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Monday, December 19, 2005

Enterprise Software Industry : Mid Life Crisis

The enterprise software industry is undergoing a massive transformation – while the demise of many smaller players are getting postponed, I wrote that it may be that the industry may undergo mutation before consolidation and predicted structural changes ahead. David Roux, co-founder and managing director of corporate investment firm Silver Lake Partners finds that small startup companies need to rapidly grow beyond $100 million for being able to make money. Most companies that earn $100 million or less tend to lose money & he does not see the return of those days . when the software industry as a whole grew at 20 to 30 percent. Likeother mature segments of the computer industry such as storage and semiconductors, the growth levels for software industry shall also stabilise. The "dirty little secret of the software business" as he sees it is the fact that that the average selling price of software products has declined over the years. Cost saving measures have ensured that the software industry has returned to growth and profitability Only those enterprises that generate more than $5 billion in annual revenue, sustain profit margins greater than 30 percent. Companies that generate annual revenue of $1 billion to $5 billion in annual revenue drop down to profit margins of around 17 percent. Midsize companies that are producing revenue of $100 million to $1 billion can sustain 9 percent margins. But companies that can't quickly grow beyond the $100 million level are generally losing money. The question before small to midsize software companies is how quickly it could get to be a $5 billion business or bigger. These factors are behind the consolidationthat is going on in the software industry & the market share of the top three software vendors, Microsoft, Oracle & SAP have increased from 24 to 30 percent just in the past five years. Four years ago corporate IT departments devoted 65 percent of their budgets to maintenance of existing systems and 35 percent to acquiring new technology. Today maintenance spending has increased to 75 percent and new acquisitions are down to 25 percent. This means it will be harder than ever for small companies to win a share of this business. The software companies have a huge untapped source of credit that they could use to fund future growth & the software companies will steadily increase their use of debt to fund growth as the industry continues to mature – This could keep fanning the wave of innovation in enterprise software.

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