Manufacturing Saas: An Early Viewpoint Allen Miller (4/27/2015) Background & Motivation The manufacturing industry is one of the largest and most important industries in the world. Components of manufacturing are used in a wide range of industries including: aerospace & defense, transportation & logistics, chemicals, pharma, food & beverage, electronics and many more. In the U.S., as of 2013, manufacturing represented 12.5% of GDP with an industrial output of $2.4T. On its own, manufacturing in the U.S. would be the 9th largest economy in the world. Perhaps what’s most impressive, however, is the boost the economy gets from the industry—for every $1.00 spent in manufacturing, another $1.37 is added to the economy, the highest multiplier effect of any sector. Against this backdrop, it’s surprising that relatively few early stage software companies have focused on providing solutions to the numerous challenges that this massive industry faces. Likewise, even fewer VCs are focused on investing in the space. The purpose of this memo is to provide an early viewpoint on thematic investment opportunities in manufacturing software for investors to consider. We will start with an overview of the industry, outline 5 specific opportunity areas, discuss the key risks for startups and conclude with some final thoughts. Industry History & Incumbents Similar to most industries, manufacturing software can be described in 4 broad strokes. The mainframe era of the ‘60s and ‘70s finally allowed manufactures to move financial accounting and inventory management off pen and paper and onto computers. The Client / Server world of the 80s and 90s, which provided each employee with a PC and centralized data storage on a server, allowed software applications to extend far more computing power to end users. During this time enterprise resource planning (a term coined by Gartner) was born. In the mid to late 2000s, horizontal cloud computing marked the beginning of a very slow shift of ERP solutions to the cloud. Unsurprisingly, the leading client / server incumbents are desperately trying to keep up with this shift having learned the hard way that failing to do so results in share erosion (i.e. Oracle’s heavy losses to Salesforce in CRM). While the horizontal ERP battle is still raging, the final thematic shift affecting manufacturing in the last few years has been the development of industry-specific solutions. Well placed bets in industry-specific manufacturing software in the coming decade, will likely lead to out-sized returns for investors. We will focus the majority of this memo on the emerging opportunities in this area. But before we do so, it’s worth discussing the manufacturing software incumbents in a bit more detail. Because manufacturing software is relatively early in its development cycle, competition is squarely concentrated around the biggest and most obvious opportunity—ERP. Most businesses with a manufacturing component, whether big or small, require an ERP software tool to manage the end-to-end manufacturing process. Appendix 1 shows the key incumbents in ERP. As seen in the figure, the incumbents can be categorized by the size of the businesses they sell to and whether they are cloud-first. There is also a long tail of companies that are active in ERP beyond the main players—indicating that this is a) not a winner-take-all market and b) a very large opportunity with plenty of space for many players. We have added a few examples of these smaller players at the bottom of Appendix 1. That being said, ERP is only the first of a number of different opportunities in manufacturing software.

Opportunity Roadmap: Manufacturing Saas Playbook There are five high-level opportunities for software to impact the manufacturing industry: (1) cloud ERP, (2) applications and point solutions for plant managers and other operations personnel, (3) marketplaces and platforms, (4) software for emerging hardware and (5) cybersecurity for manufacturers. Appendix 2 outlines these opportunities on a timeline, providing a general sense of the relative timeline for each play. Appendix 3 provides a categorized table of many of the manufacturing software companies I am tracking to-date. These companies have been placed into one of the 5 categories above. We will now outline each of the 5 manufacturing plays in greater detail. (1) Cloud Enterprise Resource Planning (ERP) The first play, as already alluded to, is perhaps the most obvious as there are already a number of successful companies doing it. The central idea is to take the antiquated client / server ERP product and move it to the cloud. There are several variations of this play:

Broad “One-Size Fits All” Cloud ERP Solutions: This version of the play involves taking what established incumbents like Oracle and SAP have done in the client/server world and moving it to a Saas cloud-based subscription model. This strategy is often coupled with a strong focus on SMBs as they are more likely buyers of cloud ERP than large enterprises who have invested heavily upfront in their on-premise ERP systems. The goal here would be to become the best of breed cloud ERP solution across industries and company sizes.

Industry-specific Cloud ERP Solutions: Another version of this play would be to become the best cloud ERP solution in a specific industry. The current horizontal focus of most cloud ERP companies means that a number of industry-specific challenges often go unaddressed. While there are currently no good examples of industry-specific ERP companies, some industries that have the most opportunity include: Aerospace, Auto, Pharma, Chemicals, Retail/Apparel and Electronics.

Noteworthy companies: Aside from NetSuite, which has been a huge (public) success, Plex Systems, Rootstock and Kenandy are all well-funded, fast-growing companies using this play. (2) The Application Layer: Point Solutions for Plant Managers & Other Operations Personnel There are dozens of tasks and daily routines that plant managers and other operations personnel currently go about doing each day using antiquated methods (i.e. pen/paper, excel sheet, white board, etc.) These tasks and routines occur at all stages in the manufacturing process: during the various legs of the supply chain, on the shop floor and at the point of delivery / distribution. There is a big opportunity to provide software applications for manufacturers that simply makes their jobs easier. There are a few different variations of this play:

Mobile-Centric Dashboards & Tools: Mobile tools have the potential to be game-changing for managers and other operations personnel. One example application would be providing managers with real-time feedback on how efficient their production process is. This would include providing various efficiency metrics across various plants and factories, identifying bottlenecks and displaying underutilized machines / workers. This would also touch on pre/post shop floor operations including freight delivery/shipping, supply chain management, etc. A further step would be to provide recommendations to improve these processes (i.e. automatic decision making /decision aiding systems). One interesting approach here would be to

determine the most common issues/pain points in a plant and provide an integrated / packaged suite of solutions.

Advanced Analytics / Data at Cloud Scale: Manufacturers are increasingly in need of analytic tools at cloud scale to better manage mission critical pieces of their production processes. These tools include quality management, inventory management, demand-forecasting, energy management and machine management (across all plants/factories). This play may also include the use of CAD software and other factory-related simulation software to better aid decision-making.

Noteworthy companies: We’re just getting started with this play so the best is yet to come. However, Procurify (procurement software to streamline purchasing and reduce costs), Predikto (predictive analytics for asset intensive industries) and RtTech (dashboard that helps manufacturers improve asset availability, utilization and consumption) are interesting early applications of these plays. (3) Marketplaces & Platforms Vertical marketplaces are a core investing theme for many frims, and manufacturing should be no exception. As with the application layer above, we’re still in the early days of this play. Nonetheless some emergent trends have begun to coalesce:

General Manufacturing Marketplace: In today’s post web 2.0 era, a good general manufacturing marketplace, one that allows manufacturers to sell their manufacturing services (and vice versa on the buyers end), doesn’t as of yet exist. A winner in the manufacturing marketplace world would not only connect buyers and sellers, but would also facilitate the end-to-end connection through: collaboration / workflow tools, avenues to discuss prints/prototypes and an overall integrated high quality experience.

Niche Manufacturing Marketplaces: The jury is still out on whether market sizes would be large enough for high exits, but there may also be room for some end-to-end niche manufacturing marketplaces. One example would be a manufacturing marketplace focused on SMBs. Another example would be marketplaces focused solely on certain types of equipment such as used machines or underutilized assets.

Noteworthy companies: As with the application layer, we are still in the early days of the marketplace play. That being said, Cargomatic is an example of a company in this space. Other examples are Maker’s Row (connecting manufacturers with SMBs) and BriteHub (connecting entrepreneurs with manufacturers to get products to market). (4) Software for Emerging Hardware The next play, creating software for emerging hardware, is more of a longer term play (5-10 years out). This is largely because the hardware winners have yet to be declared. Once that happens, and there is a fair amount of standardization in areas like wearables, robotics and 3D printing, software will be layered on top of the hardware to provide functionality to that hardware. There are a number of different versions of this play:

Wearables: Products like smart eyewear will increase field worker’s functionality, thereby increasing productivity with direct impact to the bottom line.

Robotics: Robots will eventually change how factories are built, their size and where they will be placed in the world. As robotics becomes more advanced and enters manufacturing, software will be required to enable the hardware’s functionality.

3D Printing: As the early days of 3D printing morph into something more mainstream, software that manages 3D printers, expands their capabilities and makes them more productive will be increasingly in higher demand.

IoT: Once the entire shop floor is connected to the internet, information will flow from the production line back to the managers, engineers and decision makers allowing them to alter products and designs in real time. This will also allow more data to be collected on each machine in the production process. Production can then be managed on a network rather than at a single location.

Noteworthy Companies: Admittedly, this play is quite futuristic and unlikely to materialize in the near term. That being said we have seen some early signs of potential—particularly with some of the manufacturing applications attached to smart eyewear. Pristine.io and APX Labs are two companies that are at the forefront of building enterprise software for smart glasses. While not focused solely on the manufacturing industry, it is easy to see why many of the key applications will be in manufacturing. (5) Cybersecurity for Manufacturers The final play in the manufacturing Saas playbook is cyber security. As with software for emerging hardware, this too is a bit more of a long term play. The reason for this is that cyber security as an industry is still largely stuck in the client / server world and ill-equipped for the cloud world. In many ways, entrepreneurs need to first solve the problems of building robust horizontal cloud defense mechanisms against cyber-attack before building industry-specific solutions. That being said, cyber-attack in the manufacturing world is a very real threat. Threats may come in the form of stealing information on suppliers and customers or to disrupt a plant’s operations. Each of the 4 opportunities outlined above (cloud ERP, the application layer, marketplaces/platforms and software for emerging hardware) will all need to be enveloped in a layer of security to prevent from attack. Noteworthy Companies: As with software for emerging hardware, this is a long-term play. We are, however, beginning to see the emergence of a few companies that are focused on cyber security for enterprise software, including for the manufacturing industry. PhishMe and Darktrace are two examples of recently funded companies who are attacking this problem. Risks for Startups While the opportunities for manufacturing software companies are clearly quite abundant, they are not without certain industry-specific risks. This portion of the memo will outline some of those risks in greater detail.

Founders without deep domain expertise will fail: Similar to healthcare, education and other large and complex industries, the manufacturing industry is intricate and difficult to navigate. This isn’t an industry that just anyone can come in and build a software business for. There are certain knowledge and experience barriers to entry. Building a successful manufacturing saas company requires at least one co-founding team member with deep domain expertise and a comprehensive understanding of the ins and outs of the manufacturing world. To have a fighting

chance, entrepreneurs must have lived the problems they are trying to solve and speak the language of potential customers and partners.

Lengthy and complex sales cycles may stall customer acquisition: The manufacturing industry is notorious for having long sales cycles. Often selling to manufacturing businesses involves multiple layers of approval and intense integration work with other software systems. The flip side of this though is that, once you’re in, churn is likely to be low as it is costly and time-inefficient for customers to shift to a competitor.

Many customers are cloud allergic: Another challenge in the manufacturing world is that customers can be quite cloud allergic. Appendix 4 shows a recent survey conducted by Software Advice. When a sample of 385 manufacturers were asked what their deployment preference was, 85% sided with an on-premise tool vs. 15% for a cloud offering. This is likely due to the same reasons why Oracle’s client / server CRM still exists despite the fact that Salesforce has a better product—namely that many enterprises have invested heavily in their on-premise ERP solution and ripping it out and replacing it with a cloud ERP solution is a) expensive, b) potentially less secure from a security point of view (as the customer doesn’t have full control) and c) incredibly risky in the event there are any hiccups in implementation.

Incumbents have begun grabbing land in the cloud: Having learned from the loss of share to cloud-first insurgents in areas such as CRM (i.e. Oracle vs. Salesforce), ERP incumbents have been trying to move as quickly as possible towards offering a cloud ERP solution in addition to their on-premise tool. SAP, Oracle and Sage now all offer a cloud version of their ERP. That being said, the incumbents have still been very slow to move to the cloud and lag behind new insurgents like NetSuite in product functionality, design, integration, speed and ease-of-use. Moreover, the incumbents have yet to move into any of the other 4 plays outside of ERP.

Market size may not support large enough outcomes: Some of the manufacturing plays above need to be approached with caution—particularly those that are more niche focused. Areas like cloud ERP for a specific industry, software applications for a particular type of factory or a specialty marketplace with weak network effects / customer captivity may not produce large enough outcomes to warrant serious consideration. Thus, bottoms-up market sizing is a critical component in diligence.

VCs are manufacturing allergic: The final challenge for manufacturing startups is one that is actually a result of the venture community. Traditionally, VCs have avoided the manufacturing industry as it was seen as far too asset intensive and “old-world” to allow for 10x ROIC outcomes. In addition, there is a geographic challenge at play as well—at least in the U.S. Most VCs are concentrated in Silicon Valley or the Northeast while manufacturing as an industry tends to reside in the Midwest and South. This means that later stage companies that are doing well will eventually get funded, but there is a bit of a capital crunch at the earliest stages.

Concluding Thoughts The manufacturing industry is clearly a large and important part of the global economy. The lack of interest from the rest of the venture community makes it, and most other asset-intensive industries, appealing areas for venture investors to monitor closely. While most of the plays discussed here are just forming and/or yet to come, it is worth keeping an open eye as some of the opportunities outlined here have unicorn potential given the size and significance of this market. And, while there are many risks to keep in mind, these risks are far from insurmountable for the right team attacking the right opportunity.

Appendix 1: Enterprise Resource Planning (ERP) Incumbents

Appendix 2: Manufacturing Saas Playbook Timeline

Appendix 3: Manufacturing Saas Companies by Category

Appendix 4: 2014 Sample Survey of Manufacturing Software Deployment Preferences

Sources Secondary Sources & Internet Research

National Association of Manufacturers: http://www.nam.org/Newsroom/Facts-About-Manufacturing/

PE Hub: https://www.pehub.com/2013/03/vcs-arent-buying-into-manufacturing-rebound/

Software Advice: http://www.softwareadvice.com/manufacturing/

ThomasNet: http://news.thomasnet.com/IMT/2013/03/14/china-widens-lead-as-worlds-largest-manufacturer

TechCrunch: http://techcrunch.com/2014/02/17/siemens-launches-100m-fund-to-back-software-startups-that-can-disrupt-manufacturing/

Company Websites & 10ks

Epicor o Company Website: http://www.epicor.com/

Infor o Company Website: http://www.infor.com/

Net Suite o Company Website: http://www.netsuite.com/ o 10-K:

http://www.sec.gov/Archives/edgar/data/1117106/000111710615000011/a2014netsuiteform10-k.htm

Oracle o Company Website: http://www.oracle.com/ o 10-K:

http://www.sec.gov/Archives/edgar/data/1341439/000119312513272832/d531515d10k.htm

Sage o Company Website: http://na.sage.com/ o 10-K: http://quicktake.morningstar.com/stocknet/secdocuments.aspx?symbol=sgpyy

SAP o Company Website: http://go.sap.com/index.html o 10-K: http://www.sap.com/bin/sapcom/en_us/downloadasset.2014-04-apr-01-01.sap-2013-

annual-report-pdf.html

Interviews & Collaborators

Bessemer Venture Partners: Brian Feinstein, Josh Benamram and Kristina Shen

McKinsey: Ron Davidson