Etude

Mergers compute in software sector

Success in the software industry these days is less about discrete product innovations than about excelling at building and extending platforms to achieve scale in customer relationships.

Par Simon Heap, Vince Tobkin and Franz-Josef Seidensticker

First published on septembre 29, 2004
min


Name this trend: Oracle continues its fight for control of PeopleSoft. Microsoft reveals it discussed a merger with SAP, EMC buys Legato, then Documentum, then VMware. IBM snaps up middleware maker Candle Corporation. Answer: Merger pressure is building in the software industry. Software company combinations will accelerate in the months ahead, our analysis shows, for the first time since the heady Internet boom of 2000. And as concentration picks up speed, more than half of today's independent software vendors could disappear in the next five years, through either acquisition or failure. Success in the software industry used to be driven by discrete product innovation; today, the winners in software excel at building and extending platforms to achieve scale in customer relationships. At stake is future control of installed bases. Those are some of the reasons why Larry Ellison, Oracle's CEO and leader of the world's second-largest independent software vendor, bid to acquire PeopleSoft, which last year purchased its largest rival, J.D. Edwards. Ellison maintains he has to acquire PeopleSoft to keep "winning for Oracle shareholders." His continued focus on growth makes sense. Bain & Company analysis indicates only two kinds of software companies earn profits these days: Clear category leaders and those with the scale and scope that come with more than US$1 billion in revenue. Two of every three software companies didn't show profits last year, our analysis shows, which makes them more vulnerable as acquisition targets. With their stock valuations rising, the larger players have amassed war chests. Meanwhile, new licence sales are no longer generating sizable growth. So, many software companies have concluded they must pursue others' installed bases. A fundamental market shift is also hastening industry concentration. After the tumult of the Internet, IT (information technology) spending growth has slowed. The industry's landscape shifted from a welter of poorly integrated point products to a more "federal" environment. Today's enterprise architecture is built around open standards or those set by consortia of big vendors. Customers are less interested in best-of-breed solutions, which they have to weave together at their own expense. They want reliability and simplicity. The inevitable outcome: Fewer, and stronger, players. As Ellison put it more than a year ago, "It's been 'winner take all' in mainframes and 'winner take all' in desktop computing, and I think you'll see a similar consolidation in enterprise computing (software)." In such turbulent times, when product development is no longer a reliable source of growth, where can software executives extract value? Although M&As (mergers and acquisitions) are most obvious options, they can be treacherous. Tech deals have an unfortunate track record for destroying value, indicate historic data. Software companies must forge their strategies wisely. Their choices—buy, sell, partner—depend largely on their sizes and their roles in emerging platforms. Each category faces different opportunities in today's harsh ecology. Smaller players confront the starkest choices: Merge with another player, try to become a platform, or fail. Some can expand into related services, as many are doing as licensing revenue declines. Others will survive in niches. Midsize firms are also candidates for takeovers. They need to understand how to create new growth—through astute positioning, particularly within their own or others' broadening platforms. The US$1-billion-plus players need M&A growth plans based on extending scope into adjacent software categories and capturing large installed bases. Among other methods, they can work with smaller players as resellers before absorbing them. Or they can expand along industry lines, as Siebel has been doing, most recently with its pharmaceutical-industry-specific customer relationship management package. Finally, the superpowers need an M&A strategy that avoids the kind of vociferous opposition that draws regulatory scrutiny. That will be a tall order. But every big firm must eventually receive tacit permission, from customers and competitors, to grow larger. Simon Heap is a partner at Bain & Company's San Francisco office. Franz-Josef Seidensticker is a Bain partner in Munich. Vince Tobkin leads Bain's Global Technology Practice from San Francisco. (Copyright 2002 by China Daily)

Name this trend: Oracle continues its fight for control of PeopleSoft. Microsoft reveals it discussed a merger with SAP, EMC buys Legato, then Documentum, then VMware. IBM snaps up middleware maker Candle Corporation.

Answer: Merger pressure is building in the software industry.

Software company combinations will accelerate in the months ahead, our analysis shows, for the first time since the heady Internet boom of 2000.

And as concentration picks up speed, more than half of today's independent software vendors could disappear in the next five years, through either acquisition or failure.

Success in the software industry used to be driven by discrete product innovation; today, the winners in software excel at building and extending platforms to achieve scale in customer relationships.

At stake is future control of installed bases.

Those are some of the reasons why Larry Ellison, Oracle's CEO and leader of the world's second-largest independent software vendor, bid to acquire PeopleSoft, which last year purchased its largest rival, J.D. Edwards.

Ellison maintains he has to acquire PeopleSoft to keep "winning for Oracle shareholders."

His continued focus on growth makes sense. Bain & Company analysis indicates only two kinds of software companies earn profits these days: Clear category leaders and those with the scale and scope that come with more than US$1 billion in revenue.

Two of every three software companies didn't show profits last year, our analysis shows, which makes them more vulnerable as acquisition targets.

With their stock valuations rising, the larger players have amassed war chests.

Meanwhile, new licence sales are no longer generating sizable growth. So, many software companies have concluded they must pursue others' installed bases.

A fundamental market shift is also hastening industry concentration. After the tumult of the Internet, IT (information technology) spending growth has slowed.

The industry's landscape shifted from a welter of poorly integrated point products to a more "federal" environment.

Today's enterprise architecture is built around open standards or those set by consortia of big vendors.

Customers are less interested in best-of-breed solutions, which they have to weave together at their own expense. They want reliability and simplicity.

The inevitable outcome: Fewer, and stronger, players.

As Ellison put it more than a year ago, "It's been 'winner take all' in mainframes and 'winner take all' in desktop computing, and I think you'll see a similar consolidation in enterprise computing (software)."

In such turbulent times, when product development is no longer a reliable source of growth, where can software executives extract value?

Although M&As (mergers and acquisitions) are most obvious options, they can be treacherous. Tech deals have an unfortunate track record for destroying value, indicate historic data.

Software companies must forge their strategies wisely. Their choices—buy, sell, partner—depend largely on their sizes and their roles in emerging platforms.

Each category faces different opportunities in today's harsh ecology.

Smaller players confront the starkest choices: Merge with another player, try to become a platform, or fail.

Some can expand into related services, as many are doing as licensing revenue declines. Others will survive in niches.

Midsize firms are also candidates for takeovers. They need to understand how to create new growth—through astute positioning, particularly within their own or others' broadening platforms.

The US$1-billion-plus players need M&A growth plans based on extending scope into adjacent software categories and capturing large installed bases.

Among other methods, they can work with smaller players as resellers before absorbing them.

Or they can expand along industry lines, as Siebel has been doing, most recently with its pharmaceutical-industry-specific customer relationship management package.

Finally, the superpowers need an M&A strategy that avoids the kind of vociferous opposition that draws regulatory scrutiny.

That will be a tall order.

But every big firm must eventually receive tacit permission, from customers and competitors, to grow larger.

Simon Heap is a partner at Bain & Company's San Francisco office. Franz-Josef Seidensticker is a Bain partner in Munich. Vince Tobkin leads Bain's Global Technology Practice from San Francisco.