Vetting Your Vendors

It certainly isn't brain surgery, but dissecting a potential vendor's track record  and even its future prospects  is crucial to the health of your investment in its software. Here's what supply chain professionals and industry analysts suggest you ask before putting your money out on the table.

[From iSource Business, December 2002/January 2003] When Rodric O'Connor, the San Francisco-based chief technology officer for investment bank Putnam Lovell NBF, went looking for a customer relationship management application, he found a lot to like about salesforce.com, a provider of online CRM applications. For starters, at less than $100 per user per month it was dirt cheap, it required virtually no internal IT support and its technology had a good reputation.

On the other hand, it was also a relatively young company, founded in 1999, and it was privately held, which meant O'Connor did not have much of a track record to judge or have access to public financial statements.

He got the next best thing, though: a face-to-face meeting with its chief financial officer and chief executive officer. "From that I got a good sense of what their cash position or burn rate is  how many months of cash they had on hand.

"By the end of our conversations I felt comfortable enough that for at least the next 12 months the situation was stable."

Putman went live with salesforce.com in September of 2000.

Since then O'Connor has gotten quarterly reports from the CFO on the company's cash flow position. It's not completely fail-safe, he acknowledged. But he gets a measure of comfort from the fact that, as a San Francisco-based vendor, salesforce.com is a known entity.

"I always feel more comfortable with vendors that are close to me geographically. These are the same people I bump into on the street and at business functions. You get to know who is trustworthy that way."

Musical Chairs

For companies that rely on high-end applications, the bloodletting in high tech these days can be downright frightening. Finding out that a mission-critical IT supplier has gone bankrupt, or perhaps been acquired by another company, is only slightly more palatable than going bankrupt yourself. In the late 1990s these fears were hardly worth executives' time; it was a sorry IT vendor that could not find financing or venture capital to keep afloat. And even if a vendor were to go under, clients were so flush that whatever remediation steps they had to take were easily affordable.

Times have clearly changed, however. Smart companies are vetting prospective vendors as a matter of course. Putnam's O'Connor, for example, has devised a two-part strategy comparing vendors during the selection process to internal applications or competing vendors to make sure their business case is viable, and then ascertains that the company itself is financially stable.

But, just for safety's sake, he also draws up contingency plans. In salesforce.com's case it has a database export function, so every week Putnam's contact and other sales data is sent via e-mail to its headquarters.

"You have to ask yourself, even after you do all the research, what will you do if a vendor does go under," says Tom Ryan, director of Systems Integration Services for ESYNC, a systems integration firm.

There are basically three options, he says. "One, you can hire some of their people to finish the project and be on standby for any problems. Two, you can escrow the licenses and software source code and build up an internal presence to support the software. Three, you can buy the company, if it comes to that."

More Than One Way

But before one gets to this quite drastic point, there are a number of methods an IT buyer can use to vet the financial and business case viability of a prospective vendor. Some are very upfront  like asking the CFO how much cash he or she has on hand.

Other measures are basically just deductive reasoning. Diane Boothroyd, a principal with North Highland, a national business and technology-consulting firm headquartered in Atlanta, suggests looking at a prospective vendor's client list. "If there are some big names among the clients, it is unlikely they are going to let their vendor go out of business, assuming this is an important application to them," she says.

There is always something a company can use to get a handle on a vendor, Gareth Herschel, research director for Gartner, says. "Ask yourself, how motivated is the owner or CEO? How realistic is the vendor's development schedule? Is the sales process well organized? Watch for significant diversion of resources away from product development. Monitor sales momentum. Demand monthly updates of the product development road map and let the vendor know you are attaching great importance to its claims."

In the end, though, unless you decide to go with a huge player like Oracle, SAP, IBM or PeopleSoft, there is always a risk.

"IT buyers spending in excess of $1 million should conduct a detailed background investigation of the vendor, its management and its salespeople," Jack Vonder Heide, president of Technology Briefing Centers, an IT risk assessment firm based in Oakbrook Terrace, Ill., says.

Financial Checkup

The first stop in a background investigation is a check on the financials. If the vendor is privately held, then you will have to take a leap of faith and trust the information that is provided to you  no small feat post Enron, WorldCom, et al.

Fortunately it is very difficult for a vendor to fiddle with the cash item on its balance sheet, Vonder Heide says. "It's easy enough to manipulate if you want to hide cash for tax avoidance purposes, but it is next to impossible to create cash."

Basically, you don't want a vendor with a low cash buffer of just one or two million dollars. Instead, look for a company that has at least $30 million in available cash.
Also check to see if the vendor is laden with debt, Vonder Heide suggests.

Other measures to look at include the percentage of revenue that is plowed back into research and development, who are the major customers and are they experiencing trouble, and how much revenue is made from license fees versus services.

The People Involved

Especially if the company does not have much of a financial track record, the strength of the vendor's management and other key employees is very important.

"Basically you want to figure out, does the management have a spine," ESYNC's Ryan says. "Will they do what they say they will do?"

Vonder Heide warns prospective buyers to look out for management that has a history of changing jobs as a team, instead of devoting energy to building a long-term, successful company.

"What we see in many cases is that a vendor will hire a key executive, typically a CEO, who will be under tremendous pressure to fill up the management suite very quickly. He or she will typically reach out to individuals known from past lives."

This is not uncommon and usually indicates a solid management team, he says. Indeed many companies have an executive suite that is loaded with a CEO's friends and former colleagues. The downside, though, is that one executive might jump ship and take the others with him or her. "A buyer needs to look to see if there is this kind of risk," he says, citing the most recent example of Qwest.

Vonder Heide also suggests that a company take a look at the vendor's sales staff. "We always recommend that anyone considering a substantial IT investment investigate the backgrounds of the people they will be dealing with on a day to day basis. Does the salesperson have a history of over-promising and not delivering?"

Searching lawsuit records, not only under the sales person's name but also under his or her previous employer, is not very hard and can yield some interesting findings, he says.

"Our experience in doing these sorts of searches is that, in about a third of the cases, we uncover situations that prompt further investigation."

He cites one instance in which the previous employer of the vice president of sales had a class action suit filled against it for not following through on promises made.

Quality Partnerships and Clients

Look at the quality of partnerships a vendor has with other companies, Gartner's Herschel says. "If the vendor is committed to having in-depth relationships with its partners it will usually dedicate one employee to maintaining just that relationship." So if a vendor has one employee managing several relationships, then most likely that person is either grossly overworked or just generating press release partnerships.

He also advises a company to look at the quality of the vendors' customers  and not to be misled by any blue chip company names. Companies like "AT&T, for example, will typically have multiple relationships with vendors in the same space. What you need to look for is the depth of use of a certain application. If a vendor started with one group and then expanded the use of its application throughout the enterprise then that is very impressive."

On the other hand, if the vendor has stagnated in one division, it might be that it doesn't have a good strategy of pushing further into that company.

Look for Potential Mergers or Acquisitions

Okay, this one not even a vendor's employees can do reliably, but it is important to consider the possibility, Herschel says.

"Build scenarios about potential acquirers, and consider the implications for the vendor's product and services in each case," he instructs. For some clients "expressing concern or favor of a different acquisition scenario could well impact the vendor's decision, whether it will admit to that or not."

The rationale behind a particular acquisition could range from a company that wishes to expand its functionality or product line to a company that finds it easier to buy their competition than beat it. In the latter situation, the user base is out of luck, because the acquiring company will either discontinue the application or simply neglect it until it becomes obsolete.

Rob Novick, vice president of North Highland and manager of the company's Denver office, recounted the history of one firm called Systems Techniques, which marketed an ETL (extract, transform and load) data warehousing application. It was acquired by Prisms Solutions, which "basically bought it to take it off the market," he says.

As it happened, Prisms Solutions was acquired by Ardent Software, which was in turn purchased by Informix, which then got bought by IBM. All together, this series of transactions took place within three years, he says.

But not counting such extreme examples, an unexpected acquisition can be disruptive in more ways than one. "Maintenance fees can go up suddenly, and service levels decrease," Novick warns.

In truth, there is little a client can do to prevent the acquisition of a strategic vendor, short of purchasing the company itself. However, there are steps a company can take to minimize any negative fallout that might occur. Before it licenses any software, a company should include in the contract with its vendor a clause that puts a copy of the software code in escrow, Novick says. "That way, later on if the vendor is acquired or goes bankrupt, at least you have a copy of the software. It gives you a lifeline for a little while."

Where Is It Going?

In the end, though, it is the big picture that counts  what is the vision or direction in which the vendor is going?

"A lot of the time it is not a question of whether that vendor will be around in three years, but whether or not it be operating in the space you want it or expect it to be," Jeetu Patel, executive vice president of research at Doculabs, an independent industry analyst and advisory firm, says. "Make sure they are going in the same direction, embracing the same technologies and have the same vision of your industry as you do."

SIDEBAR: Have a Backup in the Wings & At Least in Theory

Since you are going through the trouble of vetting a prospective IT provider, you might as well do it for a short list of companies  if for no other reason than to put yourself in a good negotiating position when it comes time to dicker with the vendor about the price, according to Jane Disbrow, Gartner research director.

She tells of companies that stop evaluating other vendors, thinking a deal can be reached with a particular company. But it is at this point that companies lose their leverage with the vendor. "That's a common mistake," she says.

This rather basic rule of negotiation has become ever more important in recent months as software vendors have introduced new pricing models that many buyers are finding confusing, according to Steven Bonadio, a senior program director with the META Group.

"There is a move away from traditional per-seat pricing to role-based, value-based or site-license pricing," he says. "At the same time, many vendors have begun repackaging applications to reflect different concepts to incent the buyer to buy more that way."

Lenny Riley, director of business services in AMR Research's Contract Negotiating and Benchmark Practice, a separate service that negotiates with software vendors on behalf of clients, says he has seen complicated software pricing models develop in recent months that are based on everything from revenue, order lines, payroll records, cost of goods sold, total cost of goods sold, number of servers and value of transactions.