is the conventional
wisdom for his beloved Yankees and, I suspect, for him.
We shall see. For his Yankees, it's worked out well. For other teams,
when they try this sort of thing, they've sometimes discovered that
it's better to take the pitcher out, even if he is Pedro Martinez.
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