Global CIO: Where Do Oracle's Profits Come From?

Oracle's quarterly numbers show all of its profits came from "software license updates and product support"--aka 22% maintenance fees--and only 20% of its revenue came from actual software sales.

Bob Evans, Contributor

September 17, 2009

4 Min Read

Oracle continues to grow faster than our competitors. In the quarter, we also increased GAAP and non-GAAP operating income by $209 million and $144 million respectively over last year’s first quarter and we delivered the highest Q1 non-GAAP operating margin in our history, 46%, substantially higher operating margins than our peers. I want you to understand that though keeping expenses in check is part of our margin story, the real contributor is that as license updates and product support are a larger percentage of the quarter as they were in this quarter, the operating margin percentage goes up. This is clear as our software license update and product support revenues, which were over $3.1 billion this quarter, continued to grow off their very large base. Our customer renewal rates and satisfaction levels continue at record highs.

Catz didn't offer any detail on those renewal rates or satisfaction levels, but as I've said before, Oracle should charge what the market will bear—and if the market bears 22% and Oracle customers feel that's a fair price for the value Oracle is delivering, then bully for Oracle and for its customers. Most people are smart and will not put their money where it is not delivering a good return.

But—it is also possible that Oracle customers feel that at this time they don't have viable options to switch away from Oracle, and that while they are frustrated by the 22% fees and do not feel they're getting good value in return, the lack of options is forcing them to bide their time.

From many many conversations with CIOs, I believe this latter scenario is the real story. If that is indeed the case, then Oracle's playing a dangerous game of "Chicken," hoping that no viable alternatives emerge in the near term while dawdling its way along with its own leisurely cloud initiatives, which are most unlikely to provide the fantastic financial returns that the on-premise model currently does.

And here's a bit more from Catz on those annual fees and their meaty margins, which are propping up the entire company—first the question from an analyst, and then Catz's answer:

[question from Sara Friar of Goldman Sachs] Safra, can I ask you on the sustainability of the margin improvement, clearly in an improving environment we should start to see license revenue as a percentage of total begin to increase again. Do you still think you can put up those types of year-over-year improvements as the environment improves and clearly the maintenance of the portion starts to go down?

[Catz's reply] Well, there's two things -- one is the maintenance as a portion in different quarters isn’t as dramatic. The maintenance base, which is existing customers who want the newest version of the software without having to re-buy the whole license again, you know, that base continues to grow period. So that’s obviously one piece. The other thing is just the general leverage of our business and that is our regular—you know, revenues do increase and faster than our expenses increase because it’s a business in which scale is a huge advantage.

Not a bad answer from Catz—certainly a whole lot better than 9 months ago when she said that Oracle keeps winning new customers who sign up for annual maintenance contracts "and as the number gets bigger and bigger it is really impossible for us to actually spend our way through it."

So is Oracle a services company that also happens to sell some software that Oracle surrounds with relatively expensive services? Does it matter either way? Yeah, I think it does, because within a few months Oracle will become a hardware company as well with even more software assets, and at that time it will be extremely important for Oracle to be perfectly transparent about all those questions we asked earlier: where its revenue comes from, where its customer value is based, and where does the profit come from.

Because while it's true that as JD the CFO says "a dollar's a dollar," this analysis of Oracle's business model shows that some dollars are a whole heckuva lot more precious and valuable than others.

About the Author(s)

Bob Evans

Contributor

Bob Evans is senior VP, communications, for Oracle Corp. He is a former InformationWeek editor.

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