Introduction
Today there are many IT companies in the world and all are in competition to be the best. Computer Associates is one among them which is the third-largest software company in the world. Charles Wang was the founder of Computer Associates and it was developed by a Swiss company, which succeeded in developing and marketing of soft wares. This company mainly focused on selling anti-virus software and internet security software all over the United States. They initially developed the software for IBM and it was a success to a great extent. This success is the starting of the company becoming world-famous. Then, they developed and marketed software for many customers in other parts of the world. Computer Associates produced high-quality software products with the help of efficient and qualified staff. Nowadays system downtime is the main problem faced by most of IT companies and other companies using a computer system. As the main product of this company is security software, their products were sold soon in the market. Later, they also started creating other soft wares. Computer Associates has many branches in different parts of the world and these branches also succeeded in developing and marketing of software. Most of their products were intended for large companies but some of their products were sold to home and office uses, like security software. Thus, this company earned huge profits and also paid high salaries to the employees. The company bought a new business model, and changes in the financial reporting helped in the development and success of this company. Not only the company but the customers and workers of this company also gained more benefits from this new business approach. There was a vast increase in the revenue of Computer Associates compared to other IT companies. Customers are ready to accept the new technology of the company, and the new business model is making a competitive difference. Under these new business models of the company, software license agreements permit customers to accept undetermined future software products without any extra fees. These agreements help use the software products in the right way. The authorities of computer associates were ready to face challenges that were occurring through the new business model which they implemented. In a proxy context when a new business model performed in a better way it led to a fall in the stock price of a company which created a major conflict between the management and the shareholders. When the new business model was introduced, pro forma numbers of the company increased and it also provided flexible licensing to the customers.
Critical analysis/ evaluation of the case
What was Computer Associates trying to accomplish by the change in the business model? How did the changes accomplish these goals? What risks does the new model create?
There were various changes occurring in a Business industry, and the employees of the firms were forced to change according to the new changes. But, there existed some difficulties to accept those changes. The new members of the Board of Computer Associates made some significant changes to the business model and the financial reporting. The new business model, which was developed by new members including Sanjay Kumar, CA’s CEO, offers some advantages to the business industry. In order to make some improvement in the business model of the company and its governance, they made some changes in the company. And also they considered the importance of Computer Associates in the stock market.
Implementation of the new business model changed the reporting, but not the revenue. The change in reporting included additional steps, regarding the production and distribution of pro forma numbers from the computer associates.
CA tried to achieve maximum gain by making some changes in the business model and also in the accounting system. By doing this, there was a significant increase in the company’s revenue. The new business model developed could attain the objective of the business. The company tried its best to communicate with Wall Street. Thus, there was a tremendous improvement in investment. They are the third-largest software company after Oracle and Microsoft. The license fee for the software is the main source of CA’s revenue. The fee of the software varies depending upon its validity. Also, the company charges some maintenance fees annually. There is also an option for financing the initial license. That makes its financial statement different from competitors. The old business model in the company had to face various problems. The main problem was that customers had learned that pressure on sales representatives for CA to meet their sales target build-up towards the end of each quarter. And the customers had to wait some days to get their license agreement. This badly affected the customers by losing some attractive license fee discounts. As a result of this, CA could record their sales details only after the end of a week. The pattern of the software selling was determined by the incentives of the sales representatives and the high-level management. Sales representatives got money on a commission basis. The commission was calculated by considering the present value of the sales. Therefore, sales representatives’ aim was to wait for their quarter-end sales. The top management also had some problems; they had to visit Wall Street to attain their quarterly revenue and to understand, whether they can reach their expectation. The management was considering all the quarterly sales, then only they could calculate their year-end profit.
Sales representatives would, therefore, consent to deep discounts on licenses signed in the last week. Discounts were particularly significant for the coming years of a contract. Top management offered heavy discounts to get high earnings at the year-end. The cost of software production being small, reducing license fees for the later contract years helped the shareholders get their profit since even minimal revenue in those years contributed towards recovering the costs of software development. The other negative aspect of the sales was the difficulty to maintain the margin. Once a discount was announced, it was very difficult to refuse that. The customers were satisfied with that attractive discount on the license of the previous years and they already made a contract on those terms. The pattern of the quarterly sales was difficult to predict and it was difficult to analyze the profit also. Therefore, it was difficult to take precautions, if there was any decrease in revenue. This resulted in difficulties to calculate the earnings. Some of the other difficulties of the systems were the sales representatives focus only on the clients who take long-term license. Once the customer signed the contract, the representative got some incentives for the period of the contract. Therefore, representatives did not bother about new customers; it led to dissatisfaction of the new customers.
CA took a very serious approach to this problem. Therefore, they introduced a new business model. The changes include, reducing license validity of the software from one year to few months, refreshing the customer support in a better way etc. They also made some changes in the method of compensation of sales representatives. Regular visits of the sales representatives to the customers result in good service. Then, it will be easy to renew their license and also they get an idea about the new software which is used in the current market. By minimizing the product license, customers can familiarize the new products. Also, shorter contracts time wouldn’t affect the economy because the rate of renewal is high. According to the new business model, the sale representatives get monthly salary. But, additionally they get different commissions depending upon the product they sell and also customer satisfaction. Sale of new products attracts higher commission compared to older ones. The authorities of CA formed an organization and they promised higher compensation for the employees.
How does the change in accounting fit with the new business model?
There are various changes in the field of accounting, which offer benefits to the customers and shareholders; also, there are some changes in the license fee revenue. According to Sanjay Kumar, the CEO, the new business system improves the aptitude value of the customer to realize the value of financial output. Some problems regarding the new system are the change in the accounting system, in that they compare the past and future performance of the company. They got advice from the investment bankers in this regard. For the comparison process, they use proforma and pro rata and noticed that there is large profit in the industry. Other advantage of the system is high profit margin. Thus, the new model developed was really helpful to business system. “In October 2000 Computer Associates proclaimed a new business model, which featured a new accounting as its centerpiece. As with other enterprises that created all sorts of pro forma earnings during the last five years or so, Computer Associates produced a New Accounting that just happened to generate better results than GAAP.” (Ketz, 2009, para 1).
The new business model involved a change in accounting procedure in the company. The change in accounting was a good thing for the new business model. The new method of accounting helped the new business model. The new accounting system was more suitable than the previous approach of revenue recognition. There was confusion for the investors about the new accounting change. The customers of CA were provided with the opportunity for financing the initial license fee. Its financial statements were different from other companies. It had balanced flow of cash. Instead of collecting the revenues at the time of sale, it was collected over a period of time. When CA changed its business model, it also changed its method of collecting revenues. The changes in the accounting method were a challenge to the investors in the process of evaluating the performance of the company. The new model unlocked CA’s value for the employees, shareholders and customers. This model improved the facility of partnership with the customers. The output required for the investors were made transparent and consistent. The business model change and the change in accounting were made by the board of the company. One of the problems which the company faced was the difficulty in showing company’s future and past performance.The investment bankers specified that investors will require time series comparability of reported numbers. This worried the board stronger. CA offered “pro forma, pro rata” revenues and earnings to help the investors in the new method of accounting. This data was contained in the annual report of the company. This data have to be attested by the auditor of the company. The pro forma numbers were also used in many functions of the company. Thus, this method was an advantage for the investors to understand the benefits of business model change. It also does not misinterpret the decline in the profits and revenues in the present year due to the accounting principles. Reactions to the company’s change in accounting system were mixed. One of the results was higher profit margins.This was because the company does not need to make any price concession. Also revenue is less at the beginning than at the end of the quarter. Recognition of revenue is more realistic in the new accounting method. CA is trying to get in contact with new customers and also with partners which are just emerging. To cover the fall in sales, the company is presenting the financial results in a method that confuses the analysts. The company introduced the new method of accounting as an improvement over the present accounting method. The accounting change will help the new business model to withstand the competition from its competitors. The source of revenue for the company is from software product licensing, professional services and post contract customer support. The ratable identification of the revenue that is attributed to license arrangements in the new model is the subscription revenue. This revenue is divided into two which are the amount that is collected more than the revenue and the amount which is collected that is not identified as revenue. Both these revenues come in the company’s balance sheet. The revenue of the company also includes the software fees, financing fees etc. In the new business model, maintenance revenue is included in the subscription revenue. Revenue from consulting services and educational programs makes up the professional services revenue. The new accounting method smoothed the process of earning and thus decreased the standard deviation.
Do you agree with the company’s decisions to produce pro forma earnings numbers?
The pro forma earning method of CA benefited the company to a great extent. By following this method, the company can foresee and estimate its income and expenditure in advance. “To help investors compare performance across year, CA provided “pro forma, pro rata” revenues and earning for the current year (2001) and the year before (2000) under the new accounting method and new assumption that it had always owned two companies acquired in 1999 and 2000” (Healy & Palepu, 2002, 6). As the company was giving all details, it helped in achieving customer satisfaction. The pro forma, pro rata revenue and earning method helped the customers know about the latest accounting method. The company provide information in the website and this helps in getting more new customers and in turn the customers get the relevant information about the company. When a customer invests money in a company, it will give the relevant information about its income; along that it will give some irrelevant information also to the customer. In early stages CA provided license agreement for a long period to the customer. It is a great loss to the company. So they started decreasing the period of license. This approach helped them in earning more profit. By reducing the life of license they got regular meeting of customer too. The customers became familiar with the latest software which led to the success of Computer Associates.
Summary
Technology is changing very rapidly and in order to cope with the latest technology, companies have to bring new changes for their success. Computer Associates is the third largest IT Company in the world which succeeded in its business by following new methods. Even though this company is famous for its mainframe computers, its main business is software developing and marketing. Computer Associates succeed in developing software with efficient and qualified developers and they also entered into contract with large companies. In order to achieve success in business, they brought changes in the business model and accounting system. They gained income mainly through license fee. Computer Associates reduced the validity of the license and by reducing the validity period of the license, the customers became well-known with the latest software. So the demand for software increased. They also brought changes in the method of remunerarion to sales representatives. In order to give good service to the customers, they offered more compensation to the sales representatives. The company offered high salary to the workers along with extra commission. Computer Associates also provided various discounts on license fee and also gave license very fast to the customers and they do not need to wait for long time to get the license. The company also adopted the pro forma method to help the customers in new method of investing. This method provides full data about the company to the customers which helped them in understanding more about the company. Thus, the company achieved customer satisfaction in their project and it increased the number of customers. This pro forma and pro rata brought large profit to Computer Associates. By bringing the latest methods, they are able to overcome from the problems faced in the traditional business model. The adoption of new business model also helped them to withstand competition from their competitors.
Conclusion
Computer Associate is one of the largest IT Companies which attained great success through bringing changes in the business model and financial reporting. The latest approach of Computer Associates helped them in developing their business, that is, marketing and developing of software. This company gained revenue mainly through license fee. The license agreement is made in the way which benefits both the customer and company. Thus, they attained increased sale of their product in the market all over the world. The realization of the new business model changed the reporting style of the company.
Reccomendations
There should be a good relation between the company owner and customer because then only they can know the needs of the customers and provide best sevice to them according to their wish. When a company launhes a new product, it should bring the information about the latest product to the people through advertisement, so that people can know about the new product available in the market very fast, because media is the best technology to give rapid information to the people. When the people are aware about the new product in the market, sale of the product will increase.The new business model should offer value to the customers, shareholders and the employees of the company.Then only the company will get sincere cooperation from them for the progress of the company.
Reference
Healy, P., & Palepu, K. (2002). Computer assiciates internatioan, Inc.: Governmence and invester communication challenges. President and Fellows of Harvard College, 6.
Ketz, JE. (2009). The accounting cycle, computer associates: A reprise. SmartPros. Web.