deal architect

Auditor Independence and ERP/CRM projects - a conversation with Francine McKenna

Francine McKenna is a prolific commentator on the accounting, audit, and corporate governance issues affecting public and pre-IPO private companies. Since 2006, McKenna has been an investigative reporter and feature writer for publications including Dow Jones MarketWatch, Forbes, American Banker, Financial Times, Chicago Booth Review, Accounting Today, and Boston Review. At MarketWatch she monitored and reported on public company accounting, fraud and financial investigations, and the often questionable financial reporting practices of pre-IPO companies. McKenna spent more than 20 years in public accounting and consulting, including for KPMG/BearingPoint in the U.S. and Latin America, and at PwC. She is also an adjunct professor of international business in the MBA program at American University’s Kogod School of Business. She speaks often at universities, conferences and other forums. You may also know her from her blog, reTheAuditors.com. She also writes an online newsletter, The Dig.

I had a chance to talk to her a bit about the history of auditor independence issues and some of the risks of using accounting firms as implementation partners on ERP and other enterprise software projects. In part 2 tomorrow we will talk about differences in automation in the audit and consulting practices of such firms.

Francine, I read your story about the SEC’s recent auditor independence enforcement against PwC and thought, "What are some of the risks that companies that use accounting firms may be exposing themselves to on their consulting projects?" Talk in terms of something around an ordinary business executive, not necessarily a CPA would be able to relate to.

The rise in ERPs and the large software vendors like SAP and Oracle mirrors the rise of the Big Four public accounting firms involvement in consulting, especially systems implementation, design and implementation consulting. When you think about when Enron happened and when Arthur Andersen collapsed, if you go back to the late nineties, you had the emergence of ERP software. They started to work with systems implementers like the Big Five auditors including Arthur Andersen and other systems integrators.

Then, unfortunately, you had Enron's bankruptcy and the collapse of Arthur Andersen. There was a push already to look at how the rest of the Big Four public accounting firms were addressing or working with issues around doing both audit and consulting, in particular systems design and implementation consulting, for the same client. The firms were already under pressure.

A lot of people think that three of the four Big Four firms sold off their consulting arms because of Enron but, actually, the pressure was on them before that. They were already being criticized for potentially compromising the integrity, objectivity of audit work because of their disproportionate focus on consulting and consulting revenues from the same clients.

When Enron occurred, there were already, I think, at least two of the four had already sold their consulting arms. EY sold to Capgemini, KPMG spun off BearingPoint, and PwC eventually sold their consulting arm to IBM. Deloitte, uniquely, never sold. It's not that they weren't planning on doing it but they actually just never got to it. I think I've written more than once that they never ended up doing it because, once the other three sold their consulting arms and Deloitte saw that even though they hadn't, no one was coming after them. There was no significant enforcement of new auditor independence rules enacted as part of the Sarbanes-Oxley Act of 2002. There were no new enforcement actions at least in terms of significant scrutiny over whether they were doing consulting, systems integration, and design implementation work in their audit clients. The actions the SEC did take related to actions prior to 2002 that were egregious violations of exiting rules.

The SEC and the new audit regulator, the PCAOB, never really aggressively implemented or enforced the new rules that were put in place to try to prevent that kind of combo audit and consulting work that was blamed for Arthur Andersen’s mistakes with Enron.

Deloitte, I think, just decided, "Hey, let's hold onto it and keep going." They ended up being able to build on that base and now pretty much dominate the consulting business in the Big Four, although PwC is a pretty close second.

When I think about the conflicts of interest inherent in being a public accounting firm, Accenture got out of that issue a long time ago. When the consulting arm of Arthur Andersen split off and became Accenture, they eliminated that worry. Accenture can do any projects for anybody they want. Certainly, Accenture can have conflicts of interest like any other professional service firm, but they eliminated the inherent conflict of interest that a public accounting firm has when you're an auditor for a large public company.  In that case you're restricted, in particular now, post the Sarbanes-Oxley Act of 2002, from doing audits and financial reporting-related systems design and implementation at an audit client. Sarbanes-Oxley is the law that came into effect in reaction to the conflicting priorities issues that people thought had occurred at Enron, WorldCom, HealthSouth, and some of the other corporate frauds that occurred during that period.

The SOX auditor independence rules prohibit an auditor from doing systems design and implementation work at an audit client. It's strictly prohibited. What's happened is that those services, that software, that activity, which are the kinds of things companies want from big consulting firms has grown, changed, and developed. Now we have lots of different modules for all of the different large ERP systems and many of them can arguably not be tied directly to financial reporting, the direct financial reporting and financial statement preparation, which is where the prohibition comes into play. In other words, the auditors are not supposed to be designing and implementing software, implementing the controls, the internal controls and the configuration, developing the training and the user instruction associated with how you use those systems if they're going to go back, turn around, and go back and supposedly independently audit the company's use of those systems.

What happened after the financial meltdown? Did that have any effect on the accounting firms? Was there any scrutiny after that?

Yeah, absolutely. Actually, the financial crisis was a boon for them. Let's go back a little bit. One of the big reasons why Deloitte and PwC dominate in this arena as opposed to KPMG and Ernst & Young is that BearingPoint, the KPMG consulting firm that spun off and went public, ended up going bankrupt in February 2009. PwC and Deloitte split that carcass. Deloitte bought the federal services portion, so all of the big public sector clients of KPMG consulting, which became BearingPoint, and PwC took all the commercial clients. Those two firms got a really big head start in the midst of the crisis, which was approximately right after PwC’s non-compete clause with IBM expired.

The crisis deepened. The crisis root cause analysis really didn't focus on the accounting firms.  The perception was the financial crisis was about this cataclysmic economic event that no one could control, it wasn't perceived initially as a sort of broad kind of a corporate fraud-related crisis. It wasn't the auditor's fault, in other words, at least at first.

Later, when it became apparent that there had been a lot of fraud related to subprime mortgage origination and securitization, mortgage and foreclosure processing, mortgage servicing, how people who went through or were threatened with foreclosure and were charged multiple fees, in error in many cases, then that sparked or was a catalyst for a whole new area of consulting called GRC, Governance Risk & Compliance. Many of the biggest banks and many other financial firms ended up on the wrong side of regulators in terms of how they had addressed those issues. In order to get out of civil and criminal liability for those issues, they signed settlements and consent decrees that said they were going to go back and fix those problems. They were going to calculate what the damage was to consumers and find a way to repay consumers for that damage.

This Big Four firms stepped into that arena in a huge way, in particular in a process called the foreclosure reviews that were ordered by the Fed and the Office of the Controller of the Currency. Three of the Big Four firms participated in the process in addition to Promontory, which was an independent consulting firm and now is part of IBM, and a couple of other smaller firms.

They did these humongous projects at the banks, which were essentially sort of hybrid audits. They went in looked at systems, looked at compliance with agreements and they tried to develop and extrapolate calculations of damages to consumers from having been inappropriately foreclosed on or inappropriately charged fees or other kinds of penalties related to mortgage servicing and processing.

Deloitte made out big, but PwC was the biggest winner in that arena. For everybody that PwC or Deloitte or EY didn't audit, they could do that foreclosure review. Deloitte, however, did a big project at JP Morgan that focused on mortgages at Bear Stearns and Washington Mutual that JP Morgan bought in a forced acquisition, essentially a bailout of those firms. Deloitte had been the auditor of Bear Stearns and Washington Mutual. PwC and Promontory did almost everyone else. Ernst & Young did a few small ones.

The only one who didn't really do much on that was KPMG. That created an enormous opportunity to do that kind of work in many other realms later. Any time a company is charged with some kind of a regulatory issue, whether it's anti-money laundering or something, like in the banks, related to their processing of some kind of consumer loans or something like the subprime loans, you have an opportunity for someone to be appointed as a monitor or as some kind of a consultant after the fact to help that organization correct the issues, often systems related issues.  The Big 4 consultant or monitor then also does the work to calculate the number used to repay customers for the damages that occurred from the violation.

The firms have cleaned up on GRC. And it’s a whole new area of software that Oracle and SAP have incorporated into the ERP systems that’s required by regulators.  The Big 4, especially Deloitte and PwC, now partner with Oracle and SAP to implement the software on behalf of clients.

What I'm seeing is that a lot hasn't changed since the time when I actually was last working in a Big 4 firm. The last firm I worked for was PwC in 2005 and 2006. At that point, I was part of an internal team looking at how well PwC was responding to the new rules under Sarbanes-Oxley, things like auditor independence and making sure that they were prepared to respond to inspections of audits under the new independent regulator the PCAOB, established by Sarbanes-Oxley.

There were things that I was concerned about then, things I looked at and said, "Hmm. You know, I don't think that some of the people in the firm understand that they can't do these things anymore." The ability of the large global public accounting firms to control partners, to monitor partners' activities, and to actually have good governance to make sure that there's a structure that identifies and addresses when somebody wants to go rogue or do something that is against the rules is always, always a challenge. The bigger they grow, the harder it is, especially because they're global firms.

Tell us your opinion about the recent SEC enforcement action against PwC

I looked at the recent SEC enforcement action against PwC that covered almost a five-year period from 2013 to 2016 and it said there was one person responsible for implementing governance risk and compliance systems from Oracle in multiple audit clients. PwC, as a firm was charged with violating the auditor independence rules in 15 different clients 19 different times during that short period and seemingly attributable to one partner. The SEC said one partner was the cause of these violations.

That one partner was a hybrid IT audit partner, who participated in the audits with as a specialist, with expertise around IT general controls and other IT controls. He was also a partner who was responsible for identifying opportunities for advisory or consulting projects related to Oracle ERP products.

That sort of hybridization of partners, with a dual incentive structure, is inevitably going to lead to potential conflicts and will present a constant challenge to try to interpret the rules, and for somebody to actually be willing to say, "No, you can't do that." When you say, "No, you can't do that," you're forcing the partner to turn down revenue. I saw that that was going to be a challenge for some partners to comply back in 2006, and it seems like PwC has not implemented any better rules or governance structures in all this time. PwC had one partner running around doing this over and over and over again and obviously without any real, effective constraints.

Given that, now talk about two audiences - the clients and the software vendors. When a company is implementing packaged software, it could be ERP, CRM, whatever. They look at consulting firms and they end up hiring a Deloitte or a PwC, an accounting firm. Are they exposing themselves to some risks?

They're exposing themselves to multiple risks, and not just the risk that a regulator is going to decide to crack down on this and they're going to be left without a consultant or having to change consultants suddenly, mid-project. When the rules were implemented in 2002, we saw companies come down into two different camps, and they're kind of distinct. One is the company that loves, loves, loves their auditor, that's been with them for 99 years and has built their whole professional services relationship around that firm. Usually, it's obviously one of the Big Four and if it's one of the Big Two, PwC or Deloitte, it’s a special problem because of their ubiquity in consulting.

Companies still get full service from that firm. They look for every opportunity to use that firm whenever possible. They know that there are some things that are prohibited. But if the firm and someone else within the company, in their board of directors audit committee, can find a rationalization or can find a way to interpret the rules such that that audit firm can do the work, that company will always choose the audit firm to do the work.

On the other hand, you have companies that only tolerate low risk. They're very much oriented around following the rules and not buying anything beyond the audit. It's so obvious, it's so stark, the comparison between the two kinds of public companies.

These companies have very, very, very strict rules that the audit firm can do nothing but the plain vanilla audit. But then those companies are faced with, whenever they want to do something else, any kind of systems implementation, any kind of upgrade to an existing system, any kind of evaluation of internal controls, any kind of enhancement of any kind of operational system, they put out a tender, entertaining bids and reviewing RFP responses, doing the whole vendor demo thing, and being forced to select from another firm. Then obviously, they have to work with another large firm on something financial or accounting related, negotiate another big professional services contract and vendor relationship and manage all the complexity that entails.

They've signed up for the fact that they're going to have to manage multiple, significant professional services vendor relationships and they do that because they want to keep everything nice and clean and legal. They don't want any trouble with the SEC, and maybe they don't want to let any one vendor get too much power over them. There are advantages and disadvantages to both approaches.

In the Big 4 firms, obviously, individual partners are rewarded for getting what we used to say way back in the '90s at KPMG, “A bigger portion of the client wallet.” That's not changed. Even though it might be frowned upon for the audit partner or anybody else to get a bigger piece of the client wallet for the firm by selling more consulting or tax work, in the end, the Big 4 firms have become these very large organizations with gray lines between the various practices.

From a customer's perspective, though, there's no legal risk. The risk is what?

There is somewhat of a legal risk. For example, if the audit committee and the company executives are not aware of the auditor independence rules, do not fully evaluate those rules when contemplating opportunities for the vendor to do certain kinds of work, and they choose the auditor despite the fact that that work will violate the auditor independence rules, the SEC can sanction the company or sanction its officers or its audit committee. That happens rarely – rarely, rarely.

In the case that I wrote about with PwC, what happened was it all came down on PwC and on that partner in particular. They didn't even name the names of the companies that were subject to these 15 engagements and 19 different instances. They don't want to embarrass the companies because they want to make the assumption that it's the auditor's responsibility to fully inform the client and, in particular, as cited in the PwC case, if the auditor or the audit partner fudge the information in the scope of services, in the engagement letters in order to kind of get in under the wire or fool somebody, then the SEC really holds the auditor and the audit firm responsible.

What happens then? You have to look at the company, you have to look at its audit committee, and you have to look at sort of the company executive who is the purchasing executive or the one that's responsible for hiring, evaluating the vendor, and say, "How could they not know? They know what they want to have done and they are allowing for a contract or scope of services to not accurately state the work that's going to be done." What's going to happen then if there's a dispute?

In order to get in under the wire and be able to use the auditor as a vendor, the SEC enforcement action against PwC implied that there were executives at some of these companies that knew very well that they were fudging the information in the contracts, scope of services, and invoicing. That presents a very significant risk to the company if they do that and then there's a dispute.

Certainly, if the SEC wanted to come back to the company or come back to the audit committee, they could if they thought that there was some kind of collusion in order to create an opportunity, let's say, for a particular official to get some kind of kickback or if there was some other kind of illegality involved. You could have a situation where an official of a company or of a board of directors allowed for this kind of a situation to occur in return for some kind of an illegal payment.

How about software vendors? Do they have any liability given these situations? You look at Salesforce or Infor or whoever has these as partners. Do they have any risks?

As you know, most often when these types of big projects occur, the Big Four firm, the consulting firm, whether it's Accenture or whether it's one of the public accounting firms, they take the lead as the prime contractor. They might have subcontractors and the software vendor is the subcontractor. To that extent, they may be sort of "see no evil; hear no evil" in that situation. It may be that, as a subcontractor, they're doing their part and they're not responsible for the other piece.

What was stated in this SEC enforcement action against PwC is that there was an ongoing relationship between this PwC partner and the Oracle rep. There was probably an ongoing multiple engagement relationship and the vendor provides all kinds of other monetary and nonmonetary benefits to PwC as a strategic partner, an implementation partner, and also to this specific partner potentially on a personal and a professional level. In the end, the SEC said the partner actually provided nonpublic material, nonpublic information to the software vendor about at least one client.

That's public knowledge?

Yes, that's in the SEC enforcement action. I'm assuming that if this partner felt compelled to provide nonpublic material, nonpublic financial information to the software vendor, it was probably so that that software vendor could evaluate pricing or creditworthiness of particular clients. That to me is not very kosher.

What other risks does a software vendor have when they evaluate an accounting firm as a partner?

Well, certainly, if the accounting firm is fudging the information in the scope of services or in the contract in order to get it under the auditor independence wire and they're a subcontractor, if for some reason someone in the company or someone at a regulator determines that that's not allowed, prohibited, and tells them they have to stop the project, well, the software vendor is going to have a break in the project. They're going to have a delay. They might have the contract canceled and have to start all over again with a different integrator or, potentially, have some kind of a breach of contract with regard to the software licensing because the whole contract is canceled if the system integrator has breached some kind of terms.

That's hypothetical, right?

Right.

You don't know of any that have gone to that extent.

Well, in the case of one of the clients cited in the SEC enforcement action, PwC bid on two different projects at one client. I identified that client as Logitech. In that case, PwC had to resign as the auditor because of these independence issues.

Now, in some sense, that might actually be a blessing in disguise because, once you resign as auditor, then you're free to do the consulting work. But the question is, did that cause a stoppage of the project or were the projects delayed because these issues are being fleshed through and potentially there's a lot of back and forth and issues around whether or not the contract is going to go forward or whether or not the contract is going to be completed.

What else should buyers of consulting projects, implementation projects be aware of when they look at accounting firms?

Well, I think the biggest lesson from the PwC enforcement action was that audit committees either are still not aware of these prohibitions against the auditors doing certain kinds of work or they're willfully kind of trying to deflect the understanding or appreciation for those rules to other people. In other words, executives and board members, including audit committee members, claim plausible deniability or delegate the responsibility for evaluating auditor independence.  Sometimes they delegate it to the auditor itself.

When you ask the audit firm itself to evaluate whether it's independent in providing services, you're basically giving the fox access to the henhouse. The vendor is not the one who is supposed to be evaluating whether or not providing those services presents an auditor independence risk to the company.

I would say the biggest lesson was that audit committees, in particular, and executives who are hiring the firms for these types of projects really need to get better acquainted and take more seriously these prohibitions. They are on the books. Whether or not the SEC or the audit regulator, the PCAOB enforce them at any point in time doesn't mean that they can't come back later and doesn't mean that a sudden spike in enforcement action or scrutiny is not going to disrupt the project for the company as a whole and cause a lot of money and a lot of delays on perhaps a mission-critical project.

I'm sure some people will say, “She is a little too alarmist.” I think it's healthy – it's important to look at a segment of the market from different eyes.

Tomorrow, we will talk about how the audit and consulting arms of the accounting firms have evolved differently when it comes to automation.

The "fog" of enterprise software

So many data points cannot be wrong, can they? Larry Ellison talks about SAP's customers moving away during the Oracle earnings call. IFS runs a billboard ad suggesting the same. I get whispers from several other competitors suggesting SAP is in trouble. I see countless retweets of an article which says the new SAP leadership faces big challenges in 2020. I hear many analysts talk about the activist investor, Elliott. So many of the executives I had in my book SAP Nation 3.0 released just a few months ago are no longer there.

Except that when I talk to SAP customers I hear concerns - but very different ones. Those around integration across SAP products. Those around SI and other costs when they consider migrating to S/4HANA. How they have a tough time developing an ROI for S/4. How few are considering the public cloud route to S/4. But I don't hear of them migrating to a different vendor. Five years ago, in volume 1 of SAP Nation, I showcased customers who were ring fencing SAP with other solutions, moving to two -tier ERP, to third party maintenance. When I wrote volume 3 that trend had slowed down and if anything, SAP had reversed some of those defections.

What to believe?

I watch Dreamforce and have to wonder if I am watching a stream of the Democratic National Convention. So many caucuses talking about ethnic, ethical and equality issues. Protests in and around Moscone. I read CEO Marc Benioff's new book, Trailblazer and I see he invokes Steve Jobs and the launch of Apple's App Store. He forgets to mention his AppExchange was born before and still does not have even 10%  of the App Store revenue. I am glad I also got to see sessions which go into Salesforce's efforts in various verticals. To me, they should have been Day 1, center stage.

What to believe where the company's priorities are?

I listen to Microsoft pitches on their retail vertical and parse Satya Nadella's keynote at NRF, the annual retail show. Lots of good capabilities, particularly in the CRM and infrastructure area but I notice there is very little on supply chain and logistics. The hottest topics in retail these days, many driven by Amazon, are around last mile coverage, robotic warehouses and reverse logistics.

What to believe about the company's vertical strategy?

In the last few months I have written blog posts detailing most of these points. But those are individual notes in an orchestra. In 2007, I wrote a post which talked about the "thousand points of influence". Now, there are x times more - many often rumor and conjecture based. It forces you to keep going back to your True North. To me, my "fog lights" are conversations with customers and distilling their technology strategies and investment trajectories. Then use that as a guide to measure vendors on their functionality, their architecture, their economics and their ecosystems. Because customers make really long term decisions when it comes to their enterprise software.    

Interestingly, in the auto world, fog lights are gradually disappearing as a standard feature. In a world of LIDAR and automatic braking, that trend will continue. In the enterprise software world we need to develop similar capabilities to navigate our fog. Till we do, drive carefully, and pray that others on the road also behave responsibly.

Innovation Season

My innovation blog, New Florence will celebrate its 15th birthday this March. It will have clocked over 6,500 posts. I recently looked at various patterns on that blog. Innovation stories and news ebb and flow from different industries and geographies. One particular search tried to identify the most active phase of the year I get to curate from. I would have sworn it would have been the enterprise conference season when I attend a number of events.

I was wrong - it was actually a "quarter" from the end of November through early March. Here's some of what shows up on a regular basis, year after year.

Holiday festivities

Thanksgiving, Christmas, New Year's and the Chinese New Year always allow opportunities to highlight spectacular decorations, fireworks and meals. Black Friday, holiday deliveries and returns allow for showcasing advances in ecommerce, same day delivery and reverse logistics.

Winter travel

The growing global passenger traffic and weather challenges always allow for showcasing how airports, airlines, traffic control and meteorologists are perfecting their craft.

Industry events

Plenty of innovation is showcased at CES, NRF (Retail) and HIMSS (Healthcare) events. In the past, the Detroit Auto Show in January would also provide fodder.

Sporting/entertainment events

The NFL SuperBowl commercials lineup usually brings out the best from Madison Avenue. The game itself allows for reviewing stadium, on-field and broadcasting technologies. Daytona 500 showcases auto and broadcast innovations. The Oscars usually allow for a review of how STEM is helping Hollywood innovate.  Fashion weeks in Paris, Milan and elsewhere, the Westminster Kennel Dog show in New York often provide other ideas. Every four years, the Winter Olympics provide inspiration.

End of year

There are usually plenty of "best of year" and "forecast for next year" stories to select from.

Other inspirations

The US President's State of the Union address, Bill and Melinda Gates annual foundation letter, Warren Buffett's annual Berkshire letter, and the WEF annual meeting in Davos, Switzerland usually have nuggets of progress in healthcare, government and elsewhere.

It's not to say the rest of the year does not provide innovation inspiration - I average a post a day, come rain or shine, but for this "quarter" from late November through early March, I could easily have 4-5 posts a day.

I will share thoughts on other patterns I noticed across the 6,500 posts over the course of the next few months.

Ad Maiora Natus Sum: We are born to aim for greater things

Happy New Year! Welcome back! Hope you had a relaxing break. I had plenty of time to reflect on the last decade. And to introspect on what we should do in the coming decade. Let me share with readers some of my reflection, starting with the title of this post.

I am not Catholic, but did study at a school managed by the Salesians of Don Bosco. My wife was born Catholic, but in our travels she seeks out Buddhist and Hindu temples.  She does like to go to cathedrals which offer masses in Latin, which remind her of her childhood in Ireland. As a result, I am exposed to more Latin words than you would think. Recently, I saw the expression Ad Maiora Natus Sum - and I recognized that as the motto of my school. And I had a bit of a flashback. Without consciously recognizing it, it hit me that the motto has guided most of my life.  I have gravitated towards topics of innovation, Six Sigma, progress. That is a common theme in most of my books. 6,500 posts on New Florence reflect that. My advice to clients always pushes for continuous improvement using technology.   

So, in all honesty, I am disappointed at the missed opportunities in the last decade in the two big markets I write and advise about. Over a million on-prem customers have not moved to the cloud, even when their on-prem systems have become compliance and security risks and recruiting liabilities. And even staying on-prem, they could be running them much more efficiently and have not explored third party maintenance, cloud infrastructure, multi-tenancy in application management etc.  Cloud functionality barely covers 20% of the grid of applications by geography and industry. SIs and outsourcers lost the data center market, they missed out on contract manufacturing, they have barely automated their own labor intensive operations - see my notes on enterprise software and outsourcing for more details. 

I had to honestly ask - how much blame do analysts deserve for not screaming louder about these missed opportunities? My initial introspection was not tough enough. In fact, I felt proud our research consistently surfaced opportunities years ahead of others. I have written about the contract manufacturing opportunities, new data center architectures, about automation in every sector in several books. I have been screaming about vertical opportunities for so long that my colleagues crack jokes about it. What more could I have done?

I heard someone recently say we have moved to "slash titles" and "portfolio jobs". Deal Architect has been doing that for 15+ years - we have an adviser/analyst/author model. We have been publishing plenty but perhaps we have not been advising enough about how to take advantage of them.

That was one aha from my introspection. Increase the advisory component of our offerings. Help vendors increase their TAM, their competitive intelligence, help customers modernize, get more value from their technology investment.

Do vendors need more advice?  I don't see it as traditional advice, more guidance about white spaces and efficiencies, but many are afraid to seek advice from analysts. Some see that as a sign of weakness. Others are not prepared to evolve business models. Most CRM vendors missed out on the massive digital advertising market that Google, Facebook, now Amazon have grown to dominate. It did not align with their software licensing models.  Many others have the "help me sell what I have" mindset. When I was a young PwC consultant, a partner told me "a good salesperson sells what is in his bag, not keeps asking for more product". I was not sure about that but was too young to argue. Now I know he was wrong. A good salesperson listens to the market and goes back to R&D/product group and asks for changes and additions.

Will customers accept advice? Honestly, many are happy with traditional services we provide, and have too many conflicting priorities to consider new ones. Others prefer to buy advisory services only from larger "brand name" firms. Still others want it packaged in bite size units.

I have told a few colleagues I started my career when building technology was far more common than buying it. Back then, it was not much fun championing the Buy side of the Buy v Build equation. It has been a lot of fun since. I am afraid, however, I may end my career with the market custom building, insourcing much more.

Hey, pendulums swing all the time and I have no intention of retiring any time soon, but I feel loyal to the Buy side and want to keep helping that "team"

We will keep doing and publishing plenty of research which helps us unearth market opportunities early. But we will also add more advisory services - that will mean new partnerships, new packages of services. I expect I will be reaching out to many of you for input.

Happy New Decade! Let's all aim for Ad Maiora.

2020s - Embracing Complexity in Enterprise Tech

I wrote couple of weeks ago about missed opportunities in the 2010s in enterprise software and in outsourcing. That backlog did not disappear - it has created even more opportunity for this decade. However, as I caught up on my reading, podcast listening and keynote watching over the holiday break, I have become even more convinced that enterprise vendors and customers will need to make sure the 2020s are very different. In this post, I will explain how and why. Next week, I will discuss how we at Deal Architect hope to help the industry aim much higher.

A) Inspiration from FritoLay/PepsiCo

I had a chance to listen to Michael Lindsey, SVP, Chief Transformation Officer, and Strategy Officer at FritoLay present at Dreamforce. His portion starts around 29:00 in this video 

Here are some of his comments on how they have "embraced complexity" at Frito and its parent, PepsiCo

"Consumer expectations are just exploding in complexity....it used to be the case that we'd have five or six of our classic billion-dollar brands and that would be 90%-ish of the consumption...Lays, Ruffles, Cheetos, Fritos, Doritos, the ones that everybody knows and loves and it'd be in a relatively small number of flavors. Used to be the classic orange Cheetos. But now, we have flaming hot. Organic Cheetos. White cheddar Cheetos. White cheddar puff Cheetos. White cheddar crunchy Cheetos.

And now we have banana chips...apple chips... seaweed flavored snacks. The world is exploding around us in terms of what consumers want as we get more cross-cultural pollination. That variety introduces just an immense amount of complexity into our system.

One of the things that's unique about FritoLay besides the breadth of our portfolio is how big an end-to-end system we run. We have more trucks and a larger fleet than UPS, than FedEx, and the reason we do that is because we can control the entire process at FritoLay from the seed that's used for the potato to where it's manufactured to the distribution systems to the trucks that deliver to the store. When you go into one of our favorite customers on a Saturday and you see somebody working the shelf, that's a Frito Lay employee who is making that shelf look perfect for us.

Retail is absolutely still our dominant channel. But even within retail our large customers have become omnichannel. It's not that the store will go away, but the way that the customers, their shoppers interact with the store is shifting over time as well where people are pursuing new models, whether it's click and collect models, whether it's order and have it delivered from the store to their home. We have to be able to both supply that from a product supply standpoint to keep it always in stock, always on the shelf with perfect availability. We have to continue to invest and help our retailer customers understand their shoppers and their consumers in-depth in a way that perhaps they can't within our specific category.

Across the world about a billion times per day somebody is eating or drinking one of PepsiCo products. We have an agricultural system that touches 60 countries across the world, so we recognize that we're a big part of the overall food and beverage ecosystem and that we have to do our part to make sure that we can drive sustainability on water, on agriculture, on plastics, etc.

Our new CEO and chairman, Ramon Laguarta, developed this mantra on winning with purpose, which is that we're going to win, but we're going to embed purpose in everything we do all the way down to the way that brand is executed on the shelf to make sure that the packaging, the way that we advertise, the way that we market, the way that we develop our products has purpose and sustainability threaded throughout."

And then was to me his money quote that enterprise vendors need to factor. Too many of them defined their customer needs, their TAM and competitive landscape too narrowly in the last decade:

"(It's our) fundamental cultural idea to embrace complexity. That's one of the challenges, one of the mantras that we've been using internally because, as the world gets more complex, it's natural to then try to work your way through and manage through the complexity, trim out the long tail of SKUs. But if you want to capture every last moment of growth, every potential consumer or shopper out there, you have to just embrace that complexity; accept that the world is going to have a lot more products, a lot more channels, and you have to find a way to use technology and data to manage that and manage that effectively to delight your consumers and your shoppers."

In contrast, I next read a BusinessWeek article about Larry Ellison and Oracle and I was dismayed how "un-complex" they made Oracle applications sound.  "Ellison said doing well in the database market and with financial applications is enough for him. “If we’re successful in those two markets, it should be enough to make a living,” he said during a September call with analysts." I went back and checked the call transcript and Larry actually said "ERP back-office in the cloud, Autonomous Database in the cloud, we're successful in those two markets, should be enough to make a living." So, his scope was a bit more expansive but my reaction was "The Number 2 apps vendor in the world (at the start of 2010 but no longer so at the end of 2020 as it missed out on digital advertising, IoT, various verticals) is content just selling back office apps?"

Not just picking on Oracle. Every vendor played "small ball" in the last decade.

B) Inspiration from Apple

I was re-reading Marc Benioff's new book, 'Trailblazer" (I have a longer review here). He mentions how he played a role in the launch of Apple's AppStore 

"For me, it was exciting and humbling. And Steve (Jobs) had unwittingly given me an incredible opportunity to repay him for the prescient advice he’d given me five years earlier. After the presentation, I pulled him aside and told him we owned the domain and trademark for “App Store” and that we would be happy and honored to sign over the rights to him for free. By 2019, (Salesforce's platform) AppExchange had more than five thousand apps available for purchase, ranging from sales engagement and project management tools to collaboration aids. And nearly 90 percent of Salesforce customers were using them."

Marc rightly deserves credit but he neglects to benchmark his store's revenues against that of Apple's. His store has been in existence longer and by my estimate generated less than $3 billion in revenue in 2019 compared to nearly $40 billion at the Apple store. That means significantly higher royalties for store partners and much more choice for customers. Still, Salesforce has done much better than SAP's many stores - around mobile, HANA, cloud platform etc - and those of other enterprise vendors. The industry needs to embrace complexity to make their platforms and partner programs much more attractive to ISVs.

C) Inspiration from Tesla

While there is a big opportunity to grow bigger ISV communities, in reverse there is a significant opportunity to shrink the SI/outsourcing burden around enterprise apps.

I was fascinated by the visceral, loud reaction to Elon Musk's Tesla Cybertruck concept. As this designer, however, points out "Despite the radical aesthetics, the Tesla Cybertruck is a shining example of function-over-form, and it is perfectly designed."

Can you imagine if SAP similarly looked at function-over-form in its services ecosystem as it tries to migrate its customers from ECC to S/4HANA?

It could make consultant certification much more vigorous, it could push for more automation, shared services and virtual delivery in its services partner. Even better if its service partners did things differently this time. They have implemented millions of ERP projects in the last couple of decades. They have enough data to train machines to automate configurations, to develop conversion and testing routines, to develop training routines differently. They can use multi-tenancy concepts. As an industry we can and should make these projects predictable and much more affordable. Yes doing so will bring complexity, but we need to embrace that complexity.

D) Inspiration from Andreessen Horowitz

I was watching this video from Frank Chen, partner at Andreessen Horowitz look ahead to what life may look like in 2030 - he uses his daughter for scenarios around diet, exercise, virtual work etc. 

Frank may be sticking his neck out projecting a decade ahead but it shows how his fund is thinking.

I was hoping Infor's new management would have similarly showcased scenarios around what the retail store might look like in 2030, or even 2025. Or the hospital emergency room. Or the shop floor. Or last mile delivery. And how they are helping make those scenarios a reality. Verticalization is Infor's path to differentiation - has been for a decade. Of course, it would be much more complex, but in a recent presentation, they barely touched on what it is planning to innovate around industry applications.  

Not just picking on Infor, most vendors have invested in brilliant technical architects but missed out on process visionaries who would have allowed them to think very differently like, for example, Amazon has with its "chaotic storage" warehouses. 

I could go on - so many other opportunities for enterprise tech vendors in terms of new function points, globalization, multi-cloud infrastructure, continuous improvement in delivery and other areas.

It's not just vendors - enterprise customers have to embrace complexity as well. Many are content to stick with legacy apps which are compliance and security risks, and increasingly recruiting liabilities and unlikely to support machine learning and other innovations. They also keep waiting for the elusive single-source, wall to wall solution from a single vendor when they can already re-imagine every business process by integrating a set of modern tools.

And so do us enterprise analysts. Next week, I will describe how we hope to help buyers and vendors do things very differently this decade. To help them become more comfortable embracing complexity, we ourselves have to become so comfortable ourselves. 

A disappointing start to Dreamforce

I wrote last week I am excited about Salesforce's verticals and that I planned to watch many of the industry sessions scheduled at Dreamforce today. However, last year's CEO Marc Benioff's keynote did a really nice job showcasing customer case studies - I shared this post with several other vendors asking them to use as a guide for their own customer stories. So, I was hoping for a redux and set aside a couple of hours to listen to this year's opening keynote - here is a replay.

Marc and his team did profile a couple of customers - State Farm Insurance and Louis Vuitton. However, the focus was more product-centric and rushed. Just did not have, at least for me,  the same impact last year's format did.

Worse, there was a protest which interrupted the session. I have been reading Marc's new book, Trailblazer, and while I admire the positions he has taken on LGBTQ issues, gender pay equality and homelessness among others I have been wondering if that just attracts more causes which clamor for his and the company's attention. I got my answer during his keynote. CNBC reports

"A man standing near the stage started reading from a piece of paper, criticizing Salesforce’s contract with U.S. Customs and Border Protection.

 “Okay, we’re going to let you talk for 30 seconds,” Benioff said to the man. “But, however, at the end of the 30 seconds, you have to agree that you’re going to leave. Do you agree?”"

A giant digital timer on the screen then began ticking down. “We’re going to put the clock up. You have 28 seconds left,” Benioff said."

"Minutes later, another protester started shouting, but the comments were inaudible.

“We’ve heard from your group, and we will [be] happy to have a further conversation with you,” Benioff said. “We gave you your time. We will continue to give you other opportunities to speak. Thank you very much.”

I thought Marc handled the protesters very well and even scored points when he said he supported free speech. But with the timer and a security lady in the picture you got the distinct sense that Salesforce was prepared for this and even bigger protests outside Moscone. Honestly, I was filled with dread - what next?

I had hoped Benioff would do his fireside chat with Tim Cook of Apple as part of the keynote. It was actually later in the day when I had a conflict. Instead, the stream had a fireside chat with Anand Giridharadas, Editor-at-Large for TIME. His focus was what he calls "Voluntary Virtue" - the faux concern he thinks the wealthy show in solving societal issues like inequality. He talked about his book Winners Take All: The Elite Charade of Changing the World. He was particularly tough on Jamie Dimon, CEO of JPMorganChase. (btw I am a Chase customer and personally think their customer service sucks but I thought Anand was unfair to Jamie). More than anything as an editor of a leading magazine I wish he had been balanced. Instead he focused on the two ends of the wealth bell curve and ignored our still-substantial middle class. I tweeted him after the session

By now, I was distracted with calls and had the Dreamforce feed in background. I did see bits of pieces of two sessions which both focused on AI and ethical issues. 

I am approaching the decade milestone of The New Polymath. In that book, I had laid out many thorny technology-led ethical issues. I had interviewed lawyers, academics and analysts on these issues including Dr. Herman Tavani, professor of computer ethics at Rivier College. I had observed

"Clearly, this walking encyclopedia on cyberethics is not being leveraged enough by technology practitioners and future business leaders. (Professor James Moor at Dartmouth also confirmed he is not often consulted by technology vendors.)

In the last few years I have seen it flip. We are proactively worrying about potential ethical issues around AI and autonomous cars when they are years from becoming mainstream. As one panelist observed " AI is like teenage sex: everyone says they’re doing it, but no one actually knows what it is." Exactly, but we still seem to spend hours fretting about potentially biased algorithms, not about the productivity and payback from these new technologies. In contrast, long festering ethical issues I had laid out in my book are still being ignored.  

Look, Dreamforce has always been a "different' conference. It is a Tony Robbins type rah -rah, scream your throat hoarse event. You run into will.i.am and Deepak Chopra and Colin Powell and Richard Branson and who knows who else here.

But at the end of the day, I shuddered that a certain line may have been crossed at Dreamforce. I go out of my way to avoid political media, and in this sanctuary of a tech and innovation event, I should feel sheltered from that.    

I just hope today's vertical sessions focus much more on innovative customers and products. Yes, feel free to call me boring.  

I will see Josh's five and raise him ten!

Josh Greenbaum has a fascinating post - how Microsoft and SAP plan to take over the enterprise software market. There is much in there I agree with. All the recent executive changes - Jen, Christian, Bill, Bob - are exciting for the industry. Microsoft's infrastructure cloud is on a roll - the SAP "Embrace" and the DoD JEDI contract only add to the momentum. But I see much bigger changes in the enterprise software market beyond what SAP and Microsoft will touch.

To me, Google, Facebook, Amazon and agencies like Accenture with their share of digital advertising and CMO access will continue to significantly influence and morph the CRM space

The customer service segment will be significantly reshaped as IoT, satellite, drone based concepts mature. I expect industrial asset makers like Siemens and Caterpillar and logistics providers like UPS and Amazon to also be major players.

Contract manufacturers like Foxconn and Flex and boutique design firms will have more than their fair share of influence in the product engineering and manufacturing areas.

Amazon, Alibaba and other big commerce sites will continue to commoditize fulfillment functionality for countless SMEs and set a bar for broader supply chain and logistics functionality.

Robotics and other automation vendors will reshape many a business process. Similarly, Google will help many an enterprises rethink processes with machine learning.

A whole bunch of customers are themselves reshaping their industry specific operational systems with custom development and specialist startups - they are tired of waiting for modernized vertical packaged software.

Major economies like China, Japan, Brazil and others have seen so far only modest traction with modern enterprise applications. I have a feeling regional players will have a bigger role in the next few years.  

Josh has a lot of ink about activist investors. To me, they play a vital role in shaking up status quo, but smart as they are, I dont see them as significantly reshaping technology markets. In later, more mature markets, private equity investors have more influence in consolidations and other seismic changes. But we are not at the stage in the current iteration of enterprise software.

Net-net to me : SAP and Microsoft will continue to do well in traditional transactional areas. But the definition of the "enterprise" continues to rapidly expand, and I see a very fragmented market for the next few years.     

Of course, Josh may well be right. My little bet is my ticket to what will be a wild ride. Cannot wait for the 2020s!

Constellation Research event: Expansive, respectful vibe

Let's face it - industry events are increasingly formulaic. Most vendor conferences are predictable - keynotes and product futures, rock bands, large partner booths. Most research firm events tend to be siloed around their category definitions and what currently excites them. So, I particularly enjoy events like Cognizant Community which are about conversations with peers, mind expansion, and not so much about bragging or selling.  

I had a chance to spend a day at Ray Wang's Constellation Connected Enterprise event this week. The event honored a wide number of innovative customer executives, definitely different from other events where vendor executives dominate. It is different from the Cognizant vibe - the content here was much more dense and rapid fire. But I liked the panel and fireside chat formats. Way too many events have one talking head after another. I find in my own presentations, the conversational style with a moderator improves audience engagement. Of course, in the 30 minute CCE session format, there is not much time for audience questions. Instead you get to ask questions one on one. In fact, many attendees were outside networking. Ray had opened the event with - 'you are all here because you are intelligent, innovative...and impatient'. I was clearly a rookie - most attendees had been to 3 or more of the 9 annual CCE events. They get their value from the networking outside the sessions. Impatience personified:)

The wide breadth of sessions was refreshing, if covered a bit shallowly. CCE had sessions on sports, economics, fintech and much more. People know me as a SAP or an outsourcing analyst, but the reality also is my New Florence blog has racked up close to 7,000 posts over the last 15 years and books like the New Polymath have focused on the exponential payback from combining cleantech, healthtech, agritech and more. I enjoy diversity in topics.

I could have participated in the event remotely. Every session was streamed like this chat with Aneel Bhusri of Workday. Every session had a visual story from Heather Willem artists like the one above and below. Given Ray's own prolific Twitter habits, the audience provided instant feedback in tweets on every session. However, I am glad I was there in person and here is what I observed in the few hours I was on-site

Honoring the Past

Ray had his parents in the audience. That was very respectful as was his fireside chat with Vint Cerf. It was good to see on-stage executives from MicroStrategy, Tibco, Infosys. These companies are not dead by any means - they are reinventing themselves. It was good to see Jim Cavalieri of Salesforce and Aneel Bhusri of Workday in different sessions look back and honor Marc Benioff. In many ways, it was nostalgic and feel-good. As an industry, we don't do enough of that.

Savoring the Present

To me it is puzzling that so many people are miserable and angry when the economy is so vibrant. I like meeting content people so it was nice to spend a few minutes with Ray's wife, Tina who balances so much with a smile. Ditto with Ray's associates like Dion, Holger and Nicole who are always positive. I only had one meal at the event but have to point out several people at my lunch table went back for the to-die-for crab bisque. The administrative and event staff did an excellent job with logistics.  Dr. Alan Beaulieu of ITR Economics had an informative and humorous session on the world economy and assured the audience the US economy is healthy short-term given its energy and manufacturing balance, but cautioned about longer term impact of national debts and aging demographics.

Inviting the Future

It was nice to see Ray's son, Nathan and his school mates at a table - a good metaphor for what's coming next. There were sessions on spatial computing, blockchain, quantum computing, global opportunities. In my conversations I heard of next-gen applications - very little mention of today's vendors, much more of start-ups, custom development, platforms from Google, Amazon and Microsoft. 

Some quotes out of hundreds I heard give you a clue to the future world that was discussed - not all positive, but should give you a flavor for the variety of conversations

• The notion of pure anonymity on the internet may evaporate
• We need to get beyond Next Best Action to Next Best Conversation. If you don’t understand me, how can you support me?
• Teach your kids French. Africa will play a big role in the future and French is a common denominator on that continent.
• 3D designs that look crappy look REALLY crappy in VR
• Digital strategy should run parallel to corporate strategy - Under Armour needs have evolved from apparel footwear industry features to that of a fitness platform
• We are significantly increasing our attack (vulnerability) surface as we head into 5G and with massive amounts of IoT.
• Tracking your lettuce from farm to store doesn’t implicitly add security or prevent it from spoiling. It made zero sense to me when I first heard that use case and it still makes zero sense today.
• “Our equipment works equally well on the earth or the moon for intelligent data processing. We will have mining operations on the moon in about 15 years.“

If you were looking for a string to pull all the pearls together, sure Ray has it. I was only there for a third of the event so have no right to expect that. His loyal fans who show up every year will likely say - who cares? It is a good forum to enjoy Ray's hospitality, get some pretzel logic, energize body and soul and to renew long-term friendships. Mission accomplished. Glad I could be part of it.  

Gradually, then suddenly

Lots of people are rattled by all the executive changes in the industry over the last few months ...Bill McDermott and Rob Enslin at SAP...John Donahoe at ServiceNow...Mark Hurd and Thomas Kurian at Oracle ...Charles Phillips at Infor....Bob Stutz at Salesforce....

There is plenty of speculation ... Call me old fashioned, but I take the long view and being one degree of separation removed from many of these executives, I prefer to do my usual 360 degree calling around. Besides, as a colleague said "The signals were there if you knew where to look". Hemingway was even more poetic when he wrote “How did you go bankrupt?" Two ways. Gradually, then suddenly.”  

To me, change is healthy. And often builds up over a couple of decades. Unlike many, I am not that agitated by what is happening in Washington or London. I ignore the shenanigans and the political media but I can see why we got to where we did. And look at ways to adapt to the changes.

Same thing with enterprise tech. In my recent book, I cataloged the last twenty years and described how Apple near dead, Google, Amazon, Foxconn and many others, mere babes then have thrived. I looked at how over a million on-prem customers have not budged. How 80% of the geographic and vertical white spaces have not been filled with modern solutions. Systems integrators continue to try and do business the same old, labor intensive ways they did in the last go-around. 

It would be silly to not expect major changes given this build up. The key is not to confuse individual with corporate trajectories. The good news is we are seeing new leaders like Jen Morgan get a chance to put her imprint. With McDermott headed to ServiceNow and Stutz to SAP, we will see plenty of activity in the customer/revenue-centric segment of the market. There will be lots more activities in areas that did not see investment in the last few years.

Here's my advice to customers. Take time to revisit your application portfolio. There are plenty of opportunities to modernize, consolidate, better integrate your applications. Your legacy has security and compliance risks and plenty of recruiting risks as you look to attract younger talent.

To vendors - question what may have worked over the last decade or so. Plenty of new opportunities and threats to focus us.

There will be plenty of distracting noise and speculation as we are seeing in politics.   Ignore all that, disrupt yourself and embrace the change.  Lots coming.

A wide open race in enterprise software

If you are into speeds and feeds, last week in sports was particularly interesting. It marked the 19th anniversary of Dale Earnhardt's improbable win at the Talladega Superspeedway. Seemingly hopeless in 18th place with just 4 laps to go, Earnhardt somehow went on to win that NASCAR race. It was his last major win. Watch the last few laps in the video below.

Earlier in the week, Eliud Kipchoge of Kenya ran 26.2 miles in Vienna is a record-breaking time for a marathon in just under two hours. It was not an official race but it showed the art of the possible when technology (supplied by Nike, INEOS and others) and technique come together as I posted on New Florence. 

As we approach the end of this decade, I have thinking a lot about the race in enterprise software.

In my recent book. I looked at the last 20 years in software. By many metrics, the pace of change has been glacial. Over a million on-prem customers have not migrated core applications to modern cloud or in-memory architectures. On the vendor side there are all kinds of neglected white spaces when you look at industry or country specific coverage.

And yet the vendor landscape has changed considerably. You could argue Apple, Amazon and Google have had more of an influence on enterprise applications than did SAP, Oracle and Microsoft. Salesforce, ServiceNow, Adobe, Workday and others have become major players. Plenty of global and vertical players are nipping at the heels. With customers building more than buying applications players like VMWare have become more influential. Service providers have evolved - many these days are as much contract manufacturers, digital agencies and third party maintenance providers. Telcos are gearing up for a next wave of 5G and satellite services. Customers are themselves becoming tech vendors as they make their own products and services smarter with software and sensor support.

When I talk to CIOs these days, I hear of opportunities and challenges like vendor end-of- life dates, automation, digital transformation, multi-cloud leverage and application portfolio consolidation. They increasingly worry about their recruiting profile as younger tech staff show little interest in supporting their legacy applications.  Vendors are themselves showing signs of big change - there is new management in the last few months at SAP, Infor, Oracle and Unit4.

It should be an exciting next few years. May be the roaring Twenties again? But they also raise some interesting questions: Will we see an Earnhardt break away from an increasingly crowded vendor market? In that race he was described as"...suddenly, seeming out of nowhere, Earnhardt charged forward, parting the field like Moses parting the Red Sea.."

And who like Kipchoge is working on stuff that makes you go wow. 

In my role, I am paid to help clients put bets, so I have my views on the likely Earnhardts and the Kipchoges.  But I would love to hear your perspectives. Comment away!