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December 21, 2004

Software vendors face a rocky 2005

Software was not a good business to be in over the last year. During 2004 around 65% of software vendors were non-profitable so it was no surprise that as the year unfolded the level of mergers and acquisitions rose...

By CBR Staff Writer

There was no discernable trend in terms of application type, it was more a case of small and mid-sized vendors from all enterprise application sub sectors combining to survive, across CRM, ERP and SCM. 2004 was a year of level one acquisitions, but as 2005 plays out many of the acquirers will themselves become acquired as entities try to build critical mass.

The leading vendors were not immune to the trend either with Siebel, SAP and Microsoft all making acquisitions through the year that plumped up their respective portfolios or added expertise in specific areas. In the mid market, consolidators SSA Global and Chinadotcom continued to add to their product lines and customer bases. Often dismissed, these companies have the potential to emerge as large, strong and solid contenders over the next couple of years.

What is very clear is that software is increasingly becoming a game for large players with big customer bases and revenue streams capable of producing profits that can be used to fund expansion into complementary software sectors. As the large players expand, they gain increasing credibility and stability, which further undermines the small and medium sized players.

It was precisely this aspect of software vendor economics that drove Larry Ellison to pursue PeopleSoft. The Oracle/PeopleSoft issue dominated 2004 just as it had been the main issue in the last half of 2003 – in fact, ever since Oracle put in its hostile offer to buy its rival in June 2003. But the last days of 2004 should mean the end of this saga as what was an unfriendly merger turns into what spin doctors would describe as a friendly merger. However this only came about following the sharp nudging of judge Leo Strine, the dismissal of US and European anti trust issues, the deposing of anti-Oracle Craig Conway from PeopleSoft, stockholders voting for Oracle’s dollars, and finally an agreement over the price.

As it stands, Oracle has set a deadline of December 28 for shares to be tendered in order that the transaction can be completed, so barring unexpected mishaps the deal should be struck in Q1 of next year.

Times will be no less interesting in 2005. The difference is that questions will shift from will they/won’t they merge, to what will Oracle do next in terms of supporting, developing and merging its expensive new asset. JD Edwards’ customers were pleasantly surprised following PeopleSoft’s acquisition of the company, receiving better levels of support, albeit at a higher cost for some, Oracle will need to duplicate that scenario for both JD Edwards and PeopleSoft customers if it is to retain their business.

2005 will see Oracle making serious efforts to reach out to its new customer base in terms of support and development so that when it eventually comes out with a functionally merged suite and customers have to transition, they will stay with Oracle rather than use the opportunity to move away to a waiting SAP.

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Size matters because software vendors do not have a viable future if they continue to be just software vendors. They have to provide application infrastructure and integration platforms as well in order to maintain a competitive position. The move towards service-oriented architecture, web services, ever more granular composite applications and a business process approach combined with the demand by customers for fewer suppliers and less complicated, more flexible architectures is driving application vendors further down the integration stack.

With its Netweaver platform, SAP has a strong framework to build on, Oracle is at last combining its technology and applications lines of business and creating a coherent story and Microsoft is coming up on the outside. Over the next year and beyond these combined application and infrastructure vendors will come head to head with infrastructure-only players like IBM. The interdependencies in the real world of deployed enterprise systems means these players, who are already both competitors and partners, will face increased demands on both sides and success will go to those who are best able to manage these complicated relationships.

Similarly partnerships will be the key to success in the SMB market every vendor is targeting. Although SAP, Oracle and Siebel are twisting and turning to fit themselves to SMB needs, their prospects of success are poor due to overly complex products and business models plus lack of experience in dealing with the channel. Their opportunities are not enhanced when their offerings are compared with those offered by the hosted or on demand vendors like and RightNow Technologies, whose star will continue to rise not only among SMBs but increasingly in the enterprise sector, taking customers and revenue from the traditional players.

The challenge for the hosted players is to broaden their portfolios, but their architectural requirements mean the potential for growth through acquisition is limited so it will have to be fuelled through in-house development and organic growth. Ironically their rate of success to date may cause them development difficulties over the coming year and beyond as they try to keep up with demand for application depth and breadth.

The software sector is on the cusp of major change. The Oracle/PeopleSoft dynamic proves that no vendor can be considered entirely stable even while the economics of application software are increasing the gap between the mega vendors and the rest. For customers it means an unsettling year ahead and the need for flexible strategies that can adapt to changes in vendor status. The good news is that vendors have recognized just how valuable customer bases are and will work hard to pacify, cajole and sooth their assets to encourage their loyalty, which provides those same customers with leverage in critical areas such as maintenance and support.

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