Software Industry Crosscurrents

A keynote speech summarized the turbulent state of the software industry at the Enterprise 2005 conference I attended this week: “Investors want growth AND profitability. Customers want innovation AND viability. Employees want options AND stability”.

The conflicting priorities summarized the tone of the conference.  Because of the “no media” protocol at the conference, I am not directly quoting specific executives, but the audience reflected a wide cross section of software industry CEOs, VCs, corporate CIOs and industry analysts.

While the divergent views below reflect an industry in transition, I saw a group of leaders who love the industry (though many cannot stand each other) and continue to look for ways to morph and improve it.

Industry “Consolidation”  

The “C” word came out early and often. Bruce Richardson of AMR led a lively panel on M&A which include reps from Oracle and Sterling Commerce. But several comments during the conference show how convoluted and slow the actual industry consolidation process really is. The seeds of continued fragmentation are being sown by the "consolidators".   

Only one hand went up when the audience was asked who would like to be Oracle’s next acquisition. This, in spite of the fact that several attendees in the conference think Oracle is over-paying for acquisitions and inflating seller expectations (Oracle recently took a majority stake in i-Flex at 6X revenues).

The CEO of a much smaller vendor commented he is being shown a deal a day, but his pace of acquisitions is no quicker than it was last in the last couple of years. 

Another perspective focused on opportunities for intrepid vendors as the bigger vendors rationalize acquired architectures and modernize existing ones.  Oracle’s Fusion plans, SAP’s Project Vienna, Microsoft’s Project Longhorn will a) keep them inwardly focused for a while and b) reflect expensive migrations for their customer bases. If focused vendors could price alternative solutions at 20% of the likely migration cost, they could carve out chunks from these vendors. 

Another prediction was India and other offshore markets will increasingly move from services to developing packaged software. i-Flex’s transaction with Oracle can only encourage that.

There was discussion around a “Star Alliance” similar to what has happened with international airlines. Instead of acquisitions, there could be shared branding, delivery, capacity sharing.

A CIO described his mostly custom developed applications environment. The software industry has missed out on applications for his mortgage vertical - one of the hottest markets in the last few years in the country given the pace of financings and re-financings. And the industry complains about lack of new opportunities?

I tried not to bore too many people there with my recent blog pointing out that there are still over 2,000 software companies left in the industry. I left the conference feeling that in the next 3 years we will have even MORE software vendors (open source, offshore, new verticals, new SaaS offerings) than we do today.

SaaS and SOA

There was considerable discussion around “services” - web and people based - with an impressive pitch from the CEO of RightNow and a panel on the topic led by Ken Berryman of McKinsey which ranged from adoption challenges in bigger corporations and pricing models and the evolution to BPO.

In spite of firms like Cognizant and Wipro being valued at 10X revenues, the average software executive remains wary of “people services”. One software CEO told the audience such “services suck”.  SAP is high on SOA, less so on SaaS.  Another pointed out that software companies need to become more like Accenture or Infosys or just focus on product development and let partners provide services.  

Till some consistent definitions and excitement emerge in the industry, I suspect we will continue to live with SOUP – Services Oriented User Procrastination.

Changing economics 

I heard fascinating perspectives – on top line and on expense control. “20% of code provides 80% of customer value – let’s start delivering semi-finished software”. “Let’s move away from the" bad habits” of frequent releases and maintenance revenues”. “Using open source components like Linux servers I can host my application at a cost of 6%. I give that away and still make better margins on my hosted application option”. “The software industry has just “tinkered” with offshoring. If it truly transformed itself around an offshore model we could drop R&D costs to 7.5%”.

Not easy to implement but when the software industry calls the traditional maintenance revenue model a “drug we need to wean ourselves away from” it is a welcome change.

Investors 

The VC panel and the “Next Big Thing” panel of emerging companies reflected much more realistic expectations. Most VCs in this audience have always been fans of software and continue to be. 

There was more angst around Wall Street’s “boredom” with software, especially with small and mid-sized vendors. One school of thought is as banks themselves have gone through consolidation and firms like H&Q (which tracked mid-tier software more closely) have been absorbed by bigger banks, the “fan club” for small and mid-sized vendors has disappeared.

There was talk around emergence of more realistic “strategic investors” – vertical solution providers, BPO firms etc.

Here’s my view. As I have written about industry analysts like Gartner, Wall Street analysts are similarly “followers”. If you succeed on Main Street they have to notice.  One of the CIOs at the conference asked the industry to stand with him, not hide, as liability questions come up from data privacy and software quality issues. Other CIOs are looking for continued innovation – the “magic” that allows them to keep justifying IT spend. Keep CIOs happy with lowered utility (maintenance) dollars and higher innovation dollars (see my gallery of innovations at Hertz, Jetblue, the NFL and others) and they will help you move up in magic quadrants and investment portfolios.

At meal time, I sat next to an executive at a services firm. I asked him if he wished his firm was publicly traded like many of his software clients. His answer was stunning – “We believe in creating value for our next generation of employees. An IPO would make me very rich, but would kill our culture”. Somehow, I think his firm manages to keep its investors, customers and employees all pretty happy. The software industry is gradually learning that balancing act.