Oracle Confronts Lawsuit on Its Path to the Cloud

The City of Sunrise Firefighters’ Pension Fund recently filed a lawsuit alleging that Oracle executives lied about the company’s successes in the cloud and engaged in coercion and threats to sell its cloud products, “creating an unsustainable model that fell apart.”

I don’t understand everything about the new lawsuit, as I am not an attorney.

The plaintiff apparently is seeking class-action status for the suit. Oracle has called the suit meritless and said it would defend against it. The company might have a point, because unsustainable models emerge all the time, not as a result of malicious intent but as vagaries of the market.

Deception or Pragmatism?

While reviewing my notes from the March earnings call, which seems to have caused some of the consternation among the firefighters, I recalled thinking at the time that the company hadn’t been doing very much in the cloud. I was surprised that so much of the company’s cloud business was coming from net new customers, not the installed base.

“Less than 15 percent of our on-premise applications customers have begun to migrate their applications to the cloud,” co-CEO Mark Hurd said in the earnings announcement. “As the other 85 percent of our applications customers start to move their applications to the Cloud, we have a huge opportunity in front of us. We expect to more than double the size of our SaaS business very quickly.”

To my recollection, during the subsequent call Hurd was insistent that the cloud revenues represented net new business that did not come from the installed base.

Clearly, the company expected to ramp up its cloud business with its installed base, but just as clearly, it lacked a good deal of the public infrastructure it needed to make that happen. For a company accustomed to reporting in terms of billions of dollars, the outlier line item was this: “Infrastructure as a Service (IaaS) revenues were up 28 percent to (US)$415 million. Total Cloud Revenues were up 32 percent to $1.6 billion.”

If memory serves, at the time there were just three data centers deployed to handle the cloud business. There are more now, but there would need to be many more cloud data centers for Oracle to achieve its vision of moving its installed base to the cloud — even if many of its largest enterprise customers decided to continue operating their own data centers in private clouds. That’s why the $415 million number was so small.

Lastly, Oracle was well aware of the heavy lift the transition to the cloud would be. On multiple occasions, Larry Ellison, Mark Hurd and others cautioned that the move could take a decade or more. All of this suggests to me that the company was not lying about its progress in moving to the cloud. If anything, I thought, it was being pragmatic.

Arm Twisting

On a related topic, the lawsuit claims that Oracle used coercion and threats of software audits to incentivize customers to move applications to the cloud. This is a more difficult situation to rationalize, because each case will be different.

Each conversation between Oracle representatives and individual clients will cause individuals to take away different impressions. Did a representative try to twist an arm beyond what is commonplace in sales negotiations? It’s hard to say.

What’s certain is that software audits didn’t sprout from the ground a few months ago. They’ve been a part of the Oracle license agreements for a long time. Representatives of the company have told me that they perform a small number of audits relative to the size of the customer base (425,000-plus businesses) each year. Their purpose is to ensure compliance and to avoid mission creep in a deployment that avoids paying for additional use. Nobody likes that but it’s reality.

When a discrepancy is discovered between what’s licensed and what’s in use, several things can happen. A customer might be liable for back charges and new upfront charges for continuing a use pattern that varies from the agreed terms. Alternatively, the company might at its discretion offer to waive the charges if the business chooses to make a purchase to rectify the situation.

To be sure, none of this is black and white. Many large businesses operate thousands of Oracle databases and applications, and the audit process likely will, on occasion, surprise all parties. There’s no allegation of conscious theft in the process. It’s also true that in the cloud, the gray areas that on-premises systems can be subject to, don’t exist. Every configuration is specified, and the seats are allocated and paid for, so one of the big issues that drives audits doesn’t exist.

That means hosting a database on a computer that could support alternative uses of the software from what was licensed isn’t prevalent. Many audits turn up questionable hosting but not actual use, which is part of the gray area problem.

In such a situation, a reasonable person could imagine a conversation between Oracle and a customer that includes a statement like, “If you had these apps in the cloud, this wouldn’t be a problem.” That’s not coercion. I’m not saying that did or didn’t happen, only that it’s a gray area.

Analysts React

Shortly after the earnings call, Gartner issued a negative opinion of Oracle’s progress in migrating to the cloud, and on March 20, Oracle shares fell 9.4 percent causing the pension fund to lose money. We know that for sure, but we also know that earnings calls are full of forward-looking statements and safe harbor declarations that insulate vendors from errant predictions.

We also know that the value of shares fluctuates in the open market based on numerous factors, including what a company says about its successes and failures and what others say too.

Last Words

Oracle’s earnings numbers were solid in March, but the forward guidance was cautious, given such things as the need to build more cloud data centers and the delicate dance of moving on-premises enterprises to the cloud. I think it was the forward-looking statements about future earnings that troubled analysts and may have spooked investors, so I am not sure what the lawsuit hopes to prove.

It’s hard from this vantage point to say if Oracle did anything wrong. We can have our suspicions — but it’s also hard to believe that a company as big, savvy, and as well-lawyered as Oracle is could make the rookie mistakes alleged in the complaint.

No one likes to lose money in the stock markets, but the reality is that it happens all the time, and everyone who enters that public space should keep that in mind.