PAC conducted the latest SITSI study through hundreds of face-to-face interviews with suppliers of Software and IT Services to the U.S. market. Overall, the study finds that good and bad news seem to balance each other out, while the end of the Iraqi war has opened the opportunity for a late year rebound, since some uncertainties are now removed. Among the negative, the reports cites: a soft macroeconomic environment – the U.S. economy is not expected to recover before the middle of this year – weak corporate profits – determining levels of outlay, including IT investments, that can be afforded by U.S. companies – and geopolitical uncertainty that might catch executives’ attention to the detriment of more internal corporate issues. On the positive side, the reports emphasize the fact that IT Consulting and System Integration segments seem to have stabilized in the last couple of quarters indicating that the worst is probably over as earlier pricing pressures have diminished.
In 2001, the U.S. software and IT services market grew by 0.4 percent, reaching $253 billion from $252 billion in 2000. The successive locomotive of growth – ERP, Y2K, Internet – that drove the software and IT services spending at the end of the nineties and the beginning of the 00’s have disappeared for good and 2002 was the worst year in the industry in years if not in decades. Only a strong recovery of the U.S. economy will trigger increased spending in IT in general and software and IT services in particular. However, PAC does not expect this recovery to occur before well into the second half of 2003. Most likely, people will have to wait until the beginning of 2004 to see the situation stabilize within the U.S. SITS industry. And just like any maturing industry, the days of high double-digit growth for the U.S. SITS industry are over. Over the next five years, PAC expects to see average growth of 8 percent in the U.S. SITS industry, which will help healthy companies to expand again, but this will not be a return to the explosive growth of the late 90’s and 2000.
Application Software Products & Solutions
In 2002, PAC estimates that the U.S. market for Application Software Products & Solutions decreased by 8.6 percent compared to 2001. In 2003, PAC expects this market segment to grow by just 2.3 percent, with much of this growth coming from the second half of the year. A major change in this industry comes from the fact that customers don’t believe that the implementation of a sole software product will deliver value. They now expect IT Services firms to closely work with application vendors to analyze their processes and build a solution that will actually increase their company’s efficiency utilizing software technology. This does not mean that the importance of the underlying application has diminished, but rather that companies aren’t installing applications anymore just because their competitors are, they are doing so (hesitantly) when a specific business value can be clearly demonstrated.
Within the U.S. ERP market, companies such as SAP and PeopleSoft reported that new customers were opting more often than not for one or two core modules (such as HR or Financials), rather than the more lucrative application suites. As for existing customers, fewer were adding new functionalities and extension applications. Another factor weighing down on license sales is “shelfware.” Many companies are still implementing software that they have already paid for as their user base has increased at a slower pace than expected, or even decreased. So in order for software vendors to realize strong license revenues again, customers must burn through this overcapacity that currently exists. Early in 2003, PAC believes that we could be witnessing this burn-through of “shelfware” as IT Services companies are seeing more work on system integration work for enterprise applications, while the Software vendors continue to see weakness.
What is shaping up in 2003 seems to be the war between large enterprise suite vendors (SAP, PeopleSoft, Oracle) versus “best of breed” vendors (Siebel, Retek, JDA Software), and so far it is looking rather bleak for the latter. As new license revenues and new customers are extremely difficult to obtain during this time, vendors are focusing on maintaining their installed bases. By doing this many have been able to even out their revenues for the year by maintaining the cost for software maintenance fees as well as by boosting their professional services revenues per engagement. The problem for “best of breed” vendors can be illustrated by the following example that we find common these days. New customers seem more willing to go along with a SCM module by SAP (for example) that should integrate more easily with their existing SAP R/3 Enterprise system, rather than taking the risk of having to customize a solution from a best of breed vendor. Also weighing on such a situation is the health of these “best of breed” companies. On one hand they must maintain R&D, in order to keep their technology lead in their respective category, as well as to maintain sales costs, since they must work harder for many smaller projects. But due to the reluctance by customers to choose a best of breed vendor in favor of expanding their ERP suite, such best of breeds are hemorrhaging cash. This is a viscous cycle for best of breed vendors and PAC has seen SAP, PeopleSoft and Oracle capitalize on their weakness by out spending them on development, so that their extended application modules and solutions (CRM, SCM, etc.) are now coming much closer from a functionality/technology stand point. In 2003, we expect SAP and PeopleSoft in particular to have a lot of success in the supply-chain management (SCM) space due to the weaknesses of i2, Ariba and CommerceOne. Within the CRM market, Siebel’s attempt to broaden its offering into new areas such as ERM (Employee Relationship Management) and PRM (Partner Relationship Management) has been unsuccessful, as market uptake for such unproven technologies is quite low.
The market for vertical applications – CAD/CAM, PLM and business support systems (BSS) – is evolving much differently in some sense from what we see in the horizontal Application Software Products markets.
Within BSS, adding new modules in addition to billing has not been successful, because telecom companies are not willing to increase their application investments any time soon. In fact, they want to do the opposite by outsourcing these systems to the vendors. This is clear when looking at the leaders in this area. Amdocs has put less emphasis on its development of Partner Relationship Management (PRM) applications in favor of boosting its investment in its outsourcing division, culminating with the hiring of a former EDS executive to head the division. Convergys, which has had a focus on outsourcing its billing solutions (in the U.S. especially) has posted healthier numbers during the telecom downturn then software-focused competitors, such as Portal Software. This trend of outsourcing billing and customer relationship management systems in the telecom market should continue, but growth should not be extraordinary. Weighing down growth are outsourcing contracts that were signed in the late 90’s will be up for re-negotiation and will be re-adjusted to account for the pricing pressure in the IT Services market over the last two years.
Within the CAD/CAM, PDM/PLM market, the Automobile and defense segments, long the bread and butter of design software solutions, has given way to higher growth areas in consumer product goods, electronics, life sciences and utilities. Even though these may seem like new industries, the use of these design solutions is limited to the manufacturing components within each.
Pure PLM vendors have began 2003 with a new tactic; they believe that PLM should not be limited to design, but should spread through out an organization via existing ERP systems. Companies such as PTC believe that by having PLM integrated into a company’s supply-chain, marketing, sales, accounting, even small manufacturing companies can now use a PLM system for a products launch and maintenance. Of course this theory is good for the PLM vendor because if accepted it can increase the amount of licenses paid by a customer as well as to expand their presence in small manufacturers, but is it really necessary to have a marketing executive involved in a PLM system? It is PAC’s opinion that PLM systems were meant for large manufacturing companies in order for them to collaborate as if they were small, reducing their time to market and extending a product useful life. Although some saturation has occurred in traditional PLM segments, greater opportunities exist in its future use in emerging sectors as described before.
Short-term outlook for 2003 and 2004
With license revenues decreasing at a rapid pace, the license-to-service mix has been squeezed in favor of services during 2002 and more visibly in early 2003, according to PAC research. As a consequence, services revenues, including software maintenance and implementation, have been accounting for nearly 50 percent of total revenues in recent quarters for mid to small-sized application vendors and above 50 percent for larger, more established players. We see this as more of a short-term move for most application vendors yet something that will continue in 2003 until the market begins to rebound. An enterprise application vendor’s core competency is software, not services, and as detailed earlier, the fundamental change in how software will be deployed in enterprises will solidify this positioning. Counter to this point, a few very large application vendors that have developed significant system integration organizations will continue to exist. For example, PeopleSoft now employs 2,700 consultants at PeopleSoft Consulting, of which 2,100 were domestic. SAP’s Global PSO (Professional Services Organization), which was created a year ago, has roughly 7,000 consultants, and there are also over 1,400 consultants at SAP SI (Systems Integration).
Consolidation will also be a key trend in 2003 and 2004, as smaller players and best of breed players continue to struggle (along with their stock prices). They should all become very attractive acquisitions for larger players with plenty of cash to acquire their technology and customers. Already in 2003, we first saw Baan acquired by General Atlantic Partners, an independent investment company, who is also engaged in acquiring SSA Global Technologies, a US based ERP vendor, with some $180 million in revenues. Baan and SSA will form a new company, but the brands will exist independently of each other. And the biggest so far was PeopleSoft’s announcement to acquire J.D. Edwards. The new PeopleSoft should benefit from J.D. Edwards’ domain expertise in the manufacturing sector with its MRP (Manufacturing Resource Planning) applications as well as its focus on mid-market companies (200 to 1,000 employees in size). There are still many issues that must be addressed, such as whether they will unify the code for both product lines.
Moving forward into 2003 and into 2004, we see enterprise application vendors looking to break down the cost barriers for potential customers. Whether this will be successful is uncertain at this time. One move being pushed heavily by close application software partners of IBM Global Services is to port their software on to Linux. Recent announcements to do just that were made by PeopleSoft and Retek, however we do not see market-wide acceptance of this in the mid-term due to Linux’s limitations when it comes to running mission critical enterprise applications.
Another area for enterprise application vendors to lower costs for their customers and prospects is in the integration phase. PeopleSoft unveiled their strategy towards developing a “smart application,” by staffing over 500 developers and to devote hundred’s of millions of dollars to develop configuration blueprinting tools and online (XML-based) software patch updates. Siebel has offered its UAN (Universal Application Network) mainly through partnership arrangements, and SAP released Netweaver, which is an internally developed software integration tool.