Making a splash in an already news-filled space is a daunting task. Yet, the RingCentral-Avaya strategic partnership announced last week certainly made a splash. The two companies already discussed certain partnership details here, here and here. Media coverage abounds, too: see NoJitter, Search Unified Communications and CNBC, among other sources. In short, the two companies will be joining forces to launch a new UCaaS offering named Avaya Cloud Office (ACO) by RingCentral in Q1 of calendar year 2020. Instead of rehashing the details already covered in the press releases and media, I will just share my opinion on the pros and cons of the deal and its significance for the rest of the industry.
Long Live the Cloud!
The loudest and clearest message in this partnership announcement is that cloud has won. It’s probably the first time in this industry’s history that a cloud-born company has invested in a premises-based solutions vendor. RingCentral was quick to proclaim the dawn of a new era as early as January 2017, marking the time when Avaya filed for bankruptcy. While the full demise of premises-based communications may never take place, cloud is definitely winning by all indicators: system vs services sales, customer investment plans, vendor valuations and so on.
- Frost & Sullivan research shows that global premises-based telephony system sales (in terms of both licenses and revenue) are declining annually at single-digit rates, whereas global hosted IP telephony and UCaaS services are growing annually at double-digit rates (in terms of both installed users and revenue).
- A 2019 global Frost & Sullivan survey shows that 40% of businesses using enterprise IP telephony have already moved part or all of their solutions to the cloud and another 46% plan to do so in the next two years.
- With over 100 million installed users, Avaya’s market valuation is $1.4B, whereas RingCentral with 2 million users has a market valuation of $14.4B
Why does the Street love the cloud delivery business model better than equipment and perpetual software license sales? Well, predictable recurring monthly charges, albeit from a small base, inspire confidence in a cloud company’s future. In addition to user base expansion, new services can be leveraged to upsell and cross-sell among existing customers, thus additionally boosting revenues. Premises-based systems also produce recurring revenues in the form of maintenance and managed services; however, Avaya reports that approximately more than two-thirds of its installed customers are un-monetized with respect to maintenance and managed services. Therefore, for Avaya, as well as most premises-based solutions vendors, growth is highly dependent on new sales, as well as upgrades or expansions to existing accounts. When the installed base, no matter how large, is churning to cloud, maintenance and managed services revenues cannot offset the drop in new sales. The imperative for Avaya and other PBX vendors to reposition as cloud providers has, therefore, been abundantly clear for quite some time.
Various options exist for premises-based vendors to make the shift to cloud. Internal technology development can help build a cloud portfolio; yet, most vendors, including Avaya, have stumbled on that route. Avaya made attempts in the past to develop its own UCaaS offerings. However, prior Avaya solutions were either based on older technologies reengineered to serve new purposes (e.g., Avaya LiveConnect) or efforts to build a completely new stack from scratch (e.g., Zang Office) that felt like “too little, too late”.
Avaya has, however, been much more effective in designing a cloud communications option for larger organizations and/or businesses with more stringent compliance, customization or integration requirements. Avaya ReadyNow is the latest architectural iteration of Avaya’s private cloud services.
M&A is another viable option that other vendors—e.g., Cisco and Mitel—have taken to reposition as cloud providers. The biggest challenge with that option is finding an appropriate target at the right price, and given Avaya’s ongoing strategic review and rumored expressions of interest in the business, Avaya leadership had to think out of the box.
Does this Deal Make Sense?
I have to admit that, at first, the idea of a strategic partnership sounded like a desperate move for Avaya to secure a cloud future and a puzzling choice for RingCentral to sustain growth in view of mounting competition. The partnership details that have surfaced have convinced me that this is a deeper and cleverer arrangement than a simple resale agreement and, yet, spares the two parties involved the complications and risks of an M&A transaction. Overall, careful consideration went into designing the partnership framework to ensure maximum benefits for both parties.
This partnership turns Avaya into a service provider without having to go through the complexities of becoming a local exchange carrier and securing carrier interconnect agreements in various markets. Also important, Avaya Cloud Office proprietary customer migration tools will both sustain Avaya’s customer ownership AND provide RingCentral with a unique hook into the Avaya customer base, through Avaya Cloud Office.
Avaya officials provided the following commentary: “Avaya could have built the technology to be competitive, but the important question was when. Two years back we made a commitment to move into cloud and to grow. All of the previous forays didn’t push the company far enough. That is why we stepped back and looked at options to redeem leadership. We wanted to act like a world-class company. This partnership aims to achieve this goal.”
Here follows a summary of the pros and cons, as I see them:
- A considerable investment from RingCentral without the brand loss or portfolio and staffing uncertainty of an M&A transaction. The RingCentral investment in the form of preferred equity and payment in advance of future sales demonstrates their commitment to the partnership and provides much needed funds for Avaya to invest in the business and boost growth. Avaya also announced actions to create shareholder value (through authorization for a $500 million share repurchase program) and paydown of $250 million in debt. Avaya plans to further invest in technology and innovation to continue bringing state-of-the-art solutions to its customers and partners. The market reacted very positively to the news and Avaya stock rose by 30.7% the day of the partnership announcement.
- A differentiated new UCaaS offering leveraging RingCentral’s proven platform, but with an Avaya technology and services wrapper. The potential Avaya customization of the RingCentral solution enables Avaya to preserve its brand equity and provide unique value to its installed customers through a more familiar user experience, migration and onboarding services, and so on. Avaya deliberately chose RingCentral’s platform for its robust functionality, which will allow Avaya to jump-start its UCaaS operations and leapfrog a large number of other UCaaS providers that have competed in this space for years. However, Avaya will work with RingCentral and leverage preferential access to RingCentral APIs to add unique capabilities that will be sitting on top of RingCentral’s main code base.
- The most unique and valuable aspect of the partnership is Avaya’s ability to develop customer migration tools that will be available only through the Avaya Cloud Office admin portal. Migration tools will be critical to extract user and device configuration information and integrate the new solution with Avaya’s newest as well as legacy devices. Communications endpoints represent a considerable cost item and decision-making factor in solution upgrades and forklift replacement projects, which determines the importance of customer ability to retain existing devices to protect their investments. RingCentral will not have access to all the migration tools.
- The partnership creates a new revenue opportunity for Avaya and its channel ecosystem as the company fills the tangible gap in its solutions portfolio. Analyzing how the financials (e.g., profit margin) of this partnership compare to the business case of an internally developed solution is a moot point given that Avaya does not have a proprietary public cloud offering, instead sells Avaya PoweredBy IPO, a multi-instance solution.
- Per the agreement, the only way to purchase ACO will be through Avaya or an Avaya partner. RingCentral will not be selling the new solution. Avaya will handle the marketing, demand generation, pre-sales and order placement processes, its name will appear on the customer bill, it will be in charge of renewals and will also provide tier 1 support. Avaya’s channel loyalty program will keep Avaya ahead of RingCentral in the pursuit of its own customer base for migration to UCaaS. Support and certification benefits in the Avaya Edge Program will not be available to RingCentral. This enables Avaya to retain a high degree of customer ownership and control over the relationship.
- Avaya has been looking to increase its desktop phone penetration among UCaaS providers. This partnership creates an opportunity for Avaya and RingCentral to pair Avaya phones and other Avaya endpoints with the new offering, as well as sell Avaya devices with RingCentral’s own branded solutions.
- The new Avaya Intelligent Xperiences (IX) Subscription Program (an OPEX model) will help bridge some premises-based and UCaaS deployments, and enable less disruptive customer migration to the cloud, as well as power hybrid environments.
- With Avaya lacking direct touch (via maintenance or managed services) with more than two-thirds of its customers, the partnership facilitates RingCentral access to the huge untapped Avaya base, which lowers customer acquisition costs. The future Avaya technology and services wrapper (e.g., migration tools) is likely to also accelerate customer conversion, as well as ensure greater customer satisfaction, potentially reducing churn.
- While RingCentral has always been free to attack the Avaya base (and has done so for years), this “exclusive” partnership provides it with a preferred-vendor status, as well as potentially with access to Avaya’s international customers and channels (4,700 partners), which would otherwise be difficult for RingCentral to reach.
- By co-branding the new solution with Avaya, RingCentral is likely to gain a considerable brand boost—in terms of both awareness and trust. The partnership validates RingCentral platform and feature set leadership in the UCaaS market.
- By only acquiring a minority equity share in Avaya, RingCentral retains the ability to report separately (a bigger stake would have required consolidated financial reporting) and remain true to its business model as a pure cloud provider.
- Per the agreement, RingCentral will recognize all revenue and make initial and recurring payments to Avaya (to be accounted for as a sales and marketing expense). If the partnership is successful in driving accelerated conversion of the Avaya base, RingCentral will see a considerable boost in its already fast-growing revenue and/or maintain high growth rates despite advancing market maturity and intensifying competition.
- Businesses—both Avaya’s existing customers and net new accounts currently using third-party premises-based or cloud solutions—will have a new, compelling public cloud option available to them.
- Avaya customers, more specifically, will have a smoother, more cost-effective migration path to a public cloud solution: The two companies are pledging to make it easier to transition from legacy Avaya solutions to the ACO UCaaS product, including the ability to transfer on-premises databases, configuration settings, integrations and user profiles to the cloud. The offer will also work well with Avaya phones and devices.
- Avaya’s robust implementation, integration and other services will be key to ensure deployment success for many businesses that require more extensive support.
- Per agreement, resellers selling both RingCentral Office and ACO will be free to choose the solution that best addresses their customers’ needs. Avaya and RingCentral agree to not engage in price wars to win such deals.
- RingCentral is touted as the exclusive UCaaS provider to Avaya customers. However, customers are and should be free to choose. RingCentral will be the exclusive technology provider for an Avaya-branded UCaaS solution, which naturally leaves a lot of room for customers to choose other, non-Avaya-branded, options, as well as Avaya’s private and hybrid cloud offerings. But what if Avaya wants to develop its own solution or acquire a third-party technology in the future? The contract term length is presently unknown.
- Avaya will use RingCentral’s investment and its own capital to repurchase up to $500 million of its outstanding shares and repay approximately 8% of its outstanding debt. It should be noted that the reduced debt will also result in substantial annual interest savings. In theory, other potential options speculated about in the market (M&A, merger or go-private) may have had a larger near-term financial impact to Avaya.
- Avaya has been working hard to form partnerships with UCaaS providers to resell its phones. What happens now as Avaya grants RingCentral preferred status to target its customer base? It is possible that other UCaaS providers will be less likely to partner with Avaya to use its phone portfolio as they will see the vendor as their direct competitor. How much in potential phone sales opportunity would be lost?
- The two companies WILL butt heads on who gets to own the customer. They already disagree on how to classify the relationship. Despite carefully designed rules of engagement, should any particular deal go sour, customer ownership will come into question.
- Avaya Cloud Office customers will be hosted and managed on the core RingCentral platform rather than as a separate instance. The benefits include simplified management and commitment by both parties to the core value of the platform as well as to the partnership itself. However, this raises questions about how much the new offering can be customized and/or custom-integrated with third-party solutions to address specific Avaya customer needs. In effect, it limits Avaya’s claim to customer ownership.
- At launch, Avaya cloud contact center solutions will only be available over the top for Avaya Cloud Office customers. Eventually, access to RingCentral core platform code is likely to enable the integration of Avaya CCaaS (e.g., newly launched Avaya IX CC) and CPaaS offerings with ACO.
- Avaya customers and partners may be confused about how IP Office and ACO are differentiated and positioned. Avaya commits to carefully evaluate both solutions and their market performance going forward and postpone the decision about which one to position as its flagship UCaaS offering.
- Avaya and RingCentral will continue to compete as separate entities and may sometimes bid against each other or need to walk away from a deal to avoid conflict. Despite contract non-compete clauses, future conflicts are inevitable.
- The assumption that the new offering will immediately become available to Avaya’s global customers and partners is incorrect. ACO will be available in the U.S. first and will only be available for purchase in the markets where RingCentral has a legal entity and a LEC status—i.e., where it presently sells its own RingCentral Office solution. Naturally, as any VoIP service, the new offering can be extended to users in practically any country around the world, but the purchasing entity needs to be based in RingCentral’s countries of presence. That said, both companies will work together to evaluate new market entries based on a variety of factors.
- The struggles of all former PBX vendors to transform into cloud communications providers begs the question whether it makes business sense to keep premises-based and cloud portfolios under the same roof.
The future will tell how this partnership will affect Avaya, RingCentral, their ecosystems and their competitors. But we can safely say that, with Cisco acquiring BroadSoft and Avaya partnering with RingCentral, the business communications market has crossed its Rubicon.