Business Software: Eat or be Eaten

That is the lesson, according to WSJ, of the disclosure that Microsoft and SAP held merger talks recently.

Continued sluggishness in sales of corporate information technology is beginning to break that logjam. The emerging standard-setters — Microsoft, Oracle, SAP and International Business Machines Corp. — now are considering deals to solidify their positions in the technology infrastructure and application programs needed by businesses large and small.

The smaller companies, some analysts say, need to figure out how they fit in those major camps, including considering takeover possibilities. In one indication that slowing sales growth is prompting change, investors are starting to reassess how they value software companies in the stock market, paying less attention to sales of new software licenses and more to the recurring streams of income that companies receive from existing customers. That is akin to how investors view, say, cable-television companies.

“If you are not IBM, Microsoft, Oracle and SAP, you are going to have a hard time competing,” says Jason Maynard, an analyst with Merrill Lynch.

The financial pressures — only now easing — of the long slump in corporate tech spending have made more tech buyers dig in their heels about paying for new software. So software companies change their business models, gradually adding more services and subscription schemes for existing products.

As a result, the tally of new software sales has become less useful for forecasting a company’s performance. Instead, some investors are looking at software companies in much the way they look at cable-TV and wireless-service providers — valuing them for the stable revenue stream they receive from existing customers rather than their potential to sign up new ones.

For software companies, such revenue comes in the form of “maintenance” fees, annual payments for software updates, bug fixes and other product support. Maintenance fees generally range from 15% to 25% of the original license fee.

Goldman’s Mr. Sherlund goes so far as to say that for many software companies, “they would be better off if they forgot about new customers and concentrated on profitable maintenance revenues.”

Adds Fred Wilson: “Each layer in the technology stack is slowly getting mature and commoditized. We’ve finally gotten to enterprise software. Ten years ago, it was the sweet spot of technology venture capital. Now it’s a mature business in consolidation mode. This doesn’t mean that all enterprise software is slow growth. But clearly the big sectors that developed over the past fifteen years are mature. And so we need to move on to new areas in search of growth in the technology business.”

Published by

Rajesh Jain

An Entrepreneur based in Mumbai, India.