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CloudStrat: Managing Migration to the Cloud

Introduction
CloudStrat places players in the role of the chief strategy officer of LegaSoft, a large global
software vendor. LegaSoft is a market leader in the enterprise resource planning (ERP) market.
ERP software is a suite of applications, including financials, manufacturing, human resources, and
other modules that together automate the back-office business administration functions of an
enterprise. LegaSoft has traditionally sold “on-premise” ERP software, which is installed and run
on computers on the premises of the organization that buys it, based on a perpetual license model.
However, a disruptive competitor has entered the market. This competitor, called NetWare, offers
similar products but uses the software as a service (SaaS) model to deliver its software. The SaaS
model, also known as the “cloud computing” model, typically has a faster deployment time and a
lower cost of ownership than on-premise software. NetWare has been in the market for a few years,
and its offerings have been well received by customers. To compete with NetWare, LegaSoft
created its own cloud-based offerings. LegaSoft expects that a significant percentage of its legacy
customer base will migrate to these SaaS products. The migration will most likely proceed at
different rates for different modules, different markets, and different segments.

As LegaSoft transitions from the legacy software model to the SaaS model, its SaaS offerings
will potentially cannibalize its legacy offerings. This cannibalization will hurt revenues and cash
flows because customers pay smaller annual subscription fees in the SaaS model as opposed to
large up-front payments in the legacy model. On the other hand, if LegaSoft does not aggressively
compete in the SaaS space, its market position will gradually erode. LegaSoft’s success ultimately
hinges on its ability to navigate this migration to the cloud, by transitioning its business model to
take advantage of the SaaS opportunity while protecting the profits of its legacy business for as
long as possible.

The Market for Enterprise Software

Enterprise software has traditionally been sold and deployed using an on-premise model, in
which firms purchase the software and, in a lengthy process, install and customize it, deploy it
across their organization, and maintain and support it with their own dedicated staff of highly
specialized engineers and support personnel. The software requires a large up-front investment in
a software license, in addition to annual fees for access to upgrades and technical support. To

©2019 by the Kellogg School of Management at Northwestern University. This case was prepared by Professor Mohanbir Sawhney.
Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data,
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customize the newly acquired software, in-house development staff and/or technical consultants
spend months developing requirements and building and testing the software to the business users’
exact specifications. The in-house technical staff then integrates the software into existing systems
(where appropriate), deploys it across the organization, and provides ongoing support for it. All of
these up-front costs—software, hardware, technical expertise, and development time and
resources—are paid for and classified as a capital investment before mainstream business end users
have extensively used the software. This approach works well because the typically seamless
integration with existing systems and business processes enables businesses to reach higher rates
of productivity and operational efficiency. Moreover, the ability to house and protect sensitive
customer and business data enables organizations to protect customer privacy and business data
integrity. On the other hand, in many cases business software is underutilized by employees
because it may be complicated, difficult to use, or not functionally aligned with business needs,
leading to wasted time and money.

Although this traditional on-premise model still has significant market share, the rapid growth
of cloud computing represents a growing threat to this model. The SaaS market began to emerge in
the late 1990s, when players such as Salesforce.com began to deliver enterprise software over the
internet, accessed using a browser rather than hosted and maintained on the company’s own servers.
SaaS also differs from traditional on-premise software in that customers’ data is stored in the
providers’ data warehouses. Delivery via the provider’s infrastructure reduces the need for the
purchasing organizations to invest in and maintain databases, application servers, hardware, and IT
staff, which some SaaS vendors argue lowers overall cost of ownership. Unlike traditional
enterprise software, SaaS requires no up-front costs or investments for unproven software projects
and can be rapidly deployed throughout an organization. The up-front licensing and maintenance
fees are typically replaced by a per-user per-month license fee, and tiered pricing plans offer
different levels of functionality so that companies only pay for what they really need. The nature
of this model allows firms to classify the software as an operating expense rather than a capital
investment that must be depreciated over time. Upgrades occur automatically during short windows
of planned downtime and eliminate the need for timely and costly software upgrades to individual
computers.

There are trade-offs in adopting a SaaS solution. It is difficult, sometimes impossible, to

customize SaaS applications to a customer’s exact needs, including integration into other legacy
systems and business processes. Additionally, given the relatively standardized nature of SaaS
applications, it is difficult for a firm to use SaaS software to create a competitive advantage through
customization. Other points of concern are security, system uptime, and portability of user data.
Moreover, SaaS platforms tend to use different, sometimes proprietary, programming languages,
which can lock a customer into a particular platform. Industry players have recognized and
addressed most of these issues, however.

SaaS vendors initially targeted small and mid-sized businesses for their applications for two
reasons. First, smaller companies typically do not have (or do not want) the in-house IT staff to
build, deploy, and maintain complex enterprise software, so they like the value proposition of not
having to deploy and maintain enterprise software. Second, smaller companies tend to lack the
financial resources to make large capital investments, so they like the fact that they can pay for
SaaS software on a monthly subscription basis. As the SaaS model gained credibility, however,
SaaS vendors made inroads into large enterprises. This trend is likely to accelerate as SaaS becomes
the preferred model for software deployment for all types of companies and applications.

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Migrating to the Cloud

Your task is to help LegaSoft navigate its entry into the SaaS market while protecting the
revenue streams from the legacy business. Although LegaSoft has already made some headway
over the last two years, you need to build on this position in face of stiff competition from NetWare.
Provided with the past two years of data, you have to make strategic decisions that will determine
the success of LegaSoft over the next five years.

Your task is fraught with challenges and risks because the SaaS business requires very different
capabilities and, from a revenue and margin standpoint, behaves very differently than the traditional
on-premise model. For instance, you will need to decide how much to invest in server capacity and
performance for the SaaS offering. You will need to decide how to allocate R&D spending between
SaaS and the legacy software. You will also need to invest in platform development to make the
SaaS platform attractive to third-party developers. And you will need to decide how much to invest
in different sales and marketing channels to create awareness and preference for your SaaS offering.
These channels include physical channels, such as in-person selling and events, as well as digital
channels, such as owned and paid digital media.

You will also need to make decisions about launching a new module for human capital
management (HCM), an emerging new product category within enterprise software. For HCM, you
will need to choose between developing the module internally and buying a startup company called
HumanSoft, which has developed a module for HCM. If you develop the HCM internally, it will
cost you less and it will be easier to integrate the HCM module with your core ERP module.
However, it will take more time and you may lose out on the market opportunity. If you buy
HumanSoft, you can get to market more quickly but you will spend more money, including the
additional cost of integrating HumanSoft’s product into your suite. The longer you wait to make
the acquisition decision, the more expensive the acquisition becomes, as HumanSoft’s valuation is
increasing over time. But if you buy HumanSoft too early, your integration costs will be higher, as
the product is not mature. Keep in mind that NetWare is also working on an HCM module and will
compete for market share for this module.

While making all these decisions, you will need to balance the cannibalization of the legacy
business against the growth of the SaaS business. Your decisions will ultimately determine the
ability of LegaSoft to compete and survive this difficult business model migration.

Customer Preferences
In making your R&D decisions, you will need to think carefully about how investments in
product and platform development affect demand for your products. This requires you to
understand the customer preferences for different product attributes. Table 1 shows the relative
importance (on a 10-point scale) that customers place on different product attributes for the legacy
software as well as the SaaS software:

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Table 1: Relative Importance of Product Attributes for Customers

Product Segment Usability Feature Richness Reliability

SaaS Enterprise 5 8 9

SaaS Mid-market 7 5 8

SaaS Small 9 3 5

Legacy Enterprise 3 9 9

Legacy Mid-market 5 5 7

Legacy Small 7 4 6

Usability refers to the ease of use of your product. Small business and mid-market customers
are more sensitive to this attribute, as they want products that are easy to use. They care less about
the richness of the software’s features. Enterprise customers, on the other hand, care more about
feature richness and server performance. In addition to the information in the table, you can assume
that the emerging market region is more price-sensitive than the developed region. You can assume
that there is significant room for improvement in the breadth of applications and reliability of SaaS
software. You can also assume that legacy software, having been around for a longer time, is
relatively more reliable and easier to customize than SaaS software. Finally, you can assume that
customer preferences for attributes other than price do not differ significantly between emerging
and developed regions.

Marketing and Sales Investments

You can invest in a variety of marketing and sales channels to drive awareness and customer
acquisition for different customer segments. These channels vary in their relative effectiveness for
different segments. Table 2 gives the guidelines for effectiveness of the marketing and sales
channels across segments:

Table 2: Effectiveness of Marketing and Sales Channels, by Customer Segment

Marketing and Sales
Channel Enterprise Segment Midmarket Segment Small Business Segment
In-person selling Most effective Moderately effective Least effective
Direct marketing and print Moderately effective Most effective Least effective
advertising
Trade shows and events Most effective Moderately effective Least effective
Paid online media (display Least effective Moderately effective Most effective
and paid search
advertising)
Owned online media Most effective Moderately effective Least effective
(white papers, websites,
etc.)
Marketing automation and This is a multiplier for all other channels because a marketing automation platform
analytics makes all marketing activities more effective. However, it has a stronger effect on online
channels.

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Components of the CloudStrat Simulation Game

The CloudStrat simulation has four key sections: Intro, Dashboard, Reports, and Decisions.
Each section is described in detail below.

Intro

The intro provides the introduction to the game context and familiarizes you with the way the
game works.

Dashboard

The dashboard section gives you an overview of the simulation. It shows revenues, unit sales,
market share, product performance (on usability, feature richness, and reliability), third-party
applications available, profit contribution of legacy and SaaS products, SaaS server load, cash
balance, and customer awareness of your SaaS products. You can switch between module-specific
views and a total view of the dashboard. The dashboard also shows news (i.e., announcements
relevant to the market performance of your products). See Figure 1 below.

Figure 1: Dashboard

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Reports

The Reports tab shows you graphical views of decisions and results over time broken out into
the following sectors:

Financials shows the revenues, costs, and cash flow from the business. Revenues can be
viewed as totals or by segment, region, or module.
Pricing shows historical pricing trends for your products (by type and module), as well as
for NetWare’s.
Product Development shows the effects of your R&D investments on product
performance (usability, feature richness, reliability) by product type on a 1–10 scale.
Marketing and Sales shows your investments in different marketing and sales channels.
Ecosystem shows the results of platform investments on developer preference and number
of third-party applications developed.
Human Capital shows the level of compatibility between HumanSoft and your core
module, the level of functionality of your internally developed HCM module, the cost to
integrate HumanSoft with your core module, and the cost to acquire HumanSoft.
Capacity shows how the investments in the platform affect the platform’s capacity to
handle customers. This is illustrated in terms of server load, response time, and server
downtime.
Customer Adoption shows your installed base of customers over time for both legacy and
SaaS products. Adoption rates can be viewed as totals or by region or market segment.
Competitor shows NetWare’s software price, market share, third-party applications, and
installed base over time.
KPIs shows the key performance indicators (KPIs) that you will be scored on in the
simulation. These KPIs include:
o Compound annual revenue growth rate (CAGR)
o Market share (legacy and SaaS markets)
o Ending cash balance
o Cumulative operating income
Project Investments shows the annual costs of your investments in the legacy and SaaS
products, broken down by usability, feature richness, reliability, and (for SaaS) the HCM
module development.

Decisions

The Decisions tab is where you will make your operational decisions; it is broken into various
subcategories:

Pricing. Pricing decisions need to be made for legacy and SaaS modules. They should be
based on your knowledge of competitive pricing and your own pricing strategies. It will be

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important to monitor your pricing decisions and their effect on your profitability, market
share, and adoption throughout the simulation.
R&D. R&D decisions need to be made for both the legacy and SaaS offerings. You will
need to decide how much to spend on improving your products’ usability, customizability
(feature richness), and reliability. Your decisions will impact the future performance of
your products and therefore will impact customer preferences and market share. It is
important to note that R&D decisions will have a lagged effect on your products, so you
must pay attention to how the investments pay off and make adjustments as early as you
can. At the start of the simulation, you have a hunch that your R&D investment has been
suboptimal and that to make a dent in the SaaS market you will have to increase your R&D
spending substantially.
Platform. Investment in the platform will make it more attractive to third-party
development partners. This includes cloud-based operating environments, developer tools,
identity management services, and more. This spending will improve your development
platform’s quality, which will make it more attractive to independent software vendors
(ISVs) and other partners who create third-party applications for your system. It will also
affect the breadth and depth of your ecosystem. This in turn will drive attractiveness and,
ultimately, market share for your SaaS business.
Server Capacity. Investment in server capacity will enable your SaaS platform to support
a greater number of simultaneous online customer sessions while maintaining service
quality levels. It is important to make sure that you monitor and increase capacity as you
ramp up your SaaS business, or your customers will face poor application performance.
HCM Module Development. This is the investment you will make to internally develop
the HCM module.
Acquire HumanSoft? This is a binary choice of whether to acquire HumanSoft during the
current decision year.
Marketing and Sales. Marketing spending is allocated by type of marketing
communications channel, both offline as well as online. Offline channels are traditional
channels, such as in-person sales, events, and trade press advertising. Online channels
include display advertising, search advertising, and investments in website/content
creation. These marketing communications channels vary in their effectiveness across
products, regions, and segments. Offline channels are more effective for large (enterprise)
customers and least effective for small business customers. Offline channels are also more
effective for the legacy software, as SaaS software is more likely to be purchased through
online decision making. Offline channels are also more effective than online channels in
emerging markets, as online penetration is lower in emerging markets. You must take time
to think through the total marketing budget you will spend every year, and how you will
allocate this marketing spend across the different marketing communications channels.

It is important to keep in mind that you have finite assets to invest in your business. If your net
income does not replenish your cash position above $100 million, you will automatically borrow
against a revolving line of credit with your bank, but at a steep 13% annual percentage rate (APR).
Ultimately, it is up to you to manage your cash position and balance it with investing in your
business. Available cash refers to your current cash balance as reported on the cash flow statement.
Cash spent refers to the cash currently allocated based on your spending decisions in the various
categories. Remaining cash refers to unallocated cash.

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Finally, the “Submit and Advance” button will submit your pricing and investment decisions
and will advance the simulation by one year. After submitting your results, you should go back and
check the effects of your decisions using the Dashboard and Reports tabs.

Note that you can copy the data from any chart in the simulation and analyze it in third-party
spreadsheets by clicking the “Copy to Clipboard” button and pasting into a spreadsheet.

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Appendix 1: Sample Game Log

Your evaluation in the CloudStrat game will be based partially on the game log that you submit,
so you should spend a reasonable amount of time creating it. The following is a sample game log.
Please follow this format for the assignment.

CLOUDSTRAT GAME LOG

Team Name: ___________________________________________________________________

Summarized Strategy:
“While we will continue to invest in our core product and the SRM and CRM modules, we will
quickly begin to invest in the SaaS platform. We will not compete on price and instead will invest
in product performance. We will invest heavily in the SaaS products’ R&D, but only after two
years of heavy R&D in the legacy products. We will initially focus our Marcomm investments on
the developed regions in the legacy products and will slowly shift to emerging markets in the SaaS
products. In this way, we will allow the R&D lag to catch up so that our Marcomm will align with
product functionality when available in the market. We will not acquire HumanSoft, preferring to
focus on internal development. We will not worry about retained earnings until our market share
stabilizes.”

YEAR DECISIONS RESULTS REACTIONS

Raised R&D Seemed to have little results on Fearful about timing of SaaS
investment in core revenues or market share. SaaS investment—is the investment
1 SaaS product to $40M market is growing. Competitor is premature? Considering more
each but left all other dropping prices. emphasis on legacy products.
decisions alone.
Same as for Year 1, Market share falling in both SaaS We have better products now.
except lowered R&D and legacy products. Product The time delay associated with
2 spending on SaaS functionality is higher than technology investment may not
products. competitor, but prices are also line up with our Marcomm
greater than competitor. spending.
… … … …
Increasing capacity in Capacity increases have helped We have had phenomenal
our SaaS platform so with system performance. Our slow success in developed markets,
that we can adjust to move to SaaS in the emerging but in emerging markets our
5 increased demand. markets might have hurt our ability share has lagged significantly.
to capture market share. Maybe we needed to invest in
those markets sooner rather
than later.

General Reactions and Learnings:

State here in a paragraph or two your overall reactions and the key learnings generated from
the run. Focus on your holistic understanding of the market dynamics and system behavior.
Mention how you will apply these learnings from run to run.

After finishing all your runs, answer the following questions in your report:

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1. What are the dynamic forces that drive the evolution of the market in CloudStrat?
2. What strategy did you start with? What was your final strategy? How did you
evolve/adapt your strategy over the runs?
3. What do you think was the competitor’s strategy?
4. What information was most useful to you during play? What information was least
useful to you? Why?
5. Assess your team’s decision-making process. What were your team’s major strengths
and weaknesses? What were the issues of contention? How did you overcome
conflicts? How did you allocate effort among the team members?
6. What aspects of the simulation experience would you change? Include any reactions
you have to the assignment structure and/or the game log.
7. What have you learned about business model migration? What are the key drivers in a
migration such as the one simulated in CloudStrat?

Limit your report to a maximum of seven (7) single-spaced pages, excluding appendices.
Attach your game logs as an appendix. Do not reproduce the printouts from the game on detailed
annual decisions in your report.

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