ShoreTel goes big in hosted VoIP: A Q&A with CEO Blackmore

ShoreTel, which made its mark in IP telephony by simplifying unified communications and reducing total cost of ownership, recently broke into the hosted VoIP business with the acquisition of M5. Network World Editor in Chief John Dix caught up with ShoreTel CEO Peter Blackmore to find out how integration of that company is going and where he is taking the company.

You've been CEO for almost two years now and the largest development in that period was the acquisition of hosted VoIP supplier M5. Why did you acquire them and what have you achieved since?

Last year in June we discussed with our board the changes in the market and the growth of voice-over-IP in the cloud, and we agreed that ShoreTel, notwithstanding the continued strong growth in the premise, would need a cloud solution.

The issue was, do we buy or do we build? We knew we could build a cloud platform, but the time it takes to build it, scale it, get the data centers running, get new accounting systems that do very different sorts of billing than we do, it's a three-plus year exercise. So we decided to buy.

BACKGROUND: ShoreTel Mobility release showcases M5 cloud capabilities

The reason we decided to buy is when the market starts accelerating to the extent cloud is, there's a window of opportunity where you can find good targets and you can also afford the target. So we think we got the timing just about right.

There are 80 voice-over-IP cloud companies in the United States alone and we talked to 25 of them, not as targets, but to learn and to understand their business model and understand what worked, what didn't work. Then we talked seriously to nine companies and selected M5 by November. Between November and January we did the term sheet and closed on March 23. So it was a very diligent process.

Why M5 versus anybody else? We wanted a company with their own intellectual property. One of M5's attributes is they can link Salesforce.com in the cloud to their voice-over-IP in the cloud; you can share data. That is a very sticky application and there are many more you can add by building a network of apps and linking it to voice. You cannot do that unless you have your own IP.

The business model in cloud is totally different to premise. You ask a customer to pay monthly one month ahead of their usage. Therefore, it takes about two years to get the return on your investment, and for that to be a good investment you need the lowest churn rate and the highest ARPU [average revenue per user]. M5 has an ARPU in excess of $60, which we believe is the highest in the industry, and a churn rate of 0.2% per month, which we believe is the lowest in the industry. So that was two of the key factors.

We then asked, "Is it a proven business? Do they have a proven management team? Are they ramping?" And they were doing all of the above, so that's why we chose them. We've had our first full quarter with them, which was the June quarter, and their bookings gross was 43% higher than the previous year, which is excellent. And they're doing very well, so we're delighted.

M5 was one of the earliest players in this market. Given they've been around for so long, frankly I'm surprised they are only adding about $15 million in revenue to your books. Have we not turned that corner in the growth curve of this whole hosted VoIP business yet?

Well, if you look at the competitors to M5, you don't have the normal names we associate with the premise. For example, we don't see Cisco and we don't see Avaya. There are smaller player and most of them have been in business for 10 years. So that was my point about when the market starts really taking off, you need to get in at the right time. We think the timing is right.

How many customers do you have on the hosted side now?

About 3,000. The average number of seats is 40.

So the typical hosted user is a smaller shop. Do you see that changing over time?

It's interesting. When we were negotiating with M5 their average seat size was 30. It's now 40, so it's increasing. Our biggest customer is a human resources search agency and they've got 2,000 seats. There's no glass ceiling here. You can have bigger and bigger customers. The profile is steadily increasing, and that's why we think the M5 market is more interesting than competitors such as 8x8 and RingCentral, who have less than 10 seats on average. We're at the 40 level and it's a business customer with lower churn, higher ARPU, so we think it's the right place to be.

Your annual report says your profit margin is lower on the hosted side than on the customer premise side, which seems counterintuitive, no?

Hosted customers have a choice of either a pure Web connection or a T1 connection to improve voice quality. The vast majority ask us to provision T1 and therefore it reduces our overall margin. Over time, I think that will go away because the quality of the Web telco will steadily improve.

Speaking of time, although the hosted business is a fraction of your customer premise business today, looking out five, 10 years, does that flip-flop?

IDC says that by 2015 the voice market for premise and the voice market for cloud will be equal at $15 billion. And then on top of that you've got to add the UC market, which will be split between the two, and that would be an additional $12 billion. So you've got 15 and 15 plus 12. That's the size of the market, and it is split 50-50. So it doesn't flip but that's cloud catching up fairly fast with premise.

Is M5 fully integrated at this point or is there still work to do?

We're on track. The first step was to integrate finance, human resources and information technology. That was done in the first three months. We're now in the process of integrating engineering and we've been public about that with employees on both sides. We'll have a fully integrated roadmap and a fully integrated engineering team by December.

Our plan is to keep go-to-market separate because if you have a SaaS product and a hardware and software product, very rarely can a sales team sell both well, so it's better to keep them separate. We do share lead generation, but everything else will be integrated by December.

How about the hybrid world? Is there a need for a mixed premise/cloud solution?

Yes, and we've actually allocated some serious engineering talent to develop a hybrid architecture. That was put in place a couple of months ago. The reason you need a new architecture is for all of the security and other needs, and making sure the apps operate seamlessly. For example, if you're running a conferencing app you don't need to know whether it's being served through the cloud or served on-premise. So we are working on that. We think it's an exciting opportunity.

The first app will probably be out around July next year, and we can then also port apps that we currently have on-premise. So you can either sell a pure cloud solution, a pure premise solution or a hybrid. An application, for example, could be mobility in the cloud but everything else on-premise. Another example would be, you pick and choose around your facilities, like the headquarters could be on-premise because the CTO still believes that's the right thing, but all of the satellite offices could be in cloud and you could still do all your unified communications, sharing of information, it's seamless.

You guys built your reputation on unified communications and a couple of years ago you went out and bought Agito Networks for the mobility piece, so where do you hang your hat today? Do you still position yourselves as a UC company or lead with mobility or a blend of both?

We're still clearly a UC company, but UC is evolving and I think your question about mobility is a good one because the mobile user is extraordinarily demanding. They want the same set of facilities as if they were sitting at their desk and they had a sophisticated desk phone linked to Microsoft Outlook.

We've taken Agito's code, enhanced it a lot, and today we're winning a lot of premise sales because of our mobility capability. We also ported mobility to cloud and that was the first evidence you could port a premise out to cloud. We did it in 90 days and it's up and running and we've already got orders and people using it.

So what we're focused on is the experience of the mobile executive or salesperson or road warrior. Because we think that's the big win in UC applications going forward. We've got a very good reputation today for doing UC at the desk and also making it a very simple application to run from an IT perspective. What we want to do is have that brilliantly simple and high expectation of usability and the same sort of graphical user interface provided in mobile UC.

Do you get questions about mobility in most every engagement at this point?

Every engagement. And the interesting thing is our connect rate on desk phones has stayed rock solid. In other words, it's not like new customers are flipping from desk phones to mobile devices. They're keeping roughly what they would have bought in the past in desk phones, but they're then adding mobile devices so people have a choice. But very rarely do we get a sale now without the bring-your-own-device option, and people can pick an Apple or Android or even BlackBerry for that matter, but it's almost all Apple and Android.

Is the Agito code what is powering your mVoIP capability, which, if I understand it right, lets someone on a cell call walk into an office and have that call handed off via Wi-Fi to the VoIP infrastructure?

Yes, and that is one of our biggest selling capabilities, because it's a very good handoff, and the competitors don't always have such a good handoff. I use this every day. My home happens to have a pretty weak 3G signal, so I tend to use the Wi-Fi device in my home to support my mobile device, which is an iPhone. So if I'm on my cellphone at home and connected by Wi-Fi, when I leave to get in my car it flips to 3G, and when I get to the office it will flip back to Wi-Fi. So that is a big plus. It lowers your roaming charges and makes it very simple to use, and if you travel internationally at all it saves you a fortune.

It also gives you flexibility. Sometimes in hotels people are using a lot of data and the 3G circuits get overloaded so you can't get a signal or you get dropped. I just hook up to Wi-Fi in the hotel and then I'm up and running. So I'm often having a great conversation and I can see everyone else around me getting angry with their cellphone because they can't connect. It's a great app.

In terms of collaborative capabilities, where does video fit in?

It's an interesting subject because I think video is at an inflection point. Today we partner with Polycom and LifeSize, and in ShoreTel 13 we enhanced the connectivity so it's much easier to use, much simpler to set up. But I think there's a lot of cloud video capability coming of age. It drastically lowers the cost of connecting video, whether you're going tablet to room, tablet to tablet, room to room. We are looking at what we put in the cloud. We would not develop our own video there, we'd pick somebody else's video to save time, but we do believe cloud video is really cool. And then obviously if you could offer that as a hybrid, so a premise customer can then connect via the cloud, that's even better. The connectivity is perhaps not quite at the same level yet as it is on premise, but it's close enough that people will use it. So I think that's an area which is evolving very rapidly. [Also see: "Why video and the cloud don't mix, according to Cisco"]

You mentioned a few traditional competitors on the premise side, but you didn't mention Microsoft or Google. Do you see the competition changing? What do you make of Microsoft/Skype and Google going forward? Will they be more of a threat?

Well, Google has the capability, but they're not going to market on a unified communications approach. Microsoft is. They have Lync, which is quite good, but it's targeted at larger enterprises. It's also quite expensive if you do a fully loaded installation. And voice is not it's strength, the strength is UC. I'm sure they'll evolve that. I hear they're doing a lot of work on Skype. And we do, if you'll excuse the pun, link to Lync, so we can have a Lync/ShoreTel installation.

We don't lose business there, so it's either they go all ShoreTel or they have some sort of combo. But Microsoft could develop to be more effective in the small/medium market, but for the moment it's very enterprise focused. Enterprise being 10,000 seats and above. And Google, I can't comment on them because we don't see them as a competitor yet.

Last question: ShoreTel has posted losses for the last four years. What do you attribute that to and where do you go from there?

When I joined the company just under two years ago the company was growing at 30% quarter over quarter and the board said to the street, "We've got a product which has a 50% win rate, why don't we expand sales and marketing and capture market share." It was a great decision, the right thing to do, but clearly that limits your profitability.

Premise was profitable in quarter four last year, which just ended in June. We could deliver quite a lot of premise profit for this financial year, but we just bought this cloud company and it's growing much faster than we thought it would (I thought it was going to grow at about 30% bookings every quarter and it's already up to 43%), so I said to the investors, "Please just be patient because there's a land grab going on in cloud and I need a little bit of investment in the salesforce, and installations need to keep up with bookings so we need more provisioning capability. Not a big investment, but you need to do it."

And the investors are understanding that. So premise is now profitable and we don't need to increase R&D much there. The R&D spend is on hybrid and porting apps to the cloud, and then our cost is more or less increasing the ability to scale cloud. So the cloud will be very profitable because the recurring revenue stream model is inherently a very profitable model -- long-term more profitable than premise -- so that's why I think the investors are a little bit patient.

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