Day of the Big Sharks



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% 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% 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
companiesover 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.

Incidentally, analysts like Jeff Nolan believe that the enterprise software
industry goes through periods of expansion followed by periods of digestion. The
expansion stage lasts 5-6 years and is marked by significant market growth and
dramatic technology transformations that create new leaders. The digestion
period lasts 5-7 years and is marked by low to moderate overall market growth, a
couple of points above GDP, and declining prices.

The
Thickening Middle
The official
definition of middleware sounds deceptively simple: the software that sits
between application and system software. What makes it complex is the
diversity of architecture on both the sides that it connects: application as
well as systems software. And what makes it so much of a battleground is the
realization that integration is increasingly becoming the most important
challenge for users of IT. Middleware tries to tackle some of that challenge
in software as opposed to leaving everything to the services. So middleware
and services go hand in hand.

That is the reason for the worlds #1 IT
company, IBM, to proclaim that its software business is all middleware.
IBMs approach to middleware is as a facilitator of its services business.
Oracles middleware strategy, on the other hand, is to make its various
acquisitions in application space to work with one another so that it can
present a unifying future to the world. Despite critics claiming that it is
a glorified patchwork, the company has successfully managed to convince
everyone (most importantly, the analysts) that it is succeeding at that
game. Oracle is also responsible for talking loudly about middleware, and,
according to critics, diluting the meaning of the phrase. Microsoft, coming
from the system software side, is the #2 middleware vendor but does not talk
much about it as it sees middleware as more of an enabler than a
differentiator. SAP, coming from the other side, applications, believes in
tightly coupled applications, thus taking a diametrically opposite view of
go middle where you must, as compared to Oracles, middleware where you can.
BEA is the only specialized vendor standing there coming from what was
classically known as middleware, and has already conceded leadership
position to the big vendors.

So while the middleware battle seems intense,
the driver of the middleware strategies of each large vendor is different:
for IBM, it is services; for Oracle, it is making its inorganic strategy
work; and for Microsoft, it is making itself ready for the next challenge:
the web 2.0 and Google!

In this environment, in which the industry has been for almost four full
years, the scenario is ripe for vendor consolidation… declining prices in a
low growth market is not exactly an exciting condition for new entrants or weak
players. So, in effect, this period of consolidation is very predictable, and
indeed desirable. With the consolidation wave that has started for sometime now,
it looks like independent software vendors would soon become a relic of the
past.

Theories typically center on industry maturity, vendors in search of new
growth and market opportunities, or a combination of the two. Some view
consolidation as the natural progression of an aging industry, invariably
dredging up a comparison to the global auto industry. But consider that both
software suppliers and buyers have more cash to spend than in years past.

IT budgets have increased steadily since bottoming out five or six years ago,
and its universally forecast that spending on software will continue to rise
this year, as long as something unexpected does not derail the economy.
Meanwhile, software companies, which were under pressure from the bourses to
focus on profitability several years ago, have shifted back to revenue-growth
strategies to capture more of those rising IT budgets. So, they are buying
companies with technologies that either complement their own or drive their
businesses into new areas.

Another interesting trend often visible during this period of consolidation
is that many vendors want to claim the platform vendor title, and with it the
underlying assumption that in order to be a platform player you need to have
account control. Many enterprise software vendors believe that they have to own
an account in order to reap future rewards from it, so consolidation is a
natural strategy to employ in order to accomplish this goal, asserts Nolan.

Its not just about acquiring an all encompassing account, most of the big
platform vendors like IBM, SAP, and Oracle need to take over new markets as
growth in their own businessesdatabases and applicationsdries up. Buying
companies with mature products and a lot of customers gives them a fast and safe
way to do that. Oracle, with forty-one acquisitions in the last forty-five
months, has been the master of this trend. However, IBM and to a lesser extent
Microsoft and SAP too have learnt the tricks of the trade.

And
then, There is Google
Google, with
its search, AdSense, Orkut, and YouTube may well not be in the radar of
Larry Ellison who calls it yellow pages on the Internet. His not-so-good
friend Bill Gates would definitely have a different view.

Google is a consumer company. Software or online
is too restrictive a word for it. But Google, through its loyal users, is
soon making a strong inroad to the corporate world. Gmail is already the
default mail of many users in SMBs who see it as the best bet against
eternally struggling enterprise mail system. Google Docs, though yet to make
a dent into Microsofts Word or Excel is increasingly being used by SMB
users when there is need to collaborate. Collaboration and social networking
could well be the next area of action for enterprises, and Google would
score there too.

A host of acquisitions during the year, like Pilot Software and OutlookSoft
by SAP, Telelogic by IBM, and Agile Software by Oracle, were aimed toward this
platform expansion. And its not just software giants, even storage vendors like
EMC (acquisitions like VMware and RSA Security) and networking vendors like
Cisco (acquisition of Webex) have joined the consolidation bandwagon with an eye
on expanding their platform.

The commoditization of key software sectors, including middleware and
business intelligence, has also started driving this wave of consolidation. This
has been especially true for the business intelligence segment in 2007; this was
a domain where products that once were distinct and innovative started to look
remarkably the same. The year saw the takeovers of Hyperion by Oracle, Business
Objects by SAP, and Cognos by IBM. With these constituting three of the top four
BI vendors, it leaves SAS as the lone independent entity. Maybe the fact that
SAS is the largest privately held software vendor in the world and hence
relatively less vulnerable to investor pressure had more to do with its
independence.

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% 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.

According to analyst Bill Burnham of Inductive Capital, it is the relatively
ageing middleware crowd that is ripe for preys by the hunters in this
consolidation frenzy. More so, considering that both Oracle and IBM are going
the full hog in expanding their middleware portfolio; notwithstanding, Oracles
abortive bid for BEA Systems (the premier middleware vendor still independent),
the latters ultimate capitulation sometime in 2008 looks to be a fait accompli.
And keeping in mind Oracle chairman Larry Ellisons never-say-die predatory
instincts (rewind to the PeopleSoft saga), Oracle looks likely to be BEAs final
destination.

BEA and Tibco Systems could be the likely takeover targets in the middleware
space; even CA (a re-branded Computer Associates) might prove to be vulnerable.
The irony of the consolidation frenzy in the middleware space could be gauged
from a couple of acquisitions in 2006. Business Objects acquisition of
Firstlogic for approximately $69 mn and Informaticas acquisition of Similarity
Systems for approximately $48 mn added information quality pieces to the
acquiring vendors middleware puzzle. However, within a year, Business Objects
is all set to become history (acquired by SAP) while most industry observers
believe Informatica to be on the chopping block too.

Lawrence J Ellison, CEO,
Oracle

Another votary for consolidation, in fact a dark horse, could be HP.
Traditionally, in the software game, especially the middleware space, HP has
lagged behind not just the software giants like Oracle, Microsoft, and SAP, but
even IBM. However, as recent quarters showed, HP is betting big on software and
services in devising a turnaround in its fortunes. And the acquisitions of
Mercury Interactive and Opsware leave no doubt that HP, too, has thrown its hat
into the consolidation ring, especially the middleware muddle.

In fact, HP CEO Mark Hurd also believes that the software industry is in the
cusp of another consolidation wave. In the end, math wins, he said during a
keynote address at Oracles recent OpenWorld conference in San Francisco. If
you look at the math right now in the tech industry … only a handful of
players have more than $100 bn in cash. Hurd said those reserves are likely to
go toward just a few different things: dividends, stock buybacks, or
acquisitions. In many cases, potential merger and acquisition cases will rise
to the top of that list, he argued.

Hurd also said that there is pressure for enterprises to conduct business in
a more standardized manner, dealing with fewer suppliers. The eternal debate
between single vendor and best of breed seems to be currently going in favor of
the former and that could possibly be another reason to accelerate the
consolidation wave.

A Great White Shark
The worlds second largest software vendor and its charismatic chairman
Larry Ellison have been bestowed with colorful epithets ranging from
predatory, to rapacious not for nothing though. Any debate on consolidation
of the software industry you participate in, Oracle is bound to be the first
name up for discussion. Its forty-one acquisitions over the past forty-five
months, including high profile names like PeopleSoft, Siebel, and Hyperion, had
only helped in enhancing its reputation as the biggest shark out in the pool
looking for small fish to feed its insatiable hunger for growth.

Though during the recent OpenWorld conference, Oracle announced new database,
application, and virtualization products, as well as integration products that
ostensibly will help glue together the wares from some of its acquisitions,
Jason Maynard, a software analyst with Credit Suisse Worldwide, feels no reason
to believe that Oracles acquisition frenzy is slowing down. The abortive
attempt to acquire BEA is an example, and most likely we would soon be hearing
more on the matter in the near future. After all, BEA could provide that elusive
glue to bond together all the disparate elements that constitute Oracles
middleware portfolio.

Bill Gates, Chairman,
Microsoft

After the BEA saga plays out, Oracle may foray into services: perhaps a deal
along the lines of IBMs $3.5 bn acquisition of PWC Consulting, believes one
industry insider. Most analysts, however, are not buying that one. Oracle is not
interested in the relationship business, they feel, and system integration
profit margins are not nearly as juicy and sustainable as software margins. More
interestingly, it might be SaaS where Oracles next big-ticket acquisition could
be headed for.

Though Ellison and other senior Oracle officials are publicly maintaining
that SaaS does not fit into Oracles strategy (they are adding value for big
customers and SaaS is for smaller businesses) and does not look a very
profitable business currently, the fact remains that Ellison owns a big piece of
NetSuite, the SaaS vendor that is working toward a near term IPO. A piece of
insurance for the future maybe?

According to observers, Oracle is waiting to see how SAP fares on the SaaS
front; SAP has already bet big there with its ByDesign initiative. If SAP
succeeds and SaaS proves to be a sound business even for a large software
vendor, Oracle could simply buy NetSuite and stay with its core business and not
face the pain of SaaS cannibalization otherwise. Meanwhile, it has covered this
bet, and if SAP stumbles, it can rub their noses in it.

Some analysts, however, feel that a carnivore like Oracle cannot be satisfied
only with NetSuite. If SaaS is working out and needs to imminently join Oracles
arsenal, the company would just buy Salesforce.com. After all, Salesforce is the
one that had brought the SaaS paradigm into the software equation. And,
surprise, surprise, Ellison owns a piece of Salesforce too. Thats the SaaS
put-away shot, it makes a heck of a statement, and it further cements Oracles
hegemony over CRM (they already bought Siebel). NetSuite can come along for the
ride too, but the Oracle shark has to find acquisition prey relentlessly, and it
must be of a certain scale to satisfy their appetite.



Big Blues Big Catch?
While Big Blue has not spent as much as Oracle to acquire software companies
over the past few years, it has gradually moved into the neighborhood. It still
might not be the Great White, but its already a voracious carnivore in the
software food chain; its gargantuan services arm provides it almost with a
second alimentary system to digest its acquisitions. If Oracle can boast of its
forty-one acquisitions in the last forty-five months, IBM has not fared worse;
since 2000, it has acquired more than forty software companies.

Besides the $5 bn IBM plunked down for business intelligence vendor Cognos,
in 2007 the company spent $1.6 bn on content management vendor FileNet, $1.3 bn
on Information Security Systems, $1.1 bn on information integration vendor
Ascential, and billions more on many smaller software companies. Until recently,
IBM had maintained that it would steer clear of application vendors, but the
FileNet and Cognos deals reveal a refined approach. IBM is now saying it is
interested in buying apps vendors whose products are extensions of its
information management offerings.

Samuel J Palmisano,
Chairman of the Board & CEO,
IBM

According to analysts, this change of heart is an acknowledgement that IBM
would, otherwise, be left behind Oracle, Microsoft, and SAP in the software
game. More precisely, IBM has little choice but to move into business apps to
keep pace with Oracle, SAP, and Microsoft, which are acquiring and developing
more and more pieces of the stack. A classic example would be IBMs latest
acquisition of privately-held database vendor Solid Information Technology, a
deal that is expected to broaden its information on demand portfolio. Going by
this logic, it also makes sense for IBM to go for a CA or a BMC Software, given
their mainframe roots.

And, though Oracle may have the largest middleware portfolio (it includes
almost everything), IBMs middleware plate is definitely more organized and
sumptuous. While Oracles acquisitions have been hogging the headlines, IBM has
been quietly buying up enterprise software companies to enhance its middleware
offerings. Sample these: Isogon (software asset management solutions); Micromuse,
Ascential & Cyanea, (performance management solutions of web-based business
apps); DWL (Customer Data Integration Middleware); Collation (IT service
management software); Bowstreet (portal technologies); Datapower (message-aware
networking); CIMS Labs (virtualization of computing resources); and BuildForge
(compliance software).

However, Maynard speculates that the #1 sea change deal in the software
industry over the next two to four years could be IBM acquiring SAP. IBMs
Global Services and vertical industry expertise would introduce SAP into many
more accounts, Maynard reasons, and SAP would be freed from focusing on its
NetWeaver middleware layer to concentrate on what it does best: core business
apps. Now that could be the mother of all acquisitions (even more sensational
than HP-Compaq). Impossible, some might say, but it would be prudent to remember
that a merger between Microsoft and SAP too seemed unthinkable a few years ago,
until Microsoft admitted it had been considering exactly that. In the end it
dropped the idea only because it seemed too complicated to acquire a European
company.

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.

 Henning Kagermann,
Chairman of the Executive
Board of SAP AG & CEO, SAP

That for the moment seemed to be Microsofts strategynot 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.

Hunters or the Hunted
The software industry, in its consolidation phase, is gradually assuming
Kafka-esque proportions where the hunter does not know when he will be hunted
down. In a big pool where the M&A frenzy is gradually reaching its crescendo,
for companies like SAP and Symantec there are two clear choices available today;
either swim with the sharks and gobble whoever comes on the way, or be ready to
be swallowed in whole by bigger predators moving around you.

Historically, the most conservative of large software vendors, SAP is not
likely to make any acquisitions near-term of the scale of its $6.8 bn deal to
buy Business Objects. And it cannot expect to go on a bidding spree with Oracle
in the near future; the memories of the Retek saga still would be quite fresh.
SAP cannot sit tight though. Like the shark that has to continue swimming to
avoid getting drowned, SAPs likely strategy would be to target companies with
vertical industry and narrow technical expertise.

John Thompson,
Chairman of the Board
& CEO, Symantec

Eternal optimists and hardcore Oracle baiters would like to see SAP go after
Salesforce.com, which would make it more of a player in CRM while thrusting it
full-bore into software as a service. But that is as likely to happen as India
beating Australia in the Test series Down Under. However, the big question is:
should IBM come knocking, SAP would be interested?

Symantec is still digesting its $13.5 bn acquisition of storage and backup
vendor, Veritasand that came three years ago. Still, the company has made about
a dozen acquisitions since 2005, mostly in security and compliance. However, the
blockbuster of 2008 could see a Microsoft or HP picking up the worlds largest
security vendor. While for HP, the storage management offerings from the
erstwhile Veritas stable would be a logical extension of OpenView suite, for
Microsoft the security bit has always served as lucrative bait. Will 2008 see
someone biting it?

Potential Gatecrashers
Who could be the potential gatecrashers into the software party? HP, for
one, and EMC could be the other. Looking at the BTO (Business Technology
Optimization) division, the biggest of HPs three software units, which would
generate only about $2 bn in revenue this year, one feels HP is still not ready
to tango. For a company with close to $100 bn in total revenue, software still
looks small change for the worlds largest IT vendor. However, with sterling
performances in software and services in recent quarters, HP could finally
buckle the feeling that it lacks the passion to be a first-tier software vendor.

The OpenView system management platform is the centerpiece of HPs Business
Technology Optimization software unit, augmented by the $425 mn acquisition of
Peregrine Systems in 2005, the $4.5 bn acquisition of Mercury Interactive in
2006, and the $1.6 bn acquisition of data center automation specialist, Opsware
in 2007. HP is just starting to move aggressively into what it labels as
Business Information Optimization with its internally developed Neoview data
warehouse platform, based on the Tandem NonStop operating system. A third
software group, called OpenCall, dabbles in software for delivering voice,
video, and data services.

Total value of mergers and
aquisitions in 2005, $306 billion; in 2006, $298 bn. Software dominates the
scene by a long way

So, while HP has albeit started consolidating its middleware portfolio, it
still lacks adequate credibility in the enterprise business applications space
in the absence of any ERP, CRM, SCM, or BI suites. Clearly, if HP wants to
compete in software on a scale with IBM and Oracle, it will have to spend its
appreciated stock and cash on bigger acquisitions. Data warehouse leader
Teradata, recently spun off from NCR, is one possibility, especially given HP
CEO Mark Hurds and CIO Randy Motts historical ties with the company. Not to
rule out a blockbuster deal like one to buy security vendor Symantec, especially
for its Veritas storage management holdings, or McAfee as a purer security
player.

The HP story might have its ifs and buts but only sky seems to be the limit
for EMC. No major industry player has reinvented itself through acquisitions
quite like EMC has over the past several years. Since 2000, EMC has spent more
than $7 bn on a couple of dozen acquisitions, transforming itself from a
supplier of increasingly commoditized storage hardware to a purveyor of
information infrastructure, including software for storage management
(Legato), data encryption and identify authentication (RSA), security event
management (Network Intelligence), content management (Documentum), digital
rights management (Authentica), and virtualization (VMware).

Where would EMC go from here? Difficult to say, as senior executives like
Chuck Norris are keeping their 2008 cards close to the chest. There might be
some big-ticket acquisition in the personalized spacethat could mean anyone
from Sandisk to an Imation. Broadly, however, EMC would probably stick to
information infrastructure; perhaps even straying into data management by going
after a Teradata or Netezza.

Not all Gloom
Notwithstanding the general perception that software consolidation will
ultimately stifle innovation, the reality might be slightly different. Software
consolidation is not the voracious monster some people perceive it to be. True,
it is driven by big vendors desperate for growth. But technology managers need
not fear that consolidation will eat away at competition or innovation in the
software industry. There are still plenty of new ideas and novel approaches
seeping in. And plenty of old companies that do not operate in middleware,
mainstream business applications, or vertical focused software are likely to
remain untouched in the near future. Companies like Adobe, Autodesk, Amdocs, or
Dassault would be the best examples.

Joseph M Tucci,
Chairman of the Board,
president & CEO, EMC
Mark Hurd,
Chairman of the Board,
CEO & president, HP

Acquisition by a larger company can put a struggling software supplier on
more solid financial footing and allow it to scale its architecture. And
consolidation can actually increase a customers influence with a vendor.
Premier customer status can mean better volume licensing deals, better access to
vendor executives, and inclusion on customer advisory boards to influence the
vendors technology road map and strategic direction. Despite rising budgets,
the dictate to run a lean IT department for most enterprises has not changed.
Working with fewer vendors means for many CIOs spending less money managing
relationships.

There is no getting around the fact that the largest software companies like
IBM, Microsoft, Oracle, and SAP are getting bigger. HP, EMC, and Symantec could
remain the perennial bridesmaids without ever actually joining the big gang.
Some insist that a weak IPO market, acquisitive IT vendors, and buyers desire
to work with fewer vendors will make it impossible for a sizable fifth or sixth
rival to emerge. The dark horse could be Google; at a financial analyst meet at
Oracle OpenWorld, Larry Ellison derided Google as the yellow pages on the
Internet. But the new age Net champion does have the potential to fill up that
fifth gap, though whether it would also come up as a traditional enterprise
software company is open to conjecture.

Rajneesh De
rajneeshd@cybermedia.co.in

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