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Zoom. If someone had mentioned this word to you a year ago, your mind would have likely visualised a variety of things. Today, however, the word is synonymous with staying connected during a pandemic in which face-to-face interaction has become a distinct rarity. This new association with the word can be attributed to one company: California-based software technology upstart Zoom Video Communications. The company’s flagship Zoom Meetings video app, which soared in popularity after the outbreak of COVID-19, has rapidly become a mainstay of offices and households worldwide. As a result, Zoom’s stock price ballooned to USD 337, a 396% gain during the course of 2020. Meanwhile, the company’s quarterly revenues jumped from USD 188 million to USD 777 million. In comparison, the S&P 500 index advanced by 16%, while its IT constituents grew by 42%. Clearly, Zoom had a blockbuster year.
But does Zoom’s recent success story reflect irrational exuberance in tech stocks at a time when the virtual has suddenly replaced the physical? Or does it hint at a more permanent transformation underway in the world of digital business communications? At DPAM, we lean toward the latter.
From past to present: the evolution of business communications
Before delving into the ins and outs of modern enterprise cloud communications, it is first helpful to step back in time and understand how business communications have evolved over the past century. In the 1960s, businesses discovered that they could make significant cost savings by insourcing teams of switchboard operators to handle calls internally, thus giving birth to the private branch exchange (PBX). Another major innovation occurred in the 1970s with the development of interactive voice response (IVR), which transformed call routing by automating the role of a human operator. As a result, costs declined and efficiency improved dramatically. In the 1980s and 1990s, PBX systems became commonplace and began to incorporate additional features such as call transferring. At the same time, the concept of unified communications (UC) began to take form as different technologies started to merge, such as IVR, voicemail, and email. The new millennium brought with it the development of voice over internet protocol (VoIP), which Skype would eventually popularise. In simple terms, VoIP refers to phone services delivered over the internet. As the shift to IP-based systems gained momentum, capabilities continued to become more integrated, with newer communication channels like instant messaging and chat entering the UC solution set. Finally, over the past decade, cloud computing, which enables companies to shift their IT workloads to hosted servers instead of managing these themselves on-premise, has risen in prominence, offering scalability and versatility to unified communications. In sum, the landscape for business communications has transformed over the course of merely a few decades.
Figure 1: private branch exchange (PBX) switchboard operators manually connecting incoming phone lines with the intended call recipients in real-time
Source: Creative Commons
The criticality of communications and the benefits of the cloud
Although Zoom has made international news headlines, it is only one of several companies that are pioneering the change in enterprises’ digital communications. RingCentral, Five9, Twilio, Vonage and NICE are but some of the other disruptive publicly-listed companies that are seeking to advance the way businesses communicate—both between themselves and with their customers—by marrying traditional network connectivity services with the capabilities of cloud computing. Although none have quite matched Zoom’s public fanfare or its stock’s formidable market rally, most have done exceptionally well in their own right, owing in part to the often ‘mission critical’ nature of the solutions they provide to their customers. Indeed, communication systems are not optional for most companies, and even minor disturbances in the transmission of information between parties can result in serious reputational damage, lost customers, and, ultimately, lost revenue. For example, postal companies often use digitally automated SMS and e-mail messages to notify their customers of the dispatch or arrival of their parcels at set locations. However, if such messages fail to send (on time or at all), customers may fail to retrieve their packages from holding locations before deadlines expire. Such scenarios could lead to customers switching to a different postal service for their next delivery. COVID-19 has further heightened the importance of reliable communication systems, particularly those that are able to cater to the versatility and flexibility that are required in our current global environment.
Cloud computing thrives in this context, reflecting the new possibilities and advantages that infusing communications systems with cloud computing software provides over legacy on-premise systems. For companies, these benefits include:
lower resources required to manage physical IT hardware and infrastructure;
greater flexibility in terms of quickly scaling up or down the number of users depending on needs;
easier integration and data-sharing possibilities with other enterprise software;
more frequent updates and faster implementation times.
In financial terms, cloud offerings enable companies to shift large one-time capital expenditures (that were subsequently depreciated or amortised on the balance sheet) to ongoing operating expenses recorded on the income statement, thus providing better overall accounting visibility and operational agility. Most importantly, the lack of major upfront costs associated with a cloud subscription model has expanded addressable end-markets, opening the door to start-ups and small-and-medium businesses (SMBs) to make use of products that were previously unaffordable for them. By using certain cloud solutions available in the communications space today, businesses can evolve from micro-scale startups employing less than ten people to international enterprises with 1,000+ headcounts using essentially the same extendable technology. On older legacy systems, such changes would have resulted in logistical nightmares—assuming they would have even been possible in the first place. Just as PBX and IVR systems led to beneficial structural transformations upon their introduction, cloud communications systems are the next step in the evolution of the way businesses communicate, carrying many advantages.
The cloud communications trio: UCaaS, CCaaS, and CPaaS
The cloud-based communications space is multifaceted and brings together many technological capabilities that can be distilled into three core overlapping sub-categories: Unified Communications as a Service (UCaaS), Contact Center as a Service (CCaaS), and Communications Platform as a Service (CPaaS) . The first, UCaaS, is used primarily in B2B or internal office settings and comprises the tools that office workers use to communicate and collaborate with one another, such as video-calling & video-conferencing, VoIP, and instant messaging & chat. UCaaS vendors package these tools together into a seamless extendable platform offering that is accessible across users’ devices and delivers them over the internet as a subscription service (as denoted by the ‘aaS’ portion of these acronyms). CCaaS, on the other hand, operates in the B2C/C2B world of contact centers, providing the tools for engaging with customers across the increasing mediums of communication used by the general public to interact with companies. Unlike a UCaaS offering, which is often used by employees across an entire organisation, CCaaS software is catered specifically to contact center agents and floor managers. To sum up, UCaaS and CCaaS provide similar solutions, but the end-users and the purposes for which the software is used are distinct.
Figure 2: overview of the key vendors in the cloud communications market and their capabilities
(note: faded logos denote private companies)
Merging cloud computing with telecom capabilities has also produced entirely new channels of communication, such as CPaaS. Also known as “programmable cloud communications,” CPaaS refers to cloud-native software that enables developers and less-tech savvy users alike to easily embed communications capabilities, such as SMS messaging and video-calling, into their applications and websites. Unbeknownst to most, CPaaS technology is used frequently by people in their day-to-day activities, powering much of the seamless digital customer experiences to which we have increasingly grown accustomed. When you receive one-time passwords and last minute flight change notifications by SMS, when you receive automatic email reminders for upcoming medical appointments, or when you anonymously call your ride-hailing driver via an incorporated in-app calling functionality—you are unknowingly relying on behind-the-scenes CPaaS technology. In summary, UCaaS, CCaaS, and CPaaS form a trio of capabilities that form the core of cloud-based business communications.
Sizing the market
Like much of the cloud computing space, cloud business communications is a market that is both sizeable and fast-growing. Together, UCaaS, CCaaS and CPaaS represent approximately a USD 80 billion market opportunity by 2022, implying an aggregate 22% compounded annual growth rate (CAGR), according to IDC figures. When ancillary markets are included, estimates can increase even further. For example, IDC has assessed that programmable messaging—a sub-market of CPaaS—alone represents an approximately USD 30 billion addressable market. Of the three spaces, UCaaS currently represents the largest market at around USD 30 billion. However, it is also forecast to grow the slowest relatively in the medium horizon at circa 18% per annum. Compare this to the CPaaS market, which only generates USD 6 billion in annual revenues today, but is projected to grow at an impressive 40% CAGR over the foreseeable years on the back of evolving B2C/C2B dynamics and the increasing proliferation of internet-connected devices. The CCaaS market, which sits between the latter two in both market size and growth prospects, is currently circa USD 5 billion in size and forecasted to grow 20% year-on-year. For comparison, the customer relationship management (CRM) software market—dominated by the likes of Salesforce, SAP, and Oracle—is expected to reach roughly USD 60 billion in revenues by 2022 and almost USD 90 billion by 2025 following a 14% CAGR from 2020.
These impressive growth forecasts reflect the relatively low penetration levels of cloud-based communications products in businesses, and particularly in larger enterprises (defined as having more than 1,000 employees) where system overhauls can be complex and daunting tasks. According to Bernstein Research, approximately 20% of total global business workloads were hosted on public cloud infrastructure at the end of 2019 and they predict that this figure will climb to between 50% and 70% by 2029. Similarly, cloud communications penetration still has a long way to go before reaching market saturation. Finding exact figures on this is tricky, but by some estimates the unified communications market is today only 15-20% penetrated by the cloud while it is believed that only around 8% of the 15 million contact center agents worldwide currently use a CCaaS product instead of a premise-based one. Consequently, UCaaS, CCaaS and CPaaS present very promising growth prospects.
Current trends driving the competitive environment
Fast growth often produces a certain degree of chaos in market dynamics. The world of digital communications is no exception. While distinctions between UCaaS, CCaaS and CPaaS are helpful for conceptualising competitive forces, in practice there exists significant crossover between these areas. Add to this the increasing number of complementary technological capabilities that are being wrapped into some solution sets (such as artificial intelligence, robotic automation, data analytics, and more), in addition to differing levels of modularity and customisability, and the result is constantly shifting definitions of what actually constitutes a UCaaS, CCaaS or CPaaS solution. Some industry onlookers question whether such categorisations will persist or whether they will all eventually morph into a single, more general concept of cloud communications. The latter thesis is supported by the growing number of vendors that are starting to sell solutions across two or three of these spaces (as can be observed in Figure 2) in a bid to offer more comprehensive solutions sets and thereby capture more market share. In the future, one could also envisage a greater rapprochement of CPaaS and CCaaS given their mutual focus on targeted communications and enhancing the customer experience. In conjunction with CRM solutions that were referred to above, unifying these could lead to a more holistic end-to-end service for the management of entire customer journeys, from initial prospecting through to preserving longer-term customer loyalty post-product or -service delivery.
Legacy vendors and larger tech players are adding further dynamism to the sub-sector by launching their own rival offerings. Some of these attempts to catch-up with the cloud-native upstarts have fallen flat, such as Avaya’s initial attempt to launch their own UCaaS offering before striking a capitulating partnership with RingCentral. However, others, such as Cisco and their UCM Cloud (UCaaS) product, have become strong contenders in their own right. For companies that are unable, or unwilling, to develop proprietary solutions internally, M&A offers up another route to join the party. Israeli-headquartered NICE, previously an on-premise contact center and security software specialist, made a big bet in 2017 when it acquired then-upcoming CCaaS player inContact for USD 870 million. The wager has paid off handsomely for NICE, as today they are one of the preeminent players in global CCaaS software. Furthermore, cloud-based products are expected to account for just under 50% of the company’s total revenues at the end of this year, up from just 9% in 2016, demonstrating how the acquisition has transformed the company’s business model. Some of the tech giants have also made forays into these markets recently. For instance, Microsoft now competes in UCaaS and team collaboration with their Microsoft Teams product. Furthermore, only a few weeks prior to the writing of this article, Microsoft announced the launch of their own CPaaS offering called Azure Communications Services.
The merging of these three spaces and the increasing number and types of competitors entering the market are both trends that are likely to continue in the future. Nevertheless, we view the nimbler cloud-native providers that are best-in-class in their respective domains as the most promising contenders, rather than larger vendors or those with broader, but relatively lower-quality solutions.
Environmental, social and governance (ESG) considerations
Several ESG issues are important to consider when looking at companies offering cloud business communications solutions. The most pertinent of these is data privacy and security. Given that communications systems are critical components within most companies—from micro SMBs all the way up to multinational conglomerates—it is inevitable that much of the data and information shared across these systems is sensitive or private in nature. It is thus crucial that vendor solutions adhere to the strictest standards of data protection. Failure on companies’ behalves to guarantee this can lead to severe reputational damage, deterring users away from their products due to privacy concerns. For example, although Zoom has been the beneficiary of many flattering news headlines as of late, over the past summer the company was set back by reports that, in addition to its relatively sub-par end-to-end encryption standards, customer data was being routed through Chinese servers, raising concerns of local government eavesdropping. This led many companies and organisations to ban usage of Zoom’s app. Another important factor to consider is the governance structure of UCaaS, CCaaS and CPaaS companies. For example, many high-tech companies implement dual-class share voting arrangements. This is partly to allow founders to retain control of the long-term vision of their companies. However, such voting structures reduce the ability of institutional investors to make their voices heard and to exert influence where necessary (for example, in cases of managerial incompetence or malpractice).
On the flipside, cloud business communications arguably have a net positive impact on society overall, enhancing interconnectedness and facilitating better communication more generally. Indeed, one need not look further than the current COVID-19 pandemic to witness how cloud-based communications can serve as a key enabler of societal functioning and resiliency even in the midst of extraordinary circumstances. There is also a case to be made from an environmental standpoint, given that, on a like-for-like basis, cloud-based SaaS solutions generate lower carbon emissions than on-premise software. The reason for this lies in hyperscale cloud data centers, which service hundreds or thousands of companies on the same hardware and can achieve considerably higher server utilisation rates than private on-premise server arrangements. In other words, cloud computing is more energy efficient overall. Finally, cloud communications systems in particular lead to a reduced need for physical communications hardware, such as office phones, given that everything can now be operated from within the computer software directly. In summary, the SaaS communications space carries various specific ESG-related risks and opportunities, both at the company- and sector-level.
Forecasting the future of cloud business communications
The TMT market constantly abounds with exciting new developments for investors to mull over. Digital business communications is undoubtedly one of them. A number of companies crowding this space could act as attractive candidates for investors seeking exposure to robust growth trends. However, caution is still advised when investing in this area. We believe that assessing individual financial health, understanding the intricacies of key competitive dynamics, and thoroughly examining ESG factors are just some of the essential steps required before making long-term, high-conviction investment decisions—whether in cloud business communications or beyond.