Enterprise Incentive Management Leader's Challenges and Response

Challenges Nevertheless Linger

Because San Jose, California (US)-based Callidus Software has historically licensed its products to customers primarily on a perpetual basis, its quarterly product license revenue remains substantially dependent on product sales to new customers. In 2005, BellSouth and Cingular each accounted for more than 10 percent of the company's total revenue, whereas in 2004, IBM alone accounted for the same percentage, including instances where IBM acted as a reseller of Callidus products. US revenue still represents over 90 percent of total revenue, with the remaining amount generated in Europe and the Asia-Pacific region.

Part Three of the series Enterprise Incentive Management Leader Responds to Market Demands

The above figures bring us to the realization that although upper range enterprise incentive management (EIM) solutions are designed to roll out new plans to large sales forces in a matter of weeks, the downside of a full grown EIM solution is its hefty costs. Designing a homegrown solution for a sales team of more than a few hundred is unrealistic, and a tool offered by a customer relationship management (CRM) or an enterprise resource planning (ERP) provider will not likely have the functionality to handle the complex sales plans and transaction volume. The alternative of using large EIM solutions, however, can amount to several hundred thousands of dollars in license fees. One also has to factor in the cost of the supporting technology, since most large EIM deployments require the customer to purchase a scalable back-end database server and a reporting tool to support it. Then there is the customary software maintenance and support agreement, which typically adds an additional 15 to 25 percent to the software and hardware expenses, depending on the vendor.

Finally, companies must consider solution upgrades, and when one is upgrading a technology that involves an organization's payroll and direct deposits, there is a great deal of parallel testing that needs to be done. For more information, see Is There a Panacea for Enterprise Software Pricing Yet?. These complicated environments also lead to major implementation costs, since the rollout of a complex EIM solution can cost another few hundred thousand dollars and take up to a year to complete. This has some pundits suggesting that companies should consider upper end EIM solutions only when they have the financial assets and requirements for a solution capable of handling the multitude of sales complexities needed to go to market.

The full range of services that Callidus offers its customers includes professional and educational services, maintenance, and technical support. In terms of professional services, the vendor provides integration and configuration services for its customers and partners, which include the installation of the software; identification and sourcing of legacy data; configuration of TrueComp application rules necessary to create compensation plans; creation of custom reports; integration with other products such as Callidus TrueAnalytics, TrueResolution, and TrueInformation; and other general testing and tuning services for the software. The customers can select Callidus or one of its implementation partners to perform the installation and other professional services they desire. The vendor also provides services to its implementation partners to aid them with specific projects and training programs. Additionally, it provides Callidus Strategic Services to help customers optimize incentive compensation business processes and management capability.

For previous notes on Callidus, see Enterprise Incentive Management Leader Responds to the Market Demands, and The Enterprise Incentive Management Flagship Offering.

Callidus Service Offerings

In late 2005, Callidus announced TrueSuccess, a suite of service offerings that the company and its partners plan to deliver to ensure that customers can benefit more quickly from Callidus products through accelerated implementation or a hosted offering. The company expanded its service offerings by introducing two new strategic service programs. The first one, Compensation Strategy Services, is designed to help clients keep their current compensation systems operating at peak efficiency, manage compensation plan changes that result from organizational growth or changes in business more effectively, and optimize plans through more effective design and modeling. New and current clients may benefit from the following three packaged service offerings:

1. operations analysis and assessment,
2. change management, and
3. incentive optimization.

Another service program, Analytics Services, should have clients quickly realizing the value of Callidus TrueAnalytics because of its ability to place critical data and knowledge in the hands of sales and finance executives, managers, and analysts. To that end, Callidus Software offers rapid deployment and subscription delivery models. With these new products, clients will be able to access quantifiable incentive metrics to accelerate critical sales and business decision-making processes, thereby improving sales performance, productivity, and margins.

Halfway into 2006, Callidus announced a new strategic services program offering, Workflow Solutions, which together with Compensation Strategy Services and Analytics Services, aims at enabling Fortune 1000 companies to drive revenue and improve sales performance more rapidly, as well as enhance communication among payees, incentive compensation analysts, and business operations. Built on top of the Callidus TrueResolution framework and integrated with Callidus TrueComp and TrueInformation software modules, Workflow Solutions incorporates three packaged offerings. Each package enables customers to track and audit issues; disputes; data changes; communication and notification of compensation plans; policies; and goal sheets for US Sarbanes-Oxley (SOX) compliance:

1. Payee Self-Service: Quickly configurable to support specific sales operations and procedures, this product should enable payees, managers, and administrators to distribute and track information, and quickly identify and resolve incentive compensation-related disputes.
2. Data Management Services: A Web-based solution, this product should enhance compensation workflows by allowing clients to proactively validate, manage, and fix data issues related to incentive calculation and reporting. Improvements in compensation accuracy and in compensation and sales operations team productivity should increase the sales forces' confidence in the compensation management system of their organizations, .
3. Sales Operations Support: Also a Web-based solution, this product should allow users to submit changes to reference data, compensation plans, and policies, as well as make adjustments to compensation calculations. It also automates the review and approval of payments before release to a company's workforce.

Of course, Callidus performs all of the above professional services on a (hefty) time and materials basis. Further, Callidus has maintenance and technical support centers in the US, the UK, and Australia, and it currently offers two levels of support—standard and premium—which are generally provided on a yearly basis. Under both levels of support, customers are provided with online access to Callidus's customer support database, telephone support, and all product enhancements and new releases. In the case of premium support, customers are provided with access to a Callidus support engineer twenty-four hours a day, seven days a week. In addition, customers can purchase an on-site resource support option regardless of which level of support they have subscribed to. Lastly, Callidus offers its customers a full range of education services including computer and Web-based training, classroom training, and on-site customer training. The vendor provides classes on all of its products to its customers and educational services to its partners on either a scheduled or by-request basis.

Callidus Financials

For the abovementioned reasons, Callidus's financial performance has come with mixed blessings. The company has had a string of losing quarters and fluctuating revenues, as well as some product discontinuations and write-offs, which eventually led to a change of management in early 2005. Reported in US funds, net losses were $8.6 million in 2005 and $25.5 million in 2004, and Callidus had a net income of approximately $0.8 million in 2003. Additionally, Callidus expects its reported expenses to increase for 2006/2007 as it expands operations domestically and internationally, and as it begins expensing stock-based compensation in accordance with the US Statement of Financial Accounting Standards (SFAS), No. 123R. As a result, the vendor expects losses in 2006, and cannot yet assure that it will achieve or sustain profitability on a quarterly or annual basis in the future. If Callidus cannot increase its license revenue to compensate for its greater operating expenses, its future operations and financial condition will be negatively affected.

Fortunately, Callidus is seeing growth in this area. For four consecutive quarters, it has experienced a strong year-over-year growth in license revenue, largely due to the initiatives of its new chief executive officer (CEO). Maintenance and service revenue has grown sequentially and year-over-year. For instance, total second quarter revenue for 2006 was $17.7 million, an increase of 40 percent, compared to second quarter 2005's increase of 4 percent. Second quarter license revenue was $5.9 million, an increase of over 350 percent compared to second quarter 2005 (albeit this was a decrease of 15 percent compared to the prior quarter). On a trailing twelve-month basis, license revenues were up over 130 percent from $11.1 million to $25.9 million and total revenues are up 23 percent from $56.1 million to $69 million. Second quarter 2006 maintenance and service revenue was $11.7 million, an increase of 4 percent compared to second quarter 2005 and an increase of 17 percent compared to the prior quarter, first quarter 2006.

While this trend seems promising, especially as it continued in the third quarter of 2006 (with total a revenue of $17.4 million), it was essentially flat compared to third quarter 2005 and to the prior quarter. Similarly, third quarter license revenue was $5.8 million, equal to the third quarter of 2005 and down slightly from the prior quarter. The quarterly maintenance and service revenues were $11.6 million, an increase of 3 percent compared to the third quarter of 2005 and a slight decrease compared to the prior quarter. On a year-to-date basis, total revenues were up 18 percent from $44.2 million to $52.0 million compared to 2005, while year-to-date license revenues were up 76 percent from $10.6 million to $18.7 million compared to 2005.

Overall though, Callidus is still facing financial obstacles. Its second quarter 2005 was particularly weak, and it had losses in 2006; and although Callidus saw an increase in new licenses in 2005, this channel only generated $1.29 million. Moreover, Callidus is still losing money and has seen a string of net losses. Net losses in second quarter 2006 was $3.2 million (including $1.4 million of stock-based compensation expense), which is comparable to a net loss of $3.7 million for second quarter 2005 (including $0.4 million of stock-based compensation expense). There was also a net loss of $3.1 million for the prior quarter (including $1.2 million of stock-based compensation expense). Third quarter 2006's net loss was another $2.5 million (including $1.1 million of stock-based compensation expense), which compares to a net loss of $0.9 million for the third quarter of 2005 (including $0.1 million of stock-based compensation expense).

Callidus's cash and investments is another area that may generate trouble for the company. Its cash and investments totaled $53.2 million on September 30, 2006—a decrease of $3.5 million from June 30, 2006. In other words, cash and investments totaled $56.7 million at June 30, 2006, which was in turn a decrease of $3.9 million from March 31, 2006. This cash burn rate might be particularly troublesome, as the business went through $3 million in the first and third quarters of 2006, and nearly $4 million in the second quarter. The vendor is in real need of new business.

Thus, here is where the mixed blessing lies. While the company's license revenue has declined from its 2003 levels, its maintenance and service revenues have remained relatively constant. However, a substantial portion of these revenues, is derived from providing professional integration and configuration services associated with product licenses sold in prior periods. As such, if Callidus is unable to increase sales of its product licenses, the maintenance and service revenues are likely to eventually decline too. Further, maintenance and service revenues (which include fees for consulting, implementation, maintenance, and training) were 71 percent, 78 percent, and 48 percent of total revenue for the years 2005, 2004 and 2003, respectively. But Callidus's maintenance and service revenues have substantially lower gross margins than license revenues. The decrease in the percentage of total revenue represented by license revenue in 2005 and 2004 as compared to 2003 has adversely affected the company's overall gross margins. Failure to increase Callidus's higher-margin license revenues in the future will continue to adversely affect its gross margin and operating results.

Will On-demand Delivery Help?

To that end, given Evalueserve's research-based projections that the hosted EIM market will grow at a rate greater than 40 percent (and more than twice that of the traditional on-premise market, although it is currently four times smaller in size than the on-premise-counterpart), Callidus unveiled Callidus On-Demand Solutions in early 2006, a hosted service that extends the power of the flagship Callidus TrueComp EIM suite and enables mid-to-large size organizations and enterprise business units to benefit from a comprehensive EIM solution on a subscription basis. The overall EIM category is also experiencing a continuing shift to a subscription model, which is already well established in some segments and often suitable for companies with variability in demand (see Software as a Service Is Gaining Ground).

Callidus On-Demand Solutions is to deliver all the advantages of the "bigger" on-premise EIM suites to organizations with 100 to 1000-plus payees, and provide them with the rapid deployment, flexibility, efficiency, security, and reliability they need for an estimated 25 to 40 percent cost below that of a counterpart on-premise enterprise implementation. Customers can select from a variety of on-demand service levels and options according to their unique business requirements, and still benefit from high-availability, top-performance computing technology within the TrueComp architecture. On the one hand, the solution offers a high level of security by providing a single-tenanted database instance for each customer and by meeting the SAS-70 auditing compliance. On the other hand, customers should also benefit from the scalable performance and reliability of a multi-tenanted grid architecture that leverages a Sun Microsystems' Grid Compute Utility. Upgrades and maintenance are included and entirely transparent to end users, and customers can choose from the above portfolio of strategic services that leverage the Callidus team's deep incentive compensation and vertical domain expertise.

Callidus launched the hosted version of its on-demand offering in the second quarter of 2006. The vendor reportedly experienced strong initial success, signing a number of new high-profile customers like Harland Financial Solutions, Hyperion, and Lenovo. A recent significant development has been the launch and growth of the vendor's hosted on-demand offering. Starting from zero, the company has sold multiyear contracts with a total value of $6.1 million (USD) over the past six months, while year-to-date license revenue plus on-demand bookings totaled $24.8 million (USD), an increase of 134 percent compared to the equivalent period in 2005. These contracts are expected to generate annual recurring revenues of $2.3 million (USD). Contractual terms are generally two to five years, with the total value based on the noncancelable period. Hosted on-demand revenue will be recognized ratably over the contract term in maintenance and service revenues, and generally after an implementation is complete. Still, Callidus does not expect the impact of the revenue stream associated with the currently booked contracts to be fully realized until the first quarter of 2007, and to date, hosted on-demand recognized revenue has been minimal.

Just like on-demand CRM or human resources management (HRM) and payroll solutions from the likes of Salesforce.com, NetSuite, RightNow, Employease, or Ultimate Software, on-demand incentive and compensation management tools offer the potential to increase this market's growth by extending the functionality of EIM systems to mid-market companies that otherwise could not afford pricey on-premise applications. This is still a developing market for vendors, as there are few that play in this space—Centive, with its Compel product; Cellarstone, with its QCommission one; and Xactly Corporation, with its Incent offering—all of them being close allies of Salesforce.com. In comparison, Callidus is closer to an application service provider (ASP) hosted model of its on-premise solution, which is not exactly software as a service (SaaS).In other words, it is not the fully multi-tenant subscription service that can be easily "mashed-up" with other SaaS solutions as composite applications (see What is Software as a Service?). Given Callidus's traditional focus on the upper end of the market, where the EIM price tag can easily reach millions of dollars and several months of implementation, the 25 to 40 percent lower cost of its on-demand solution might appeal to the larger medium-size companies that neither have an extensive IT department or nor want one. Centive and Xactly would be more appealing to the lower end of the market.

On-demand and SaaS incentive and compensation management tools have the same pros and cons as their CRM counterparts. On the positive side, user companies forgo the huge upfront fees and installation costs while reducing the time it takes to get the product up and running. In addition, these solutions require no maintenance support agreements, no additional hardware, and a company's financial risk is no more than the number of months it subscribes for. However, companies must be comfortable with their data being housed at a third-party location, since security, data integrity, and service outages are always important considerations when looking at an on-demand solution. To allay concerns about storing sensitive financial data, the vendors can provide for data export on demand so that companies always have access to their own data. Also, while the code base is multi-tenant, Callidus creates a separate database instance for each customer so that no data is intermingled with data from other companies.

Proof Is Still in the (ROI) Pudding

As the importance of on-demand delivery is recognized, such solutions might bring "EIM to the masses", but big-ticket EIM purchases will continue to represent the foundation of and validation for this market. Vendors like Callidus will have to better leverage substantial market opportunity for its EIM and sales performance management solutions, both in the traditional enterprise software model and through its new on-demand offering. To do this, Callidus has lately tackled the important task of presenting the potential paybacks of its products. In early 2006, the company announced the results of a new research study that detailed the rapid return on investment (ROI) achieved by its customers in the financial services industry. Major benefits of the Callidus TrueComp Enterprise solution reportedly fell into three primary categories:

1. Revenue Growth was due to faster incentive "time to market" to promote new products and services, additional focused selling time among the sales force, and increased mindshare with broker channel and dealer networks (since management teams are equipped with the ability to analyze incentive program performance and effectiveness in greater detail).
2. Effective use of incentives included improved motivation and morale of the sales force, better visibility into sales performance, reduced cost of sales, and more effective use of targeted incentives. With better visibility into their incentive plans, real time analysis, and feedback, sales team performance was improved, while channel partners also performed better because the financial objectives, incentive plan, and commissions paid to date were more effectively managed.
3. Productivity improvements resulted from the elimination of errors, payment redundancy, administrative staff, and systems previously necessary to support inefficient compensation processes. Improved financial predictability and better use of staff for value-added business processes were also shown.

The study concluded that payback upon the implementation of the Callidus TrueComp Enterprise solution occurred in as little as six months, with a three-year return on investment in excess of 100 percent and a net present value range from $2.4 million to $79 million (USD) (see Table 1 above). Some examples of tangible individual payback metrics would be (1) reduced shadow accounting from 40 to 5 hours per salesperson per month, (2) increased cross-selling/up-selling of strategic product sets to achieve an additional 570 (or more) sales transactions annually, (3) reduced incentive overpayments by 60 percent (or a savings of $2.4 million [USD] per year by avoiding incentive overpayments), (4) decreased compensation disputes by 38 percent, despite the tripled number of payees, and (5) reduced average time from 22 to 9 hours to resolve a dispute (a 244 percent improvement), and more.

Some other customers purchasing Callidus solutions in the second quarter of 2006 included First Command Financial, Mentor Graphics, and The Prudential Life Insurance Company of Korea. The recently released TrueAnalytics module has apparently demonstrated the EIM strategic value, and it was sold in over half of the second quarter 2006 new deals. The solution was demonstrated in all sales opportunities and was often a key differentiator versus both Centive, Incentive Technology Corp. (ITC), and Oracle. Callidus plans to pursue sales of new product modules to existing customers of the TrueComp software. For most of these customers to take advantage of the new features and functionality of these latest modules, they may need to migrate to a more current version of Callidus's products at an additional cost, and therefore they may delay or decline altogether. If a sufficient number does not migrate to the new solution, the vendor's ability to sell additional products to these customers may be significantly harmed, as well as its revenue and operating income. Thus, it is an encouraging sign that 20 percent of customers have reportedly already deployed on TrueComp Enterprise 5, while approximately 15 percent are on the move to the release. Also, a quarter or so of these customers are reportedly considering the Callidus On-Demand Solution.