During 2011 the semiconductor and high tech industries witnessed natural disasters in Japan and Thailand cripple their supply chain, starting with the disruption to supplies of parts, to the subsequent shutdown of contract assembly and test facilities.  Consequently, risk management of future natural disasters and strategies to better plan for future supply disruptions have been the subject of much discussion among industry and business thought leaders. 

Two of the key lessons learned include:

1) The criticality of implementing a geographical, multi-sourcing strategy.  While reliance on a same region subcontractor based on ease of maintenance or volume favored pricing may provide convenience, the reality of disruptions due to natural disaster warrants the assessment of alternate sourcing locations.

2) The importance of diving deep in Tier 2, 3 or 4 suppliers' sourcing relationships, confirming that they also  diversify their suppliers' geography. Otherwise, supply disruptions caused by natural disasters occurring thousands of miles away from your lower tier vendor's location may unexpectedly whipsaw product availability or suspend subcontractor services altogether.

A parallel may be drawn here to the process of qualifying of cloud computing providers. Many Software-as-a-Service (SaaS) companies maintain relationships with single location or same region data centers to host their customers' data. Take, for example, an ERP SaaS company which maintains data centers located throughout California.  In the event of a catastrophic earthquake serious disruption of services to its customers may be inevitable. Regardless of the number of data center locations utilized and possible safeguards, the fact remains that dependence on a single geographic region greatly increases risk.

Be it a semiconductor company or SaaS provider, black swan events such as those from mother nature may be greatly minimized through a multi-geographic sourcing strategy.  And, like companies who depend on the semiconductor supply chain, companies who depend on SaaS providers would do well to include some inquiry into their data center sourcing strategies as part of a thorough due diligence process.

We’ve recently posted a great new customer case study to the Tensoft website that beautifully illustrates the benefits of cloud deployment. Focusing on our customer, Syndiant, the four-page case study describes how this technology industry start-up has been able to leverage Tensoft’s industry-specific solutions in the cloud to quickly gain better visibility, control, and efficiency.  .

 Syndiant’s V.P. of Operations, Tupper Patnode, provided much of the commentary in the document, discussing in detail how Tensoft FSM and Microsoft Dynamics GP, running on a cloud platform provided by Tensoft partner SaaSplaza, enabled the company to comfortably plan and scale their growth from a $1 million company to $20 and up to a $60 million enterprise. Take a look at the Syndiant case study and tell us what you think by responding to this blog.

And, if you’re planning to attend Microsoft Dynamics Convergence in Atlanta on April 10-13, discuss the particulars of the Syndiant project or your own future project with our own Michael Chadwick and Sonam Thandi in the SaaSplaza booth #1316. They will only be at the booth part of the time, so contact me ASAP if you’d like to arrange a time to meet.

See you in the Cloud!

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the fifth of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Stand-Alone Value - Delivered and Undelivered Items (Part 2)

To elaborate on whether we have stand-alone value on the undelivered element, we generally sell our hosted services on a stand-alone basis. There is no requirement for the customer to purchase professional services. However, we do have one service offering in which consulting is always sold along with the hosted services as a bundled package. Each element (hosted and consulting) is itemized and assigned a value in the contract. Similar to example 4 in the webcast, my conclusion would be that we do not have stand-alone value for these specific service contracts and therefore must account for the entire arrangement as a single unit of accounting and recognize the revenue ratably over the hosted service term.

Where the guidance gets a little fuzzy for me is with respect to the revenue allocation when there is no stand-alone value for any of the elements in an arrangement. For these scenarios, is it still appropriate to allocate revenue between hosted revenue and consulting revenue on the basis of their relative selling price versus prices stated in the contract? Revenue recognition in total is the same but the classification would be different.

Response

1) If the consulting services are sold separately on a standard hourly or daily basis, then you may be able to establish stand-alone value. If you have adopted EITF 08-1, you would estimate the selling price, assuming that the consulting had a separate value to the customer, independent of the hosted services.

2) If there is separate value to the customer independent of the other elements, the accounting depends on your method. 

If you are under the current accounting of EITF 00-21, without VSOE you would take all the revenue ratably.

If you have adopted EITF 08-1, you would estimate the value of each separate element and use the relative selling price method.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the fourth of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Stand-Alone Value - Delivered and Undelivered Items

I attended the webcast yesterday on revenue recognition for SaaS. The presentation helped my understanding of the new guidelines for multiple-element arrangements. I do have a question I’m hoping you can clarify for me regarding the stand-alone value criteria. Only the “delivered item” needs to have stand-alone value; the “undelivered item” does not need to have stand-alone value. Is this correct? So as illustrated in example 3, training courses and consulting packages sold with a hosted services contract are still considered to be the delivered items even if they are not actually delivered up-front but rather at some point later in the hosted services term.

A simplified common multiple-element arrangement at my company is: 12 months of hosted services, training course, non-implementation hourly consulting.

Since we frequently sell both training and consulting services separately, we have met the stand-alone value criteria. We also do not have a general right of return. Therefore, in the above scenario, once we have allocated based on their relative selling price, we can appropriately recognize the hosted services ratably over 12 months and recognize the training when complete (i.e., month 2) and recognize the consulting as performed (i.e., 50% delivered in month 3, 25% in month 4 and 25% in month 6). Am I interpreting and applying the guidance correctly?

Response

There are two issues with "stand alone value" – determining whether elements can be separated and determining the value of each separate element.

First Separation - in order to separate elements of an arrangement, each element must have stand-alone value. That means each element must provide value that is independent of the other elements. An example of an element that does not have stand-alone value is set up fees. The customer only receives value from them in conjunction with the monthly use of the service. If the elements of an arrangement have stand-alone value, then we can proceed to the next step and allocate value to each element.

Second Allocation - we can allocate the value to each element in several ways. 

For software companies and companies that have not adopted EITF 08-1, the value is determined by allocating the VSOE (Vendor-Specific Objective Evidence) to the undelivered elements and allocating the residual value to the delivered elements. 

If a company has adopted EITF 08-1 or for all calendar year-end companies after January 1, 2011, we allocate using either VSOE, TPE (Third Party Evidence) or BESP (Best Estimated Selling Price).

Regarding your specific question, it is hard for me to understand how a multiple element arrangement would have a delivered item with stand-alone value and an undelivered element without stand-alone value. If that were the case, it would seem we would only have one element to account for: the bundle.

In a transaction with monthly hosted services, training and non-implementation consulting, it would seem that there are three elements with stand-alone value. Each element would need to be allocated a portion of the total fee which may or may not be the invoice amount depending on the facts and the revenue recognition method (Residual or Relative Selling Price). If the training and consulting are frequently sold separately, those separate sales could be used to establish their value. Since the monthly services are undelivered, under the residual method we would need VSOE for these. This could be established with a renewal rate. Under the Relative Selling Price method, we would need to estimate the value of the monthly services and then allocate the total fee to each element using the relative percentage of the total fee.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the third of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Monthly User Fees

Have you come across monthly service fees based on a per-user/per-month price, but with a minimum monthly commitment which the customer has to pay?  I was wondering when the actual monthly usage is less than the minimum monthly amount and whether the difference should be deferred and recognized once the minimum is being reported, because the earnings process is only complete up to actual usage.  In a simple example – price per user per month: $1.00 and minimum monthly commitment: $10,000, which the customer must pay.  If in month 1 the customer only reports $7,500 (7,500 users) should we recognize the $10,000 or only $7,500?  In this example, the minimum monthly commitment is non-cancellable and non-refundable.

Response

The answer to your situation could depend on the contract language. 

If the contract specifies that if the minimum is not reached there is no recovery in future periods of the difference, then it would probably be appropriate to recognize the minimum each month. There would be no carry over or credit in following months when the minimum was exceeded.

If the contract allows credits or carryovers to future or prior periods for less than minimum usage, then the lower amount based on actual usage should be recognized.

^* Click here to view this on-demand webcast in its entirety.

Question - Best Estimated Selling Price

How are you seeing the “Best Estimate Selling  Price” (BESP) working in practice, especially where there’s no pricing history and management doesn’t establish firm pricing methodologies? Should we just bundle everything together (set-up, monthly service, etc.) and recognize over the longer of contract or expected customer life?

Response

BESP is required. If there are multiple elements that are separable, then the company must come up with estimated selling prices using the best available information and analysis. 

The elements have to meet the separation criteria in order to have BESP applied. SaaS arrangements often do not have separable elements because the elements do not have stand-alone value. An example is setup fees.

There seem to be a few approaches that are being used consistently for elements that can be separated. 

In companies with significant hardware costs and low volume, high-dollar products are often approaching BESP using a gross margin approach. This approach takes the cost of each element of a transaction and adds the expected or average gross margin to arrive at the estimated selling price. The gross margin is often at a division or product family level. Some companies with fewer product offerings might use a company-wide gross margin.

Other companies are using a discount from list price approach. This works when the company has a consistent pricing approach and a discount range by product or product family that has some consistency. Companies look at the average discount and then apply that to list price for each product to arrive at the BESP.

Some companies are using what I call a "VSOE Light." PwC calls this the “broken” or “failed” VSOE approach. These companies apply the same analysis as a VSOE study but allow greater variances in the covered population and the plus or minus percentage. For example, if the pricing of a product is consistent for say 60% of the population with a 20% plus or minus variance, that might be a good indicator of a Best Estimated Selling Price. This would compare to the normal VSOE analysis of 80-85% of the population covered with a 10-15% variance.

Obviously, there are complexities to these approaches and often there are “devils in the details.” Companies should work with consultants and their auditors to develop a reasonable approach.

^* Click here to view this on-demand webcast in its entirety.

On May 25^th, Tensoft hosted a webcast^* with Silicon Valley software revenue recognition expert Jeffrey Werner entitled: Revenue Recognition Accounting for Software as a Service (SaaS). This is the first of five blog entries detailing Werner’s responses to audience questions posed after the live webcast.

Question - Upfront Fees

What is your definition of an upfront fee? If a customer requires additional professional services to customize the SaaS but could actually use the SaaS based on the standard setup, is that defined as “setup fees” or “professional services?” The revenue treatment would be different if VSOE exists on the SaaS. If the services were deemed to be professional services, the revenue could be recognized as delivered. If they were deemed to be setup fees, revenue would be recognized ratably.

Response

Additional professional services that were not required to use the service but instead to enhance it for a specific customer could be considered an independent element.

The facts of the situation would determine this. For example, if the professional services were contracted for separately – several months after the service started and the initial contract was signed – then they would probably be accounted for as a separate element and recognized as provided.

If the professional services were an element of the original agreement, you would need to consider whether they were truly optional. If they are considered optional, you would move to separation and allocation to determine whether they have independent value and thus could be recognized separately. If not, they would be ratable with SaaS revenue.

The thing to remember is whether they are truly separate elements or just a way of pricing. In a true upfront fee, there is no option, and the cost is truly part of the cost-of-use. 

You might want to discuss this with your auditors to understand where they draw the line on being independent or having a relationship to the expected customer relationship period.

^* Click here to view this on-demand webcast in its entirety.

I'm here in Atlanta, GA for Microsoft Convergence, the 14th annual user conference for Microsoft Dynamics business applications, along with over 8,000 attendees.

Yesterday, Microsoft announced the general availability of the Dynamics GP 2010 (version 11.0) ERP software solution.  The opening keynote address was delivered by Stephen Elop, President of the Microsoft Business Division. The spotlight was the agile interconnectivity of Microsoft Dynamics GP 2010 simultaneously working with both on-premise and on-demand systems including Customer Relationship Management SaaS software, instant messaging, video conferencing, word processing, spreadsheet and email programs. Some of this was pretty interesting, so you may want to take a look at this live demo: http://www.microsoft.com/presspass/presskits/dynamics/videogallery.aspx. 

Dynamics GP 2010 enhancements include:

• Tighter integration with other Microsoft business solutions and cloud computing technologies
• 100+ new dashboard indicators / KPI's
• 400 Excel and SQL Reporting Services (SRS) web based reports
• Simplified and enhanced workflow automation
• Web based ERP enhancements

Interesting Microsoft facts shared during the keynote on their cloud strategy including the Windows Azure platform:

• 20 million customers now using Microsoft cloud computing applications
• 70% of programmers focused on developing applications for the cloud
• Spending $9.5 billion on R&D in 2010

Simply put, it appears that Microsoft is "all in" as it relates to cloud and software-as-a-service technology.

- Mike Chadwick, Director of Sales, Tensoft