The Shrinking Software Middle Class

When Oracle acquired Primavera, it not only picked up a leading project management software firm with 5,000 customers, but it also eliminated one more application vendor from the “software middle class,” those vendors with annual revenue between $100M and $500M and valuations ranging from $500M to $1.5B. That latter category is arbitrary given the wild gyrations on Wall Street, but is a good place to start examining what’s happened to the software middle class. But first, we have to look at where it was…

Sherman, set the Wayback Machine to 1998

If we go back a decade or so, the ERP market was led by SAP and Oracle, followed by Baan, Great Plains, Intentia, JD Edwards, Lawson, MAPICS, QAD, SSA, and a host of others.

At the same time, there was a brisk best-of-breed market. PeopleSoft rode the human resources market (now renamed human capital management). Siebel capitalized on sales force automation and played a pivotal role in the expanded customer relationship management space. On the supply chain planning front, i2 Technologies and Manugistics competed for the lead, with Red Pepper determined to overtake both, while Manhattan Associates challenged a host of contenders in warehouse and transportation management.

On the product lifecycle management front, Agile Software and MatrixOne were newbies, and Dassault, PTC, and UGS were looking to move to product data management and PLM from their CAD roots. Speaking of Agile, remember when Ariba announced its plans to acquire Agile? At the time, Ariba was battling Commerce One, FreeMarkets, PurchasePro, and a host of others for the top spot in sourcing and procurement.

At the same time, Business Objects, Cognos, Hyperion, SAS, and others battled to create a market broader than their niches. Now, the first three are part of SAP, IBM, and Oracle, respectively, while privately-held SAS remains independent.

Sherman, take us back to 2008…after the elections, please

As we traveled back, were you surprised by the number of companies that have been acquired? I don’t think it’s over yet.

Look at the software middle class. Ariba is the lone large publicly traded company in sourcing, procurement, and spend management. I’ve already written about its attractiveness as a takeover target.

Once JDA completes the i2 deal, the supply chain market will consist of three middle class vendors: Manhattan, JDA, and privately-held Red Prairie. Does Oracle buy one and SAP purchases a second, a la the business intelligence and performance management market?

Who’s next in CRM? salesforce.com may be too large to buy unless Cisco, EMC, or IBM wants to make a bold bet on CRM-in-the-cloud. I don’t see it. Chordiant or RightNow (or both) may be more likely pick ups.

What about HCM? The middle class includes private-equity-owned Kronos and publicly traded SuccessFactors and Taleo as well as others. Again, does Oracle buy one and SAP another? The HCM space may be attractive to Cisco, too, as part of its plans to build out a collaboration suite that started with the WebEx buy.

What about the remaining ERP vendors? Intuit and Infor may be too big to buy, but if you look at the high cost of customer acquisition, do Oracle and SAP buy Deltek, Lawson, QAD, or any of the others for their customer bases and recurring maintenance revenue streams?

Will we move from five tiers to three or two?

If you look at today’s vendors in terms of market valuations, there are five tiers. At the upper crust are Cisco, EMC, Google, HP, IBM, Microsoft, Oracle, SAP, and others. Until the meltdown, all had market valuations north of $50B.

Well below this is a small, upper middle class of application vendors, which are limited to Dassault, Intuit, PTC, salesforce.com, and others with market caps in the $1B to $10B range. One could argue that it could include divisions of larger companies, such as AT&T’s Sterling Commerce and Siemens’ UGS, which could be active acquirers, too. Until the last seven trading days, Ariba could have been considered in this class, too. Are they predators or prey?

Slightly below this are the application vendors with valuations between $100M and $1B. These include many of the best-of-breed vendors and midsize ERP companies we’ve already discussed.

Then there is the fourth tier, consisting of dozens of companies with annual revenue in the $35M to $100M range. With a couple of exceptions, most are private, venture-backed firms, and many are struggling with elongated sales cycles, shrinking license fees, and nervous investors laser-focused on liquidity. They don’t enjoy the same recurring maintenance streams as the large vendors to help sustain product development or sales and market expansion.

At the bottom of the food chain are the smaller vendors. They may find themselves in the perpetual funding chase. You may have seen Sarah Lacy’s references to Jason Calacanis’s “Startup Depression” in her blog and in her Valley Girl column on BusinessWeek’s site. Mr. Calacanis posits that half to three-fifths of venture-backed firms will cease operations or be reduced to a skeletal crew within the next year and a half.

Real question: Where will future innovation come from?

I’m sure you can see where I’m going. My bet is that the rich will eventually buy most of the middle class, mortally wounding the viability of best of breed.

This puts more pressure on vendors in the fourth tier. Can they offer a unique enough product or service that can get them in front of potential buyers? Or, should the smart ones be positioning themselves to be bought, too? I suspect that many are thinking about the latter.

So, if the vendor universe gets sharply reduced, where will innovation come from in the future? Not from the giants that usually have to buy their way in.

The good news is that there are a lot of interesting software companies out there. Whether they can remain independent or viable is another story.

To help introduce you to some of them, we will be starting a new series, “Software Innovators from A to Z.” Look for our analysis of two new startups, Amitive and Zuora, as well as continuing coverage of vendors ranging from Accruent and Aegis to Zyme.

New at the Blog: How low can the stock market go?

We’re following the stock market sink closely at the First Thing Monday blog. Be sure to check back frequently for our updates and speculations on how low the stock slide can go.

What do you think?

Will it come down to two tiers? If so, will this slow or kill innovation? Will VCs abandon the enterprise market once and for all? What does this mean for buyers? Where is the bottom of the stock market slide? I welcome your feedback and ideas, leave a comment on our blog. As always, brichardson@amrresearch.com.




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