Global CIO: How 22% Annual Fees For You Equals 51% Operating Margins For OracleGlobal CIO: How 22% Annual Fees For You Equals 51% Operating Margins For Oracle

New software-license revenues totaled $2.7 billion. Year-on-year, that's down 4% in constant currency, and down 13% in U.S. dollars. That $2.7 billion breaks down into two categories: new technology-license revenues, and new applications-license revenue. Here are the details for those two categories:

New technology-license revenues were $1.9 billion. In constant currency, that's down 1%, and in U.S. dollars it's down 10%.

New applications-license revenues were $805 million. In constant currency, that's down 11%, and in U.S. dollars it's down 19%.

Services revenues were $1.1 billion, which is down 7% in constant currency and down 16% in U.S. dollars.

So in terms of revenue generated by the products and services that Oracle sells and you buy, the numbers were down across all three categories the company specified: new technology licenses, down 10% in U.S. dollars; new applications licenses, down 19% in U.S. dollars; and professional services, down 16% in U.S. dollars.

That’s hardly a top-line performance to celebrate but, in today's brutal global economic climate, it's at least understandable. But it’s also clearly not the type of performance that will deliver a spectacular 51% operating margin -- so where did all that profit come from?

The answer is: your annual maintenance fees. And here’s how Oracle reported them for the fourth quarter:

• Software-license updates and product-support revenues totaled $3.1 billion for the quarter. Year-on-year, that was up 17% in constant currency, and up 7% in U.S. dollars.

And to be very precise about what goes into that $3.1 billion revenue category, here's how Oracle CFO Jeff Epstein defined it on an earnings call with analysts: "These revenues are annual fees that customers pay to receive updated versions of and enhancements to their existing products."

So revenues from technology, applications, and services were down 10%, 19%, and 16%, but revenue from annual fees was up 7%.

Now again, from the perspective of Oracle, that's exceptional, and here's what CFO Epstein said about the overall performance: "This is the highest operating margin in Oracle's history as a public company and further demonstrates the success of our operating model."

Echoing Epstein's perspective, Oracle co-president Safra Catz said of the 51% operating margin: "The reality is that the margin story really has to do with the fact that we have an enormous installed base of customers that renew their agreements with us every year and the bigger that number becomes, that’s really the main issue."

In the fourth quarter, while those annual fees contributed less than half of Oracle’s total revenue, they were still nothing to sneeze at: Oracle reported quarterly revenue of $6.9 billion, and of that, the 22% maintenance fees that you pay each year totaled $3.1 billion, or 44.9%. So it’s clear that those maintenance fees have become more than just an add-on bump for Oracle to plow into product updates because those fees in the fourth quarter accounted for 45% of Oracle’s overall revenue. And for the year, as noted above, that percentage topped 50%.

Here’s another perspective: Oracle’s professional services business brought in revenue of $1.1 billion for the quarter, which is a pretty darn big number--spread out over a year, that would be a $4.4 billion business. But as big as that number is, it's barely one-third the size of the revenue Oracle gets from your annual maintenance fees.

Look at it across the year: Oracle revenue from new software licenses was $7.1 billion, while its revenue from your annual maintenance fees was $12 billion. Now, I might be the last knucklehead on Earth to understand these figures, and if so I apologize. But from the scores of people I've talked with over the past week or so about this, I don't think that's the case.

Let me repeat: Oracle has every right to charge whatever prices and fees it wants, and I admire greatly their recent superb overall financial performance, particularly on the operating margin of 51% that co-president Catz always, always chalks up to the enormous installed base of customers who pay their non-negotiable update and support fees every year.

But as sweet as those numbers are to Oracle -- and to the financial analysts and investors who are rewarding Oracle's terrific bottom-line performance in this brutal economy -- they might or might not be as sweet to the folks paying those annual fees. And those differing perspectives raise a series of important questions:

1) Will Oracle be able to continue to deliver to its customers a level of value and innovation that those customers think is worth the 22% annual maintenance fees?

2) Have Oracle and SAP and to a less extent Microsoft achieved such dominance in the enterprise software market that customers will have only limited options to pursue, regardless of whether they feel Oracle and the other big players are delivering full value for the prices they charge?

3) Oracle has begun to say that it is more open than ever before to on-demand software models, and even CEO Larry Ellison acknowledges the validity of the desire among some customers to step outside the traditional on-premises model. Will the company's gradual, decade-long evolution toward more-diversified offerings be sufficient to match the needs and desires of customers to lower the cost of infrastructure and transform both their businesses and their IT operations?

4) If customers chafe as they gain greater understanding of Oracle's business model, as touched on above, will Oracle be willing to reconfigure what it includes in its up-front “price” and what it includes in its annual fees to more accurately present a value-for-value exchange for customers?

5) And finally, will customers who've spent the past 12 months having their budgetary backsides reshaped with an industrial belt-sander continue to accept the value exchange with Oracle that has, quite clearly, worked very well for both parties for many, many years? In the new and different economic reality that's likely to emerge over the next few years, will those customers be willing to do business as usual with Oracle, when in fact they and the global recession have forced almost every other IT vendor/partner to alter long-standing terms and conditions, no matter how sacrosanct those at one time appeared to be?

I have a ton of respect for Oracle. Look at the Exadata machine, look at the Sun acquisition and the daring capture of MySQL, look at its remarkable vertical-market expertise and its $3 billion R&D investments, look at its enduring database franchise, and look at the way that CEO Ellison forces everyone to look at him and his company all the time. Those all combine to form a compelling package of leadership and vision and boldness that don't come along too often, but when they do, they reshape entire industries. as I believe Oracle has.

But while you're looking at all of that, be sure to take a long, hard look at the fundamental building blocks of Oracle's business model here in the middle of 2009. Because you'll see that the cornerstone -- the piece on which everything else sits and everything else depends -- has become the annual maintenance fees that you pay to Oracle.

And ultimately you'll have to decide if you're getting fair return for 22% maintenance fees that account for more than half of the company's revenue and that allow it to generate an operating margin of 51%. If you decide that the answer is yes, that you are getting fair return, then Oracle has in place the annuity funding to continue delivering that deep and enterprise-wide value your business and customers have come to depend upon.

And if you decide the answer is no, that you're not getting fair return for all that you pay to Oracle, then buckle up tight because while you'll have lots and lots of options from which to choose, you won't have the resources and experiences of a company that convinced a lot of companies over a lot of years that its products and services were so good that those customers were willing to fund a model that eventually reached an operating margin of 51%. And you don't reach sustained profit levels like that without being awfully good.