The story of XACCT Technologies should be featured in business administration textbooks in the chapter explaining how a series of mistakes can push an excellent company with leading technology to a state of total business and financial failure.
Six-and-a-half years after its founding, after it had raised $87 million in five financing rounds, Israeli mediation company XACCT was sold for only $29.5 million. Sources inform “Globes” that the founders, employees, and service providers received $3.5 million of the sale price.
XACCT’s end was bitter for all those involved: the investors got $0.29 on the dollar, most of the employees got almost nothing (except for a few who got at most a few tens of thousands of dollars), and the founders did not achieve the wealth they had hoped for, although they made a pile while the company was still going.
XACCT was founded in 1997 by Eran Wagner and Limor Schweitzer, two talented entrepreneurs, who developed IP mediation technology. The purely voice mediation market had dominated up until then, with companies like Intec Telecom Systems (LSE: ITL) and Comptel (OTCBB: COPTF). Wagner and Schweitzer’s revolutionary idea created a new market: IP mediation for the Internet market.
They were the first to realize that Internet providers could not make a living in the long term by collecting a uniform rate, and would require other pricing models, which could enable them to charge according to information volume and type of content.
The company set up its development center in Israel and its headquarters and marketing center in California, and put the first version of its product on the market a year later. The future seemed promising, and the company began recruiting senior managers.
The great question is why a company that made a good start and had what were considered the best employees in the business, market-tested cutting-edge technology and a good reputation, failed the value test. The delay of several years in the development of the data communications market unquestionably played a role. Nevertheless, with $87 million in the bank, XACCT should have been more resilient.
The industry lays the blame at management’s door, but adds that the board of directors, which should have prevented mistakes in time and instituted tighter cost controls, shares the responsibility.
This is where the key issue arises where did the money go? Sources close to the company claim that the money was spent mostly in marketing and sales. “Marketing and sales met most of their targets,” one industry source says. “The company’s sales reached $22 million at the peak, which is a good level. Another achievement was the creation of a brand name the billing market learned to identify IP mediation with XACCT.
”Nevertheless, $87 million is a lot of money. Had it all been spent wisely, the company should have made a profit, or at least broken even. Today, almost seven years after its founding, XACCT is still losing money. It’s true that the company broke even in one quarter at the end of 2002, after its big wave of lay-offs, but its losses resumed the following quarter, mostly because the telecommunications market crisis depressed its sales. At the same time, thanks to the IP mediation recovery, XACCT now has a fine pipeline.”
Venture capital sources say the company undoubtedly made a long series of wrong decisions. The main problem was the company management, particularly CEO Eric Gries, recruited in February 1998.
A confidant of one investor cited Gries’s lack of attention to details as one problem, but added that Gries’s complete lack of understanding of the market in which XACCT operated was more serious. “The most glaring example was the unsuccessful sale to D2 of the Vodafone Group (NYSE; LSE; FSE: VOD),” the source said.
”In order to sell a system to tier-1 telecommunications operators, the company’s management must be involved on the highest levels, and the CEO has to be involved in major transactions. The relevant unit managers at tier-1 telecommunications operators are very senior personnel. They won’t meet with junior executives of small companies, and even if they do, the company’s chances of winning a tender by such an operator without the CEO’s involvement are extremely small. That’s the ABC of supplier-customer relations. Unfortunately, XACCT didn’t know that, and paid dearly for its lack of understanding.
”Over a year ago, XACCT lost a huge tender by D2, a German communications operator subsidiary of the Vodaphone group. It’s believed that the main reason why XACCT lost was that Gries was totally uninvolved in the deal. The local sales person was entirely responsible for the submission of the bid.
”The HP-Hewlett Packard (NYSE: HPQ) mediation division, which competes with XACCT, assigned its biggest guns to the tender, including senior VPs from the US and the HP Europe CEO, and it won. I estimate that this tender has earned HP $8 million to date, and that’s a lot of money for XACCT. In addition to the actual sale, XACCT missed a golden opportunity, because success with D2 would have created opportunities with other Vodaphone subsidiaries, and opened doors to other tier-1 European operators.
”It’s known that D2’s technical personnel were interested in XACCT’s system, and I’m convinced that had Gries become involved, XACCT would have had an excellent chance of winning the contract.
”A CEO doesn’t require technical expertise. He doesn’t have to understand every screw in the system, but he absolutely must understand the business. Above all, understanding the business means realizing that local sales personnel don’t close major deals with tier-1 operators. Secondly, the CEO must understand the customer’s business requirements. He must be capable of showing customers how the product can solve critical problems for them, and he must know how to adapt the product to these needs.
”In order to do that, you must first of all understand the significance of IP in the wireless market, and that requires a profound knowledge of the customer’s business. Unfortunately, Gries brought no added value on any of these matters.”
Another source says that XACCT’s first mistake was that, at the beginning, it gave its marketing personnel in the US responsibility for marketing all over the world. The source asserted that Americans didn’t understand the European market, and certainly not the Asian market, which created a problem.
Another problem was the remoteness of the product managers from the development center. Product managers play a key role in developing products. Since they were in California, the information regularly received from the markets was not always awarded the right priority at the development center in Israel.
The results were soon felt. XACCT launched its product for the wireless industry later than its competitors, and lost the advantage it had when it began. XACCT did not set up a marketing unit outside the US until early 2000.
Furthermore, XACCT was a year late in realizing that its principal market was the wireless industry, not Internet providers. Its US sales unit continued selling products to the Internet provider market for more than a year after the company’s sales unit outside the US had stopped selling products to that industry. As a result, the development center had to develop two products simultaneously: one for Internet providers in the US, and one for the wireless market in Europe and the Far East.
So much for management and product. As far as cash flow is concerned, as already mentioned, XACCT’s difficulties are said to have stemmed from the extend of spending on sales and marketing. XACCT worked mostly on a direct sales model, although it sold through distributors in a few countries. It direct selling policy obliged XACCT to set up six subsidiaries, five in Europe and one in Hong Kong, which employed salespeople and technical staff. That significantly inflated costs.
Telecommunications industry sources claim that more selling through distributors would have made it possible to save on many costs. Sources close to the company say that XACCT had to sell directly, because its product had to be customized to a certain extent. Billing industry sources assert that XACCT’s system required a minimum of customizing, which could have been accomplished after the distributor finished its work with the customer.
Other billing industry sources say that the main problem was lax control over spending. “XACCT flew its people all over the world, whenever and wherever they wanted,” one source said. “In the long run, the number of tenders the company won was small, compared with the size of the company’s market. While the presence of XACCT’s personnel all around the world helped increase the company’s exposure to the market, it cost a lot of money, and led to a loss of focus.”
A glaring example of wasteful spending was in early 2001, when XACCT paid for a week’s vacation for its outstanding salespeople and their spouses in the Cayman Islands. The company flew salespeople there from all over the world; the vacation cost an estimated $400,000.
”That’s the kind of thing that a large company generating cash from its activity can afford,” a telecommunications source said. “It’s very doubtful whether a company living on money from investors can afford such luxuries.”
Another example can be found in the S-1 document that XACCT filed with the US Securities and Exchange Commission for a possible IPO. The document reported that XACCT granted Gries a personal loan at an extremely attractive interest rate. The document did not state whether Gries had repaid the loan.
Another problem was the creation of separate development entities. XACCT’s main development center was in Israel, but at a certain point, the company established a parallel development outfit in California, in order to develop an IP mediation probe including both hardware and software (XACCT’s main mediation product is completely software-based).
While the California development unit was set up specifically to develop the probe, it demanded that the development unit in Israel adapt its product to the one developed in the US. Billing industry sources said this demand was logical, since the two products had to be fully compatible. The creation of two separate development centers, however, caused friction between them.
Another complication was that the multiplicity of products led to a loss of focus. XACCT entered several new fields towards the end of 2001, which were not part of its core business. One product was a reporting module. Billing industry sources say that entering the reporting field was the right thing to do, since it improved the company’s position in the market, but it might have been wiser and more economical to cooperate with another company working in that field.
XACCT also produced a rating engine for pricing activities on the network. This forced the company to invest heavily in training and support for the product, which made no contribution to its core business. The company’s rating engine was designed to support its prepaid product.
”XACCT tried to provide a complete solution, and that was a mistake,” one billing industry source said. “As long as the company stuck to selling only an IP mediation system, it was approaching the customers in cooperation with the billing companies. Since no billing company had an IP mediation product as good as XACCT’s, in many cases billing companies preferred to include XACCT’s system in their billing tender bids. This method enabled XACCT to win deals, regardless of whether Amdocs (NYSE: DOX) or its competitors won the tender.
”The moment that XACCT decided to offer a complete solution, including an independent rating engine and prepaid solution, it started unnecessary competition with its billing partners. As far as is known, XACCT actually had no revenue at all from sales of its rating engine and prepaid product. A lot of damage was caused several billing companies stopped offering XACCT’s system, and replaced it with systems from XACCT’s competitors, which weren’t competing with the billing companies.”
Finally, there is the matter of XACCT’s entry into the voice mediation field. It acquired a system for $1 million from a failing Indian company. “Entering the voice mediation field didn’t harm the company’s relations with its partners. It could have proved a wise decision, had XACCT bought a system from a successful company,” a billing industry source said. “XACCT’s decision-makers should have known that no operator would buy any other than a leading voice mediation system.
”Telecommunications operators can’t afford to have their voice systems crash just because the mediation system isn’t working properly. No smart operator will touch a system purchased from a company that hasn’t been installed on sites. While the system that XACCT bought had been installed on some unknown site in India, it hadn’t been successfully installed on any other sites.
”XACCT should have known not to enter the market, unless it could purchase a leading system. XACCT wasn’t able to attain a market share in this field, and its entire investment was wasted.”
The company’s many products created another problem it had to recruit employees to develop and maintain all of them. The increased staff was another cause of higher costs. The company also needed salespeople familiar with the material. When XACCT’s salespeople were saddled with the task of selling a wide variety of products, they had to understand a large number of fields.
There is no doubt that the responsibility for the series of decisions that brought XACCT to its current state does not rest solely with the company’s management. After all, XACCT’s board of directors included some of the world’s leading funds and technology companies.
The job of company directors is to watch out for the investors’ interests. They should guide the company, above all in strategic matters. Almost none of the above-mentioned measures could have been taken without the consent of the board. If the investors in XACCT want to know who to blame for the drop in the company’s value, they should take a good look in the mirror.
Eric Gries declined to respond to the report.
Mediation systems gather information from telecommunications networks, enabling the activity on those networks to be priced. Voice mediation systems gather information from switches: the main pricing criteria are usually call duration and distance. IP mediation facilitates differential pricing for data communications networks according to type of use and data volume - downloading a film from an Internet site, for example, as opposed to receiving an e-mail message.
Published by Globes [online] - www.globes.co.il - on January 14, 2004