Seeking Alpha
Long/short equity, short only, growth, special situations
Profile| Send Message| ()  

In my previous article on ServiceNow (NOW), I described what I learned about the company and the IT Service Management (ITSM) industry. After interviewing industry insiders to write my first article, I interviewed more people to gain a deeper understanding of ServiceNow's situation. My latest interviews were with a former ServiceNow employee, a technology analyst for a hedge fund who says ServiceNow "is his highest conviction short", and Matt Selheimer, the VP of marketing for the innovative ITSM company ITinvolve. The hedge fund analyst is the only one out of the three who has a position in NOW. Thank you all for your help in giving me a better understanding of ServiceNow and the ITSM industry.

Further evidence has confirmed that ServiceNow is on a downward trajectory. Its bread and butter ITSM business is falling behind in innovation and has much tougher competition than it used to, and its efforts to expand to other markets are not nearly as successful as was hoped. This should become apparent in the company's upcoming earnings call on January 30th, and in the proceeding two stock lockup period dates within the two weeks afterwards where I expect insiders to sell many shares. Savvy shareholders will not continue to hold this stock with a price/revenue multiple of 12+ and negative earnings once they realize that ServiceNow's growth is rapidly slowing down.

Single Tenant Vs. Multi Tenant Architecture

ServiceNow has many problems, but the biggest one is its single tenant architecture. ServiceNow has had this same model since its beginning in 2004, and hasn't changed it. While other ITSM companies are innovating and changing their models to multi-tenant, ServiceNow is stuck in its old way of operation.

"The fact is that ServiceNow has stopped innovating in the ITSM market," says Matt Selheimer, from ITinvolve.

Think about the dollars being sucked into supporting its single tenant model that could have been used for application innovation instead. Sure, ServiceNow's product has gotten incrementally better since 2004, but it isn't innovating in the ITSM space. They really have simply been filling in product gaps relative to their longer-established peers.

With the single tenant model, every customer gets its own data base and own version of the ITSM application. Compare that to multi-tenant, where every customer has the same coding for its application and is on the same database. The single tenant model is bad for the customers, the company, and especially bad for the shareholders. Most new and innovative ITSM companies are crossing over to the multi-tenant approach. All of the big four legacy vendors: IBM, CA technologies (CA), Hewlett Packard (HPQ), and BMC, which are the biggest threats to ServiceNow's growth, have moved to a multi-tenant architecture.

A good analogy would be to imagine if you were a landlord and had 100 tenants. Would you rather have them all live in separate homes, or all live in one high rise building? Obviously the high rise would be superior. You would only have to pay rent on one plot of land as opposed to 100, and you could have plenty of maintenance employees and mangers right there on site to fix any problems. There are many other advantages to having them all live under one roof rather than spread out all over in different homes. This also holds true in the cloud space with multi-tenancy compared to single-tenancy.

The following are the disadvantages of a single tenant architecture, and the accompanying advantage with a multi-tenant architecture with an ITSM cloud application:

1. With single-tenant, every new client scales out linearly. All of ServiceNow's costs are linear. ServiceNow leases third party data centers. These data centers charge per server and per virtual machine, so when adding customers, they're adding costs. ServiceNow also must pay for each individual upgrade for each customer, and this also is a linear cost. This extra cost is paid for by ServiceNow, and some of the extra cost is passed on to its customers.

Multi-tenant is primarily an economy of scale business. Each new customer is put on the same database, so the company doesn't use as much data to lease more data machines. Upgrades are the same for every customer, and at the same time, so the company doesn't have to pay for individual upgrades for each customer, it's just a uniform, one-time process. Customers are getting offered a better price from ServiceNow's competitors since they don't have the same costs that ServiceNow has.

2. With single-tenant, each customer has their own code. With so many different versions of an application, it's hard for ServiceNow to support each one. The former employee of ServiceNow said that its support department is a "nightmare". The following is his description from my interview with him:

When customers contact ServiceNow with a request or ask for help in solving a problem, and technicians first have to learn that customer's original code before being able to resolve the issue. This causes the support tickets to linger for a long time, and it creates bottlenecks and large backlogs. Junior technicians on the support team have to constantly ask senior technicians for help in understanding the code. This takes up the senior technicians' time when they could be spending time innovating the software. Problems often get escalated, and sometimes even the sales guys get involved. This distracts the sales team when they should be focusing on sales. Instead of solving support tickets on a first in, first out basis, support is running around putting out fires and attending to emergencies. This makes the customer frustrated because its ticket is put on the back burner unless it's an emergency.

ServiceNow is trying to hire more people to help resolve support tickets in a more timely manner, but the company has dried up the market in San Diego. ServiceNow's human resources policies are still that of a startup, they aren't developed enough. The company is quick to fire people with no due process. Employees are expected to work long hours and on the weekends Work/life balance is non-existent at ServiceNow. That's one of the reasons why I left. Employees have ideas on improving processes, but they fall on deaf ears making it an unbearable work environment. Employee morale is low. This low morale will bleed over into the product. ServiceNow has a negative reputation with many tech recruiters in San Diego because of the way management treats employees.

With a multi-tenant architecture, on the other hand, customer support goes more smoothly. Every customer has the same application and the same version of the software with the same upgrades. Problems and requests are often repeated, so a junior technician can easily learn and satisfy most issues. This means there are less instances of backlog. Since the technicians are very familiar with the software, problems can be solved quickly without escalating into emergencies. Instead of junior technicians having to always ask for help, the senior technicians can do what they do best: innovate. The sales reps can continue to focus on new sales, without having to get involved with the support process.

3. With single-tenant, implementation takes a long time, and upgrades are few and far between, lengthy, and distruptive. Someone who recently made the decision for his company to purchase ServiceNow's ITSM product commented on my previous article. He said that it took a few weeks to implement ServiceNow's software package. He said "a Remedyforce rep said that theirs could be all deployed in five days. Anyone that believes that doesn't live in reality or knows how ITSM works in an organization". Well, I have to say that this is what innovation is. The ITSM industry has evolved and the software can do amazing things now that no one would have imagined even two years ago.

Also in the comments section, Darroll Buytenhaus, President of SAManage, a multi-tenancy ITSM company, made this statement in regards to comparing ServiceNow's upgrade cycle compared to that of a multi-tenant architecture:

The question is straightforward - would you go with upgrading every 12-18 months or are you ready to enjoy snappier "app like" upgrades which we have all come to love and enjoy in our mobile phones or in tools such as the Chrome browser. It may be surprising to some, but the SAManage upgrades that customers see every few days do not require downtime. New technologies, new ways of working in engineering and the multi-platform environment have resulted in the elimination of the "maintenance window." Customers of true multi-tenant SaaS vendors have been enjoying this level of service for many years.

While service-now does provide great functionality and customization options, it misses some of the true advantages of the new real cloud environment. The physical separation of a company's data from others may be perceived as an advantage. However, today's multi-tenant systems such as Salesforce and Workday are built on modern technologies that provide security, performance and scalability at an affordable price without any compromise.

Is ServiceNow going to change to multi-tenancy? Yes, it would be better for ServiceNow in the long run to switch to multi-tenancy. However, it would cause disruption to their clients as they transition to the new architecture and would also confirm to the world that it has lagged behind its competitors in this area. What's more, the effort would consume additional R&D dollars that could have been spent elsewhere on innovation.

Is ServiceNow Expanding To New Markets, Or Just Spinning Its Wheels?

In order to fit into its $4.5 billion market cap, ServiceNow must be successful in breaking out into other areas of IT. ITSM is only a $1.5-$2 billion industry, and in 2011, ServiceNow only had an 8% market share. In 2012, that percentage went up a bit, but even if ServiceNow acquires a 30% market share in ITSM, as many bulls claim, that still would only be about $600 million of annual revenue per year. However, to deserve its current market cap, it will need to get to $1 billion in revenues by 2016, and $4 billion by 2024.

Below is the total percentage market share per company of IT Operations Management and Application Development in 2011 given by Citi Research and Gartner.

(click to enlarge)

As shown above, ServiceNow had a strong ITSM market share of 8% in 2011. However, its configuration management and workload automation market share of only 0.2% each shows that ServiceNow isn't making very good traction there. It started its configuration management business in 2007, and its workload automation department in 2010, so that's plenty of time to gain momentum, especially in configuration management.

In my interviews with the industry insiders, the following is what they had to say about ServiceNow's push into other areas besides ITSM:

"ServiceNow has really shifted who they are as a company over the last year or so," said Matt Selheimer from ITinvolve.

They were very much an ITSM company prior to the IPO. After Slootman came over from Data Domain, we've observed a shift in the company's priorities. They are trying to position themselves more and more against Platform-as-a-Service offerings like Salesforce's force.com, and that's what's helping to drive their stock valuation. For both prospective and current ServiceNow customers that are interested in ITSM primarily, it raises some interesting questions to consider. Is ServiceNow going to invest more in their other businesses, and less on the ITSM business? Could the same thing happen to them where they find their customers replacing them with newer, more nimble innovators like what they did to the Big Four install bases this last decade? How are they going to fare against formidable competitors with dep investment pockets like Salesforce.com, Microsoft Azure, and other PaaS behemoths? Will customers be willing to develop applications on the ServiceNow platform over the other PaaS platforms?

"Workload automation is very complex and only a handful of people have the knowledge to expand that industry in house and make it better and support it," said the former employee of ServiceNow.

ServiceNow only has a few senior developers in the whole company who can understand it, and that's not enough to help the customers. Those senior developers have to try and explain it to the junior developers in customer service, and that wastes their time when they should be spending time innovating the technology.

"With its configuration management, there's a lack of resources in the company and that hinders it from growing and stabilizing", he said. "ServiceNow's asset management application is substandard. It is slow, and sometimes doesn't scan everything."

"ITSM is all that ServiceNow has," said the technology hedge fund analyst who is short NOW.

Simply put, three years ago, none of the big ITSM guys had a SaaS cloud offering. ServiceNow fulfilled a need and now everyone has a cloud offering. The low hanging fruit is gone and the sales reps are now forced to deal with servicing issues. From my research, I've found that ServiceNow isn't having much success with branching out of ITSM. A ton of R&D guys are leaving the company. ServiceNow's Platform as a Service (PAAS) isn't taken seriously by anyone in the industry. I spoke with a manager at an application development company, and he said he would fire his developers if they made applications for the ServiceNow platform.

"It's very labor intensive to create an application that works," said the former employee. "The ServiceNow platform is tough because when a sofware developer makes an app, and then leaves, then the people who are left don't know how to work the app because the coding is a work of art."

"I would think an application development company would be reluctant to create apps for ServiceNow," said Mr. Selheimer,

How can ServiceNow expect to compete with these behemoths who are constantly innovating and improving the technology? The big guys can invest to make their platforms more reliable, scalable, more secure, and with more elements. For example, force.com bought Heroku to allow people who developed in Heroku to run Heroku apps on the platform.

An Example Of ServiceNow's Unevolved Technology

Matt Selheimer alerted me to a very inefficient example of ServiceNow's ITSM user interface. To see it, go to servicenow.com. Click on "DEMO NOW" on the bottom right hand corner. Login as an IT employee by entering "itil" in the user name and password. Now, on the left side of the screen, there's a scrolling bar. Scroll down to where it says "social IT". One would think that social collaboration would be part of it. But it's at the bottom because it's not a priority. When you click on "live feed", you can see it's like the news feed on Facebook. It's just a bunch of noise. Notice how there are a wide range of types of messages like "Breaking ground on the new Chicago office complex!" and "Company barbecue is Friday!" It also has a message that says: "High priority incident opened".

(click to enlarge)

Now if you're working in a company of 5,000+ employees, how are you going to notice that high priority incident if it applies to you, when every employee can just write anything they want in the feed? You would have to scroll through all the comments, or do a search. You aren't alerted if there's an important incident in your department.

ITinvolve's Model

Compare ServiceNow to ITinvolve, which is a next generation ITSM product that is built from the ground up to be social and collaborative (and is also multi-tenant, by the way, running on the force.com platform). Social collaboration for ITSM is ITinvolve's specialty. ITinvolve was created because one of the biggest challenges that IT departments have, is that knowledge is scattered all over the place like in spreadsheets, in configuration management databases, Visio diagrams, word docs, PDFs, SharePoint sites, etc. But most of the time these silos of information are out of date because things are always changing in IT. The most up-to-date information is actually found in people's heads, and what ITinvolve does is leverage social collaboration to bring the system and human knowledge together, and make it easy to keep it current.

In ITinvolve, you follow a certain server, a database, or anything IT manages, just like Twitter. Then when someone adds a new piece of knowledge about that item, you are alerted about it and can collaborate with the individuals(s) who made the update. In this manner, IT employees can add information or change it, to crowd-source the best, most accurate understanding of the IT environment just like how Wikipedia works. When there is an issue, most IT organizations spend 80% of the time figuring out what changed or broke, and only 20% of the time actually fixing it. ITinvolve's social media ITSM helps IT staff figure out what the underlying problem is quicker so that IT services can get back up and running.

Similarly, when planning a change, ITinvolve creates a collaboration workflow to get everyone's opinion who is following the items affected by the change. This allows the organization to do much better and faster risk analysis before executing changes and that, in turn, means fewer changes go wrong or cause unintended consequences and disruptions. ITinvolve's innovation is an example of an ITSM company innovating while ServiceNow isn't.

Source: After Interviewing More Industry Insiders, I Am Even More Bearish On ServiceNow