Seismic Shifts for the Software Market
In five years, we'll look back and not recognize the "old" enterprise vendor. Here's the major market shifts that will reshape the industry.
By M.R. Rangaswami, Sand Hill Group
Apr. 22, 2005
Everyone agrees the ground is moving beneath the software industry. More than simply market maturation, the enterprise software sector is shifting to an entirely new way of doing business. Product development, sales and marketing, operations and strategic partnerships are all transitioning to new models and new benchmarks for success.
A look at the enterprise software landscape reveals the market is shifting along four fault lines.
1) Proliferation - Consolidation
Software companies continue to be one of the most common startups in America. Software accounted for 24 percent of U.S. venture capital investment in 2004, according to Dow Jones VentureOne. An amazing 655 software startups received $4.9 billion in funding last year alone - and that doesn't count the hundreds of bootstrapped operations that get off the ground in garages and lofts every year.
While there will always be an opportunity for new software companies, the big companies are becoming increasingly bigger. Oracle-PeopleSoft-J.D. Edwards. Symantec-Veritas. Adobe-Macromedia. While the number of U.S. software M&A deals has rose 27 percent between 2002 and 2004, the value of those deals has nearly tripled according to Thomson Financial.
Leverage buyouts are also on the rise, witness Silver Lake Partners' orchestration of the SunGard deal, and Fransisco Partners' acquisition of Red Prairie. Thomson data shows technology LBO deals through mid-April 2005 already exceeds that of full year 2004.
Enterprise customers are pouring more and more of their budgets into the hands of the largest software vendors, leaving a smaller budget for software from young independent companies. Savvy software startups will understand this from birth. Their exit strategy will most likely be one where they sell themselves to a larger vendor. That means the startup must immediately become part of the target acquirer's eco-system: using their development platforms and products, targeting their customers, and so on.
2) Proprietary - Open
Open source is impacting the enterprise software industry in many ways. Vendors are leveraging the robustness of the open source stack in their product development. In addition, many software startups are using open source to save money.
Most interestingly, vendors are both competing and partnering with open source solutions vendors. IDC says packaged software is the fastest growing segment of the Linux market, growing 44 percent annually to hit $14 billion in sales by 2008. And enterprise acceptance of the technology is also increasingly widespread: SG Cowen estimates Linux is in use at more than 50 percent of enterprises and usage of open source applications is growing steadily.
As the ecosystem embraces open source, there will be a tremendous opportunity to provide products and services to both customers and vendors retooling their operations. Yet vendors must be aware of the blurring of line between open source and proprietary software . As vendors increasingly incorporate open source code into their offerings, care must be taken not to infringe on public licenses.
3) In-house - Outsource
Whatever concerns software makers had about outsourcing development of their products have largely disappeared. The offshoring wave hit enterprise software with its greatest intensity 2 to 3 years ago and its force continues unabated. The CEO Outlook 2005 survey from Sand Hill Group found 60 percent of software companies are offshoring some part of their business. And two-thirds of executives report satisfaction with their efforts.
India has emerged as the largest beneficiary of this trend. Nearly 70 percent of offshoring companies surveyed by Sand Hill Group are working in India. According to Nasscom, software and services export revenue hit $17.9 billion last year.
But the offshore market is also in transition. Companies that started outsourcing to India are moving to different geographies - even back to rural parts of the U.S., where costs are lower and time zones similar. Vendors that began outsourcing their one function, such as support, have transitioned to other areas, such as product development. These companies are now exploring a variety of offshore capabilities such as accounting and BPO.
The vast resources and relatively low cost of many offshore endeavors will reinvigorate the industry and make it more innovative and adventurous then ever before. That's because both vendors and customers can afford to experiment and take risks. Vendors can also create product offerings that before seemed to be price-prohibitive and develop them in such a way that an ROI can still be achieved.
4) Product - Customer
As the industry reeled from the tech bubble's burst, enterprise CIOs took stock of their I.T. assets and efforts and did not like what they saw. The transition to more prudent spending and more conservative technology strategies seemed to happen overnight. Rather than software reps pushing end-of-quarter deals, customers began demanding evidence of ROI, new pricing models and digestible product portions based on open standards.
The message has been received. Software companies, not traditionally known for their customer focus, are making efforts to be more customer-focused. The Sand Hill Group CEO Outlook 2005 study found 40 percent of software CEOs say their customers want to buy via a service or subscription model. The surprising thing? Many software companies are complying. The study found 35 percent currently sell via one of those models.
And products are changing. Customers are re-architecting their I.T. strategies and want to work with vendors who support them. According to Forrester, 36 percent of enterprises surveyed are pursuing a services-oriented architecture at some level within their organization, and another 15 percent will do so within the year.
Yet a true commitment to customer satisfaction remains elusive. Software companies need to work harder to ensure their buyers are pleased. Just under half of executives surveyed for CEO Outlook 2005 say their firm has a formal plan to evaluate customer satisfaction. Unless carefully and quantitatively monitored, satisfaction cannot truly be gauged. Making customers truly happy - perhaps more than any other metric - will create a foundation for future success.
The market shifts bring new opportunities for vendors, customers and investors alike. Consider a company that marries the benefits of offshoring and open source? Or what about a new breed of BPO company that extracts the systems, people and software out of a certain function - purchasing, for example - takes them offshore and then sells the product as a service? Or even a pure open source solution assembled via a series of LBO-ed best-of-breed vendors?
Many software vendors will not be able to hang on during the coming tumultuous five years. The survivors will operate in an entirely new landscape - with new models for business, hiring, development, services, marketing and so on. These vendors will not look back nostalgically on the "good old days." The enterprise software business of the future will be more dynamic, innovative, efficient and business-driving than ever before.
M.R. Rangaswami is co-founder of Sand Hill Group and publisher of SandHill.com. Send us your opinion about how the industry is evolving. Email editor@sandhill.com -
A look at the enterprise software landscape reveals the market is shifting along four fault lines.
1) Proliferation - Consolidation
Software companies continue to be one of the most common startups in America. Software accounted for 24 percent of U.S. venture capital investment in 2004, according to Dow Jones VentureOne. An amazing 655 software startups received $4.9 billion in funding last year alone - and that doesn't count the hundreds of bootstrapped operations that get off the ground in garages and lofts every year.
While there will always be an opportunity for new software companies, the big companies are becoming increasingly bigger. Oracle-PeopleSoft-J.D. Edwards. Symantec-Veritas. Adobe-Macromedia. While the number of U.S. software M&A deals has rose 27 percent between 2002 and 2004, the value of those deals has nearly tripled according to Thomson Financial.
Leverage buyouts are also on the rise, witness Silver Lake Partners' orchestration of the SunGard deal, and Fransisco Partners' acquisition of Red Prairie. Thomson data shows technology LBO deals through mid-April 2005 already exceeds that of full year 2004.
Enterprise customers are pouring more and more of their budgets into the hands of the largest software vendors, leaving a smaller budget for software from young independent companies. Savvy software startups will understand this from birth. Their exit strategy will most likely be one where they sell themselves to a larger vendor. That means the startup must immediately become part of the target acquirer's eco-system: using their development platforms and products, targeting their customers, and so on.
2) Proprietary - Open
Open source is impacting the enterprise software industry in many ways. Vendors are leveraging the robustness of the open source stack in their product development. In addition, many software startups are using open source to save money.
Most interestingly, vendors are both competing and partnering with open source solutions vendors. IDC says packaged software is the fastest growing segment of the Linux market, growing 44 percent annually to hit $14 billion in sales by 2008. And enterprise acceptance of the technology is also increasingly widespread: SG Cowen estimates Linux is in use at more than 50 percent of enterprises and usage of open source applications is growing steadily.
As the ecosystem embraces open source, there will be a tremendous opportunity to provide products and services to both customers and vendors retooling their operations. Yet vendors must be aware of the blurring of line between open source and proprietary software . As vendors increasingly incorporate open source code into their offerings, care must be taken not to infringe on public licenses.
3) In-house - Outsource
Whatever concerns software makers had about outsourcing development of their products have largely disappeared. The offshoring wave hit enterprise software with its greatest intensity 2 to 3 years ago and its force continues unabated. The CEO Outlook 2005 survey from Sand Hill Group found 60 percent of software companies are offshoring some part of their business. And two-thirds of executives report satisfaction with their efforts.
India has emerged as the largest beneficiary of this trend. Nearly 70 percent of offshoring companies surveyed by Sand Hill Group are working in India. According to Nasscom, software and services export revenue hit $17.9 billion last year.
But the offshore market is also in transition. Companies that started outsourcing to India are moving to different geographies - even back to rural parts of the U.S., where costs are lower and time zones similar. Vendors that began outsourcing their one function, such as support, have transitioned to other areas, such as product development. These companies are now exploring a variety of offshore capabilities such as accounting and BPO.
The vast resources and relatively low cost of many offshore endeavors will reinvigorate the industry and make it more innovative and adventurous then ever before. That's because both vendors and customers can afford to experiment and take risks. Vendors can also create product offerings that before seemed to be price-prohibitive and develop them in such a way that an ROI can still be achieved.
4) Product - Customer
As the industry reeled from the tech bubble's burst, enterprise CIOs took stock of their I.T. assets and efforts and did not like what they saw. The transition to more prudent spending and more conservative technology strategies seemed to happen overnight. Rather than software reps pushing end-of-quarter deals, customers began demanding evidence of ROI, new pricing models and digestible product portions based on open standards.
The message has been received. Software companies, not traditionally known for their customer focus, are making efforts to be more customer-focused. The Sand Hill Group CEO Outlook 2005 study found 40 percent of software CEOs say their customers want to buy via a service or subscription model. The surprising thing? Many software companies are complying. The study found 35 percent currently sell via one of those models.
And products are changing. Customers are re-architecting their I.T. strategies and want to work with vendors who support them. According to Forrester, 36 percent of enterprises surveyed are pursuing a services-oriented architecture at some level within their organization, and another 15 percent will do so within the year.
Yet a true commitment to customer satisfaction remains elusive. Software companies need to work harder to ensure their buyers are pleased. Just under half of executives surveyed for CEO Outlook 2005 say their firm has a formal plan to evaluate customer satisfaction. Unless carefully and quantitatively monitored, satisfaction cannot truly be gauged. Making customers truly happy - perhaps more than any other metric - will create a foundation for future success.
The market shifts bring new opportunities for vendors, customers and investors alike. Consider a company that marries the benefits of offshoring and open source? Or what about a new breed of BPO company that extracts the systems, people and software out of a certain function - purchasing, for example - takes them offshore and then sells the product as a service? Or even a pure open source solution assembled via a series of LBO-ed best-of-breed vendors?
Many software vendors will not be able to hang on during the coming tumultuous five years. The survivors will operate in an entirely new landscape - with new models for business, hiring, development, services, marketing and so on. These vendors will not look back nostalgically on the "good old days." The enterprise software business of the future will be more dynamic, innovative, efficient and business-driving than ever before.
M.R. Rangaswami is co-founder of Sand Hill Group and publisher of SandHill.com. Send us your opinion about how the industry is evolving. Email editor@sandhill.com -
