In the enterprise technology industry, the most noteworthy IPO of the year so far is one that didn’t happen — Globoforce. As a category leader in rewards and recognition, its IPO was anticipated to be a landmark moment — the first major publicly traded company in the category. However, when the company abruptly postponed its IPO on March 20 citing unfavorable market conditions, many people in enterprise technology circles were confused. We believe it’s important to explain what’s going on at all levels, and we hope that this analysis will bring some clarity and sanity to the discourse. Want to learn more? Download the full Industry Bulletin from The Starr Conspiracy Intelligence Unit.
Before looking specifically at the Globoforce S-1, it’s important to understand the company’s category and its place in it. We believe that recognition has significant potential to improve employee engagement. Upstart brands have garnered industry attention by connecting this idea to sexy topics such as social technologies and engaging Gen Y employees. However, the rewards and recognition industry isn’t a new one. Many heritage brands in the category are 50 to 100 years old, and most started out as manufacturers of the proverbial gold watches.
- The heritage brands: Companies such as Inspirus, O.C. Tanner, Rideau, and others established the idea of using rewards for recognition and usually have significant investments in manufacturing and fulfillment. These companies are typically privately held, profit-focused enterprises.
- The upstart brands: The technology startups such as the two category leaders, Globoforce and Achievers, promote the social and peer-to-peer aspects of recognition as a means to drive engagement. These companies function like fast-growth tech startups and focus on grabbing market share at the expense of profit.
One key distinction between the two groups is in their billing models and how they recognize revenue. Every company has its own spin on this, and no two are alike. Understanding the differences is important to understanding the complexity of the model. Generally speaking, there are two primary billing models:
- Billing on issuance. Globoforce and Achievers use variations on this billing model. In this scenario, a client typically either purchases or negotiates “points” from a vendor upfront or budgets for a set amount. Employees can earn points that can be redeemed for gift cards or merchandise. This model makes it easy for clients to budget. It’s also favorable for fast-growth startup companies because they can recognize the revenue immediately. The vendor also likes this model because it gets to keep the “breakage” — the unredeemed value of the points. It’s generally accepted in the industry that 10 to 15 percent of all points are never redeemed because of turnover, people forgetting, leftover points, etc., which creates pure margin for the reward vendor. And it can even be a slightly higher percentage — close to 20 percent — for gift card rewards. The downside is the reward vendor is on the hook to pay. This risk can create the scenario of what happens in the (unlikely) event that all of the unredeemed points were suddenly redeemed — a “run on the bank” of sorts. How unlikely is this? About the same risk as your homeowner’s insurance company not being able to pay you because everyone they cover filed a claim at once. We believe that buyers should understand what they are getting. We believe that any vendor with a deferred cash liability issue can address the issue in one of two ways:
- A cash reserve. For other companies in this category, a secure cash position will go a long way toward heading off market concerns.
- An investment algorithm. The odds of a proverbial “run on the bank” are fairly slim for any rewards and recognition company. However, it is a concern that comes up with investors during transfer events, and we feel that the industry needs to address this issue. One solution is an algorithm — not unlike the ones insurance companies use to account for risk — to predict the likelihood that a certain number of points would be redeemed at a given time.
- Billing on redemption. Most heritage brands use this model. In this scenario, a client only pays when points are redeemed (cashed in by the end user) for gift cards, merchandise, cash, or travel and any breakage goes back to the client. If an employee doesn’t redeem points they earn, the company essentially gets the points for free, so the reward company has an incentive to get employees to use the points. Although this relationship is great for the client, it’s a much more difficult for the reward vendor because much of the profit in a deal isn’t realized until several years into an engagement. There is no cash liability to the vendor if they maintain the customer relationship.
How does this impact the rewards and recognition segment?
In the battle for market share in the recognition category, the upstarts may lack the resources of heritage brands, but they are winning the battle for hearts and minds by positioning the establishment as technology laggards. Even though heritage brands are working to hold their own and develop technology that is often much better than the upstarts, the majority of the headlines still go to Globoforce and Achievers. How does the race to grab market share and win the category now stand and what do the players need to do now to seize the initiative?
For Globoforce, it will be important to change the conversation and regain momentum. Globoforce needs to establish a go-to-market narrative that makes sense to investors: Decide whether you are a rewards company or a tech company and then be that. With its current financials, the company is telling the story of a rewards company. If it wants to be a tech company, Globoforce needs to increase clarity in its financials and clarify how software subscription, services, and reward redemption revenue (including breakage) are delineated. Cutting sales and marketing budget to make the numbers more suitable for investors would not be a formula for success. Even after everyone viewed the “lack of suitable market conditions” rationale with skepticism, it turns out that there’s a lot of truth there. As The New York Times pointed out on Sunday, it’s currently a turbulent market for IPOs and there is evidently some investor fatigue around cloud software in general. Globoforce has an opportunity to educate the market on the rewards and recognition category and explain why it is so dynamic. You can always tell the pioneers by the arrows in their backs. Globoforce has certainly taken theirs. How Globoforce responds will not only determine how the company fares in having an IPO this year, but it could also have a broader impact on the market for HR technology and services companies.
For Achievers, they have an opening for now in the race to win the category. With no announced plans for an IPO and the benefit of not having financials to scrutinize, they can see where some of the land mines are in the market when and if that day comes. In an interview, Achievers founder Razor Suleman said that he believes his company understands the issues and took steps to address them when they became a Sequoia Capital portfolio company in 2011. “We believe in the power of social recognition so much so that 64 percent of recognition on our Employee Success Platform is non-monetary,” he said. But is changing the company’s focus to recognition from rewards the right course — and will the market get it? “Even if you disassociate yourself from the rewards, the customer is still going to hold you responsible. That’s the reality,” said Peter Hart, CEO of Rideau Recognition Solutions.
For heritage brands in the space, they have become accustomed to the increased scrutiny over the past few years as the IRS has taken a closer look at how reward programs are taxed. Most of the CEOs at leading companies in the category who we have spoken to actually welcome the increased oversight because they feel it will weed out some of the more unscrupulous companies in the space. However, the billing issue isn’t one that any of these companies can ignore. Any company looking to sell or be acquired is going to go through the same due-diligence process and face the same intense scrutiny over revenue recognition as they would in an IPO process. These companies also have a different take on winning the category. They want to grab market share, but they are about profitability, not navigating toward an exit. They will never overspend on sales and marketing at the expense of profit. As a result, expect lots of FUD — fear, uncertainty, and doubt — to find its way into sales and marketing messaging. The heritage brands that have been suffering on the other side of the messaging and positioning divide may have finally found an issue — proven business continuity, stability, and profitability — that will help them regain an advantage against the upstarts. “If nothing else, this situation reinforces the idea that rewards and recognition isn’t a software play,” said Paul Hebert, a thought leader in the rewards and recognition industry and a vice president of solution design at Symbolist. “There’s an intangible factor that can’t be put into bits and bytes and can’t be factored in. And the revenue potential from rewards far outweighs the potential from the software part.” Although we don’t share this point of view, it’s hard to argue against this perspective until a tech-first company shows they can succeed leading with software rather than rewards.
Want to learn more? Download the full Industry Bulletin from The Starr Conspiracy Intelligence Unit.