Fundamental Changes Will Disrupt the Software Industry

January 17, 2006

Fundamental Changes Will Disrupt the Software Industry

by Rikki Kirzner, Partner

The software industry has become more turbulent than we have ever known it. It is undergoing a series of cataclysmic changes that are disrupting its economics and rendering it unrecognizable to those of us who have grown up under its influence. Change of this nature will prevail throughout 2006 and for the next 3 to 5 successive years due to the following factors:

  • The traditional inflexible software business model of creating and selling software can?t compete in a number of key areas with the more efficient open source sales and marketing model.  
  • Increasing consumer demand for always on and connected devices requires traditionally fierce software competitors to cooperate with each other to achieve optimal integration of applications and content
  • Companies are demanding and expecting lower cost business applications, more interoperability among disparate software systems (databases, etc), and simpler and more manageable software infrastructures
  • There is a growing trend in many areas away from best of breed products in favor of products that are ?good enough to do the job?

Open Source – A Source Of Disruption

The commoditizing force of open source software threatens the revenue streams of many ISVs. Eclipse and other open source consortia have been slowly building the software layers needed to create a complete open, robust, enterprise software stack, This has delivered an attractive platform for developing open source enterprise applications – and also delivered greenfield opportunities for open source vendors to provide more agile, better targeted, and more cost effective enterprise-class options for mid- to low-tier organizations. 

Running on Linux and Intel processors, these applications are highly attractive to small and mid size businesses that could not previously afford the “industrial strength” applications offered by the large vendors.

Meanwhile, prolonged sales cycles, complicated licensing terms and purchase processes, an inconsistent ability to sustain and generate traditional revenue streams, high prices, fickle customer loyalty and inconsistent quality in the succession of new products and new releases still plague ISVs.  Typical one-to-two year software sales cycles involve multiple calls involving sales and technical support people to convince the right person in the organization to sign a deal. Evaluating the software and conducting a pilot project, often requires technical support throughout the process.  Even more time is required to conclude the deal for multiple or enterprise licenses.

Open source macrhes to a different drum. By offering free trials of their software, open source vendors can entice new customers with sales and marketing budgets significantly lower than those of the bigger ISVs further disrupting software sales cycles. Their customers are easily able to find, evaluate, and test software applications usually without a significant financial investment or lengthy series of sales calls.  Often adoption occurs simply because some relatively lowly developer simply picks up the Open Source product and starts to user it.

If the software proves valuable, it will be adopted by the company on a gradual basis.  At some point, when the open source customer wants support, maintenance, documentation, or upgrades, significant sales can be made by the realted Open Source vendor.  The advantage to the Open Source vendor is that their potential customer already perceives the value of the open source solution and it takes very little effort to convince him/her to purchase the product or support services.  Often the sale can be concluded over the phone. 

How Will It Impact The Large Vendors?

Some of the larger vendors who have moved to support open source will, in the short term, fare better than others.  IBM, Oracle, and others can still charge premium prices for their software applications, but since these applications can now run on lower cost platforms, the overall solutions are more affordable to the small and mid-size businesses.

However, many venerable software giants with higher cost structures and inflated infrastructures are not focusing on technology innovation and next generation technologies to improve their customers? experiences (which would provide a competitive advantage against the small developer upstarts).  Instead, they continue adding more features in an attempt to lopck in the customers they already have. 

These companies will be unable to sustain their outdated business revenue models.  Their feeble attempts to maintain the revenue stream of ongoing maintenance fees produces its own software death knell.  As more features are added, the applications become more difficult and expensive to modify and maintain – driving up software prices and/or negatively impacts ongoing sources of corporate revenue.

Sales cycles for complex software products are getting longer with a greater percentage of revenue being spent on sales and marketing efforts to attract new customers.  The software business model as it exists is already no longer viable for some software organization and will force many software vendors to reevaluate their revenue models before the end of 2006.

Consolidation through mergers and acquisitions will continue unabated throughout the coming year as companies try to address more of the full application lifecycle as a way to offset the threat from these open source solutions.  Nevertheless, open source applications will take their toll on the large, established software vendors this coming year and throughout the next 3 to 5 years. 

Software partnerships are required between competitors to meet the demands of consumers for interconnected, always-on devices that need to share and exchange software programs, applications, and content.

A Time Of Transition 

Consequently, Hurwitz & Associates believes that the entire business model for selling and delivering software is undergoing a transition that encompasses a different and more efficient way to conduct business, creating partnerships and selling and marketing software products.  This trend will impact the industry throughout 2006 and beyond. 

 

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