By Michael Tanner, Managing Director, The Chasm Group, LLC
May you live in interesting times! So goes the famous blessing (or curse) that is being played out in our industry today. Certainly, the "times" that we live in are "interesting," and we are all increasingly blessed with both excitement and opportunity. But the "curse" is uncertainty and dramatic change that seem to be happening at a breathtaking speed.
In the software and web-enabled services markets there are several different views of what the market will look like in the next few years. But one of consistent themes being expressed today by many is the idea that the industry still has dramatic consolidation ahead of it. The rationale for this view goes something like this:
- Venture investors in the late 90's became the equivalent of public market momentum investors. Once a new "hot" category was on the horizon, venture capital madly rushed to find investments in companies within similar categories.
- The result of this momentum investment today is an over-abundance of competitors in many areas.
- We are now at, or close to the bottom of the capital trough. The excess capital from the 90s has not quite rung its way out of the market yet. Many companies that have not yet turned the corner to profitability continue to burn through cash raised at bubble valuations. But as their capital buckets continue to empty, many businesses continue to do everything possible to close sales to create references and proof in hopes of raising the next round of capital at something close to the last round. While they struggle to do this, they continue to take in business that is not economically sustainable in the long-term.
- As a result, there is increased pricing/margin pressure on more established software companies. These companies have the advantage of market presence and reputation, but customers who seek a better deal in times of flat or slow-growth IT spending use the offers of younger software companies as a basis for comparison shopping.
- Tougher licensing terms and conditions result. This in-turn creates lower revenues/margins for more entrenched competitors.
I have written in this column over the past few months about two other trends that might reinforce the idea of ongoing market consolidation. First, many start-up companies in the past few years have come to market in a purely "horizontal," non-market-specific way in order to position themselves as the next "platform" for one thing or another (Killing the Platform Legend, The Sterling Report, May '03) . This has resulted in great technology features and enthusiasm, but little competitive barrier to entry in any single market. Until market leadership can be created in some market segment, or until significant profitability self-funds the next stage of development, this lack of market differentiation creates an environment where cash-rich larger businesses can enter the market by simply evaluating whether to spend money, while the "buy" opportunity gets increasingly attractive over time. Second, the new world of software architecture is becoming increasingly standard at the core (The Future of Software, The Sterling Report, March '03). Standard development environments, commoditizing enterprise integration connectors, and modern software service-oriented architectures are lowering the overall switching-cost to customer, while also lowering the integration cost for software vendors.
If you believe this consolidation scenario will play out, then you are probably asking yourself some key questions at this point: (a) Should we consider partnering with other companies to become part of their solution and create a larger value proposition for our customers or should we continue to go it alone? (b) Should we consider acquiring another company to create a broader market position or bigger category of offer? And, (c) do we maximize value by selling now or holding out? Each of these questions requires us to envision a new, broader definition of the category that we are a part of and to decide whether customers would gain value out of a combination. Here's one way to think about the problem.
First, understand what the category definitions are in your market and how they are related. IT analysts such as IDC, Gartner, The Meta Group, Forrester Research, Giga, etc. do a fantastic job of categorizing companies and technologies into category buckets (e.g. Integrated Development Environments, ERP applications, Change and Configuration Management, Business Process Management systems, etc.). But the notion that one or several of these categories might successfully combine to create even greater value requires that a few things be true:
a. Is there is a single executive buyer who can purchase the combined category offer? It might seem like a good idea to combine technologies or companies, but if there is not a single identifiable buyer who can make the decision to purchase a combined offer, positioning around a larger 'meta category' offer will make little sense. For example, in the software security market Firewall, Intrusion Detection, Anti Virus, Authentication, all were separate categories at one time with mostly pure-play vendors competing. Is there a single buyer that can make a decision about purchasing all of these types of software for the business? Can we reach them? If the answer is "yes," then there may be a category worth considering called "Enterprise Software Security" where all of these capabilities get positioned as features of the larger offer.
In some cases, two different categories are being sold to two different kinds of executive buyers. As a historical example, at one point of time in history, accounting/finance software was sold to the CFO/controller, logistics software to the VP of Operations, HR software to a VP of HR. For a combined ERP offering to have made sense, Enterprise Application vendors had to convince themselves that the CEO / CIO could be interested in buying a combined offering and enterprise application backbone. While obvious today, at that point in history it was not obvious to everyone.
b. Is the value of a combined offer greater than the sum of the parts? Having multiple kinds of products available may provide value to vendors in a portfolio sense. But does a combined offer provide significant incremental value to the buyer? Such value could be significantly improved business process, data integration, common technology platform, etc. If the combined components do not provide some added-value that is relevant to the executive buyer beyond that which could otherwise be purchased via best-of-breed, then you might end-up with a nicely differentiated message and a suite of products, but not much actual difference in sales beyond that which each pure-play vendor would have achieved independently. The result will be a market that continues along in fragmented form, with pure-plays continuing to exist independently. As an acquirer, this is not the ideal outcome, and as an acquired company, this might make your earn-out period not very fun or profitable.
c. Can a single channel emerge that can be successful selling the combined category? If two businesses in two different categories come together to form a new, overarching category ( e.g. perhaps Mercury's recent acquisition of Kintana), can the new selling team successfully transition to targeting a new executive buyer? For example, will a sales team that successfully sells to the head of QA or development be able to be successful targeting the CIO?
d. Are there service partners who will make money from the combined offering? Software vendors often do not understand their professional service counterparts. They hope that system integrators and consulting firms will adopt their software as a more-or-less standard and push-sell into the market. The consulting/service firms, on the other hand, have a bench to feed and are mostly interested in getting a new deal on the table as opposed to promoting anyone's software. Having a combined software offer from two or more categories may, or may not make the SI/Consultant relationship more effective. If the domain expertise or technology expertise required in one category differs substantially from another, can a single SI/Consulting channel support both offers? If not, the combined offer won't have much value to them and the speed of adoption will not necessarily increase.
e. Can we find a single infrastructure-buyer that will standardize on the combined offer? For example, in the telecommunications service provider market, there are some software categories that are standardized by IT. There are others that are standardized by network operations groups. Both of these organizations have the charter of selecting, standardizing and supporting software infrastructure. If a combined OSS software offer can be supported by one of these two support infrastructures it has a chance of creating value that is greater than the sum of the parts. If not, then both infrastructure teams must be convinced separately, which again re-enforces an ongoing best-of-breed market evolution.
f. Can the combined offer fit within the culture of the organization? The idea of corporate culture is one that is written about all the time and intellectually interesting, but which most management teams have a difficult time to make actionable. But one cultural issue that is prevalent has to do with being a "product oriented" culture, vs. a "solution oriented" culture. For example, one of the single biggest transformation issues that software businesses are facing today has to do with migrating from selling "products" to selling "solutions" (or visa versa). Each style requires specific types of selling processes, measurements, and skill-sets. But I would argue that the differences permeate much more broadly than just the channel. Product cultures and Solution cultures are like Mars and Venus. In our consulting practice, we've seen that successful transformation from one to the other, or attempting to manage both, are huge efforts that must be managed carefully. If, for example, a company within a category that is largely product oriented acquires an earlier-stage company to enter a category that is more solution-oriented, corporate anti-body reactions is sure to ensue from the sales force all the way back to the factory. This is certainly not a show-stopper, but is an execution risk that must be considered and planned out. In recent years, companies such as Autodesk, Macromedia, Microsoft, and other very successful large volume product companies have faced this issue in spades with various degrees of success. Likewise, companies such as Oracle and ERP vendors who want to reach the mid-market face the issue of productization.
g. Can we convince the market influencers that this all makes sense? Hollywood is often criticized for the content of its programming. Their reaction to this criticism is often that "media is just a reflection of society." Others believe that media is directly responsible for creating change in society. The debate is somewhat similar in marketing to industry influencers. Some will claim that the influencers set the tone, direction, and vision for the direction of the industry and define what will happen. Others will claim that influencers and analysts are just a reflection of what vendors are actually trying to do, and that their predictions and forecasts are based almost entirely upon what vendors are telling them anyway. Having industry and financial analyst support is certainly not a pre-requisite for success. The quadrant, zone or stage that an analysts chooses to place you in has little to do with the real value that you can provide to a customer. But it helps -and sometimes a lot, so testing support for category convergence with industry influencers should be a key consideration.
If the answer to each of the above questions are yes, then there is a great likelihood that combining categories could create a single, over-arching offer that provides greater value to the customer and more economic value to the combined company/product set. This is not to say that the challenges of coming together or of joint marketing, technology or channel integration will not be a show-stopper for any two individual companies. But given the technology trends at hand, the above questions will help answer whether there is a likely category consolidation in the works. For large, multi-product company looking to be a consolidator, the question then becomes how best to transform to the new positioning and strategy and successfully execute. For the younger fast-growth startup, the question becomes how best to carve out a protected business and increase the barriers to entry so that the inevitable consolidation is slowed while your corporate value increases.
Mike Tanner is a Managing Director at the Chasm Group, where he provides advisory and consulting services in the areas of new venture development, market development strategy, operational planning, portfolio investment strategy and market positioning. Mike holds board seats for Apexion and Savi Technology, and sits on the advisory boards of Entivity and Unicru. He can be reached for comment at: mtanner@chasmgroup.com
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