Workday, NetSuite, Among Fastest-Growing ERP Software Vendors

ERP, or enterprise resource planning, software is one of the more mature enterprise sectors. As such, top ERP vendors such as Oracle (ORCL 0.35%) and SAP (SAP 5.56%) are already showing worrying signs of stagnation, and even declines in revenue from this important sector. However, this does not mean that ERP software is dead -- far from it. Upcoming SaaS ERP vendors such as Workday (WDAY 1.85%), Cornerstone OnDemand, and NetSuite (N) are proving that the sector is still very much alive.

According to a May 2014 Gartner report, the ERP software market is now worth $25.4 billion.

According to the report, the top four fastest-growing ERP vendors are all SaaS companies.

Source: Gartner, May 2014

Complacency to blame for slow growth
ERP vendors rely, to a large extent, on maintenance revenue streams to survive.The 3.8% growth of the industry is, unfortunately, not nearly enough to sustain the large and complex cost structures of the existing market leaders.

Gartner says that the market leaders have become too complacent when it comes to true innovation, and have instead been riding the wave of their earlier software hits. Many monolithic legacy ERP vendors are, as a result, struggling to meet the needs of modern business models. This is what is causing the slow growth.

Ironically, young ERP vendors are growing fast, precisely for the same reason. These companies do not typically have heaps of legacy software from which they can reap fat maintenance fees. Thus, they simply have to innovate, or die.

Thinking like a customer
What sets SaaS ERP software vendors such as Workday, NetSuite, and Cornerstone OnDemand apart from traditional software vendors such as SAP and Oracle is that these cloud-based vendors have a rapid development approach and produce major releases and new feature enhancements at a faster cadence.

Each of these companies is capable of scaling quickly to adapt to the rapidly changing business model shifts by their customers. They are also more elastic in their pricing structures and resource allocation models, which enables them to keep subscription revenue models growing.

Unique expense problem
However, peeling back the hype about cloud ERP, it becomes evident that SaaS companies face unique problems that are quite alien to their more traditional brethren. SaaS companies must spend heavily to not only grow their customer bases, but also to minimize customer churn.

Traditional software companies such as Oracle and SAP sell perpetual licenses for their software, and upgrades later. Customers typically pay for licenses up front, along with smaller, recurring fees for maintenance (usually 15%-20% of the license fee).

SaaS companies, however, are not so lucky. Instead of selling a license fee and receiving a huge up-front payment, customers use their own software on an ongoing basis and pay gradually as use increases. These companies must spend large amounts of money on customer acquisition costs, yet revenue comes in gradually over long periods of time. This leads to a misalignment of revenue and expenses.

To keep afloat, young SaaS companies, therefore, must constantly innovate, and also sign up as many customers as possible, or risk going under. Once customers are acquired, companies must also spend heavily on marketing to reduce customer churn.

This trend pervades the entire SaaS industry and is responsible for losses incurred by most young SaaS companies.

Source: YCharts

The good news, however, is that as these businesses mature, they will eventually reach a point where revenue from ongoing operations exceeds both new customer acquisition costs and marketing expenses. Once there, these companies can harvest incoming cash flow as profit.

The stocks of most SaaS companies trade at stratospheric valuations. Workday is, undoubtedly, the fastest-growing SaaS company, and its valuation reflects this.

Source: YCharts

NetSuite, however, has its own unique attractions. Several Microsoft Dynamics partners, such as Descartes Systems Group, are shifting resources to NetSuite. Microsoft does not currently deliver seamless financial/commerce/CRM solutions in the cloud, which NetSuite does.

NetSuite's goal is to break the $1-billion-revenue-per-year mark within three years. Its shares are also much cheaper than Workday's, on a price-to-sales basis.

Foolish takeaway
ERP customers are increasingly becoming impatient and are turning to companies that can deliver faster product turnarounds, such as Workday and NetSuite.

The rapid growth in some ERP segments is being driven by companies that view these cloud-based ERP systems as more agile and responsive to their needs. That's why these SaaS movers are growing much faster than their traditional counterparts.