“I think that they were just trying to give unbelievable blood, sweat and tears to grow their business,” maintains Johnson. “The accounting failure was a function of rapid growth, pricing models and revenue recognition schedules, and always wanting to put the company in the best light possible.”

Software Complexity

Software companies have the uphill task of juggling licensing deals of various sizes — with distinct and complicated contracts — together with the promise of delivering customized services within a slated period of time and then, backing them up with maintenance. This invariably makes things harder compared with a hardware company, which records revenues on the basis of unit sales.

Problems began when a MicroStrategy sales representative sealed a deal and the company recorded that as revenue on its balance sheet before it actually delivered the services and accepted payment. The functionality of the licenses sold can take years to deliver and implement. The problem is compounded by the fact that the sales force has no knowledge of the technicality of the product or how much time it may take to install. As such, they may make promises that engineers in the service department fail to keep.

“SAP implementation takes two years,” Johnson points out, underscoring how lengthy the process can be.

When delivery does not take place as promised, customers sometimes have the option of canceling their licenses or not paying for maintenance. On occasion a customer could go out of business after a deal is closed. In these cases, reporting revenues on the basis of deals closed and not on the delivery of functionality is tenuous, and that is where MicroStrategy ultimately faltered.

“It’s like you are sprinkling a bunch of seeds, but the trees never grow and bear fruit,” Johnson explains.

MicroStrategy’s founders declined to be interviewed, but Gaurav Rewari, formerly a vice president at the company, agrees with Johnson that MicroStrategy got the rap for doing what others such as Epiphany and Oracle were also engaged in. Hazarding a guess, he says that MicrsoStrategy’s visibility may have triggered a more intense scrutiny by the SEC. The company saw exponential growth from 30 to 2,500 employees and was bigger than Amazon.com at one time. Rewari, now the president and CEO of firstRain, based in New York, wonders what the auditors were up to.

“PricewaterhouseCoopers blessed the books,” he asserts. “I don’t believe they [MicroStrategy] did it deliberately.”

An attorney with Wilson Sonsini Goodrich & Rosati concurs. On condition of anonymity, he says that auditors independently check various transactions with a company’s customers to ensure that they are real and not forged by company management.

It would be remarkable for a handful of employees to perpetuate a three-year fraud because auditors of the likes of PricewaterhouseCoopers are very adept at catching such activity,” the attorney explains. Like Johnson, the attorney acknowledges that revenue recognition for software companies can be very tricky. One reason is its dependence on performance. In other words, if a company is not satisfied with the way the software is working and the software vendor cannot make the software function according to the customer’s needs, the latter can choose to not pay. In such a case, if the vendor has already recognized the revenue after the deal is closed and the software delivered, there will be a massive gap in the balance sheet.

MicroStrategy’s Failure

“I think that right out of the gate, MicroStrategy had the best technology, hands down,” Johnson says. “Their competitors would tell you that if you could get them behind closed doors.”

However, those same competitors — Siebel, Oracle, PeopleSoft and SAP — had brilliant sales teams and a strong channel. CEOs of big companies typically approach companies like Accenture and Deloitte & Touche, and build relationships with them so that engineers at Accenture and Deloitte can implement their software packages. Such companies build future customers through their relations with executives at other corporations. But according to Johnson, neither Saylor nor Bansal cultivated any such interaction with consulting firms. He attributes the failure to them being visionaries who don’t necessarily possess keen business and sales acumen.

“Who was Tom Siebel?” Johnson asks rhetorically about Siebel’s CEO. “Tom Siebel was Oracle’s best sales guy.”

Key Mistake

Instead of focusing on its licensing business, Saylor and Bansal sunk hundreds of millions of dollars into dot-com venture Strategy.com that used the company’s core competency to deliver information from any database to any device, any time, anywhere. Such data could be personalized according to each individual user. But the venture never made any money, Johnson says. It only took away focus and resources, both capital and talented engineers.

In fact, Strategy.com is rumored to have brought the accounting irregularities to light. Johnson says that before the company’s dramatic disclosure in March 2000, Saylor was planning a $1 billion secondary offering of Strategy.com through Goldman Sachs. He believes that Goldman Sachs decided to review how MicroStrategy’s business was doing and found out that the company had overstated its earnings.

Picking up the Pieces

MicroStrategy has realized a little belatedly the flip side of diversification. On August 29 the company announced restructuring measures to reinforce its focus on business intelligence software. Dan Vesset, a research manager at IDC Research says MicroStrategy has divested its interests in Strategy.com, intending to concentrate on their core competencies.

They are getting back to basics, back to what they do best,” Vesset said. “The company has a good product portfolio and is a viable player in the business intelligence market.”

The company has had a 50 percent reduction in its work force over the past year. In the quarter ended Oct.30, MicroStrategy had a pro forma loss of $5.7 million or 6 cents a share, compared with a loss of $29.9 million, or 37 cents in the same period a year ago. The stock is currently trading at around $3.50.

Although Johnson says shuttering the Strategy.com business is a step in the right direction, according to him the company still needs to improve its channel relations, especially with OEMs (original equipment manufacturers); make the software run not only on Windows but on other systems such as Unix and build out its sales force. Without batting an eyelid he recommends that seasoned executives must be hired even if it involves replacing Saylor.

“MicroStrategy has to get someone much like Oracle got Ray Lane in the early 1990s,” Johnson declares. “It is a business now, not a cult that is building grandiose things for society.”