DAY OF THE BIG SHARKS

Rajneesh De
Dataquest (Edition: January 15, 2008)

Research firm Gartner regularly brings out their much vaunted four quadrants where different companies are placed depending on factors ranging from their business maturity levels to service performances. For the software sector, the quadrant might soon lose its raison detre; it perhaps becomes meaningless to track which companies belong where, especially if only a handful of software vendors remain in the scene. Quibble if you want about the nitty-gritties but one thing is clear, that software is going the way of the PC, auto, lighting fixture, consumer goods, and other mature manufacturing industries: ruled by the giants.

The march toward consolidation by the software industry has been in full swing for quite a few years now2007 only saw the momentum reaching a crescendo. Leave aside the multi-billion dollar giants; there remain very few independent best-of-breed vendors who are holding their own. SAS, Adobe, Autodesk, Dassault, i2 Technologies, and Ariba could count themselves among these lucky handfuls. But how long they can maintain their independent status is the moot question. Many analysts believe that for many of them, and even for a handful of tier-2 software vendors like CA and BMC Software, its just a matter of time. Maybe, even 2008 could turn out to be the D-Year for many of these vendors.

When it comes to acquisitions, software dominates all technology sectors, accounting for 40 percent of the $298 bn in tech M&A deals done in 2006, and half of the $306 bn in deals in 2005, according to Thomson Financial. The runner-up: Internet companies, which accounted for just 18 percent of 2006s tech M&As.

While software always has been an acquisitive industry, the deals are getting bigger and more complex. In 2006, 1,726 software companies were acquired, the highest number since 2000, according to investment firm Software Equity Group. But more impressive was the size of some of those deals: HPs $4.5 bn acquisition of Mercury Interactive, EMCs $2.1 bn purchase of RSA Security, and IBMs acquisitions of FileNet and Internet Security Systems, both of which exceeded $1 bn.

These deals came on the heels of Oracles big-bucks, high-profile acquisitions of PeopleSoft, Siebel, and Retekas well as forty-one other companies over the past four years. IBM is not far behind, with twenty-two notches on its belt over the same period. Microsoft has bought more than twenty-five companies in that time, though most of them were tiny startups acquired under the radar. 2007 proved to be an even more eventful year with top three global BI firmsCognos, Business Objects, and Hyperiongoing under the hammer.

Consolidation drivers
For many analysts, the trend at consolidation in the enterprise software industry began in right earnest following Oracles acquisition of PeopleSoft. There have been isolated instances of mergers previously too, especially the consolidation of a wide range of startups into more moderately-sized companies following the dotcom bloodbath, but the Oracle-PeopleSoft alliance (accompanied by all its hostilities) was the landmark; not just did it signal the beginning of the consolidation frenzy, it also marked Oracle as one of the chief protagonists in the game.

Analyzing the future
According to former Oracle president Ray Lane, there is a large no mans land of smaller software makers trapped between Microsoft, IBM, Oracle, and SAP, which consume nearly 90 percent of the available revenue, and start-ups such as Salesforce.com that carry no baggage. Such software makers may seem strong with, say, $300 mn or so in market capitalization, but they are really just waiting in line at the chopping block. They do not have the might to compete against the big three or the cost structures capable of defeating new stars like Salesforce.

Enterprise, or Web 2.0
Microsoft is fighting a multi-front war: on the enterprise front mostly against IBM and Oracle; on the consumer front against Google, Yahoo, and the Web 2.0 barbarians. Microsoft once talked with SAP about merging to create a business apps powerhouse, but it now appears that Microsoft is more concerned about fending off Google. A mega deal to buy Yahoo, however, is still a distinct possibility. That, however, could bolster the Redmond giant not only on the consumer front, but also on a certain section of enterprises too.

That for the moment seemed to be Microsofts strategy not to go the enterprise way head on, but gradually move beyond its consumer face by targeting specific sections like graphists and Web designers. Microsofts enterprise-focused acquisitions will continue to be small scale, to augment its SQL Server, Office, Exchange, Dynamics, and other major lines. And surprisingly, even open source could be a part of this acquisition initiative. The partnership with Novell last year for SuSe was the first signal; strategic partnerships with eBECS and Tyler Technologies could be taking this forward.

Going for these smaller acquisitions also makes sense when considering the fact that Microsoft had a much harder time than expected integrating the business applications it picked up with its $1.1 bn acquisition of Great Plains Software in 2001 and $1.5 bn deal for Navision in 2002. The smaller deals often do not contribute significantly to the bottom line in the short run. But in some cases, their effects have been seen relatively quickly in Microsoft products. Windows Live Writer, a blogging program, was started inside Onfolio, acquired by Microsoft in 2006; Microsoft introduced a new project, called Photosynth, based in part on technology from Seadragon Software, acquired also in 2006; in-game advertising company Massive, another recent Microsoft acquisition, has been integrating its technology with Microsofts online advertising system.

Speaking at the Web 2.0 Summit in San Francisco, Microsoft CEO Steve Ballmer reiterated that the company would continue to invest in buying technology, products and market share. Well buy twenty companies a year consistently for the next five years for anywhere between 50 mn and 1 bn bucks. With Microsoft increasingly under fire from old and nascent competitors and also trailing several steps behind Google in the search business, another possible acquisition for Microsoft could be Facebook, with whom it already has a partnership on the advertising side.