Descartes Systems Group: Small Company With Large Ambition

Descartes Systems Group: Small Company With Large Ambition
S. McVey - January 26th, 2000

Vendor Summary

Ontario-based Descartes Systems Group was founded at Waterloo University in 1981 as a custom software development company focusing on financial accounting applications for consumer packaged goods manufacturers. Chairman and CEO Peter Schwartz and Vice Chairman Mark Lee joined the 5-person company in 1990, which expanded to 25 people over the next six years. By 1997, Descartes had established itself as a supply chain execution (SCE) software vendor for companies in industries characterized by short time-to-plan horizons.

In 1997, the advent of on-line marketplaces hastened the demise of buy-side economics. In response, Descartes decided to reposition itself to create customer fulfillment networks to meet the needs of e-businesses. It also began executing its plans to become an application service provider (ASP) and offer success-based pricing. Five major acquisitions in 1997 and 1998 gave Descartes the core technology and expertise necessary to build applications for dynamic planning with short time horizons and high order volumes. Table 1 shows how these acquired businesses have contributed to Descartes' flagship product suite, DeliveryNet. The acquisitions also increased its overseas presence, fortified infrastructure, and broadened its vertical product market focus. In a move to raise capital to support its rapidly evolving business, Descartes completed two IPOs: one on Toronto Stock Exchange in January 1998, the other on the U.S. NASDAQ exchange a year later.

Vendor Strategy and Trajectory

Over the past four years, Descartes revenue composition has changed drastically (see Figure 1). This change is also evident in results of Decartes's last six quarters. Until recently, Descartes saw a decrease in license revenues and advancing service revenues, a combination that resulted from its transition to a success-based pricing model that yields recurring revenues as its clients grow transactions and customers. A 27% increase in quarterly license revenues from 2Q00 to 3Q00 may indicate a reversal. Resource investment into integration of acquisitions in early 1999 and a poor indirect channel also contributed to the drop in license revenues. Descartes has lacked partnerships with major complementary software and hardware vendors throughout most of its history. Nevertheless, success over the last few years has paved the way for industry-specific partnerships with ERP vendors J. D. Edwards (3/98) and PeopleSoft (8/99). Descartes also maintains alliances with Oracle, Microsoft, and Sun Microsystems (10/99). (See TEC's News Analysis article: "Descartes Evolution Yields Revenue Growth But No Profits" December 1st, 1999)

Perhaps more than any other supply chain software, DeliveryNet targets specific industry verticals: direct-store-delivery (DSD), field service management (FSM), logistics (LOG), and home delivery services (HOME). In cases where customers require specialized functionality, DeliveryNet's common development architecture, e-Frame, acquired from Calixon, is available as a standalone platform for building custom solutions. In its revised niche, Descartes faces competitors such as Roadnet, Bakerstreet, and CAPS Logistics (Baan), although many of its applications overlap its former SCE area.

Vendor Strengths

• Product functionality: Descartes DeliveryNet is more advanced than competitive products in the areas of Internet enablement, wireless mobile communications compatibility, and supply chain visibility. In addition, the flexibility afforded by e-Frame is a welcome innovation in the mass of more restricted, off-the-shelf applications in the supply chain management marketplace.

• Strong presence in the beverage distribution industry: Among Descartes customers in the beverage industry are Coors, Miller Brewing Company, Carlsberg, Pepsi-Cola and Foster's Brewing Group. In addition, the company is a preferred vendor for Coca-Cola Co. Perhaps most in its favor, Descartes's customer base is highly referenceable.

• Dominant position in home delivery routing and scheduling software: Quick response is an imperative for these businesses and is achieved through Descartes's technology that provides dynamic planning in extremely short time intervals (minutes). One of its more ambitious clients promises same-day delivery.
  
  

• Strong presence in the transportation and third-party logistics market: Private fleet routing software and supply chain visibility software are particularly strong, with growing interest in new products like Collaborative Logistics Exchange.

Vendor Challenges

• Uncertain revenues from new pricing model: Acquisitions and transition to a success-based pricing model have resulted in losses for the last ten quarters. This trend does not portend disaster in the short term, but continued losses can erode Descartes's financial foundation. In the short term, success-based pricing carries greater risk than traditional schemes and failure for its customers to prosper can be devastating to Descartes's business. If it catches on, success-based pricing can lower risk as it yields a predictable, recurring revenue stream.

• Limited brand awareness: In spite of Descartes's commitment to e-fulfillment, its products lack visibility outside a relatively small number of target markets. Competitive offerings from big name vendors like SAP and i2 Technologies are backed by considerably greater capital and larger sales channels. Also, few are aware of Descartes's experience as an application service provider (ASP).

• Challenges of ASP: Descartes has whole-heartedly embraced the ASP business model. Unlike traditional license fees that are paid up-front, ASP subscription fees rely heavily on a company's long term ability to manage its client's applications. As Descartes's business continues to grow, so will the support needs of its client base, and short term problems are likely to be encountered.
  
  

• Small alliance network: Descartes needs to aggressively pursue strategic alliances with systems integrators, and expand its relatively small circle of complementary software partners, especially those with e-business capabilities. Descartes uses a network of small resellers in overseas markets, but relies on direct sales in North America.

Vendor Predictions

• Provided Descartes continues to gain new clients and begins to see revenue growth from its success-based pricing contracts, it could return to profitability sometime before 4Q01 (60% probability).

• Descartes may attempt a new acquisition during the next 18 months (70% probability), in spite of its sagging bottom line and lack of operating history as an e-business enabler. Favorable perception by the investing community has boosted Decartes's stock price and netted it nearly $45 million (US) in a bought-deal in January. Wall Street, though, can be a fickle benefactor.

• Descartes will begin to embark on more alliances with complementary software providers, especially e-business enablers, over the next six months. The recently announced partnership with GERS Retail Systems is a move in this direction. (60% probability).

Vendor Recommendations

• Extend DeliveryNet to new include more analytical components: Descartes should bolster its offering by developing a new module to help clients make sense of the large volume of transaction data that pass through DeliveryNet. The offering could be achieved through a partnership with a business intelligence software company, like Cognos, or an acquisition.
  

• Gain stronger foothold in Asia-Pacific Rim: Although Descartes derives nearly 10% of its annual revenues from the Asia-Pacific region, this percentage falls below the industry average of 15%. Descartes should seek alliances with application hosting companies that have successfully penetrated the Far East.

• Create brand awareness: True market acceptance of its position as an e-fulfillment software vendor will be achieved only by an aggressive marketing campaign that places strong candidates into the hands of its sales force. Descartes needs to increase its investment in sales and marketing by at least 10% over the next several quarters in order to accomplish this.
  

User Recommendations

In the increasingly competitive supply chain management marketplace, corporations either advance or are trodden underfoot. Descartes' acquisitions over the last few years demonstrate that its management is committed to the Internet fulfillment software market. Descartes offers several attractive options for different types of companies. Brick-and-mortar businesses wanting to move to e-commerce for whom efficient customer fulfillment is an imperative, such as those in the perishable goods delivery or other consumer direct businesses, may want to take a closer look at Descartes' industry-specific product offerings. Small to mid-range companies should include Descartes in selections if they are interested in having their applications hosted. Startup companies should find DeliveryNet particularly appealing as they can use Descartes software for a lower entry cost and pay as their business expands.

Some caveats to consider:

• Each DeliveryNet is composed of a collection of modules, some developed in-house and others obtained through acquisition. Although Descartes maintains that every acquired product was rewritten and enhanced for integration, prospective users should question how well the modules work together.

• In addition to software-level integration barriers, Descartes must replicate expertise from acquisitions throughout its sales and services organizations in order for it to give customers confidence that the new components are backed by a sufficient knowledge base.