Software vendors face slow spending and changed market

If there's an IT recovery in store for this year, the top software companies haven't felt it yet. Nearly every major vendor ended its last quarter with a warning that sales were slow. Analysts say the slump signifies a combination of spending jitters and of deeper issues: Fundamental changes are under way in how customers buy software, and the shift could be a rough one for the industry's traditional leaders.

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The biggest challenge the applications titans face is fierce competition, both from each other and from the rising pack of ASPs (application service providers). Siebel Systems used to sit comfortably at the vanguard of the CRM (customer relationship management) market; now, its potential customers are also being wooed by the Big Three ERP (enterprise resource planning) makers -- SAP, PeopleSoft and Oracle -- and by a host of fledging companies.

"There's a tremendous variety of products in every category," said Josh Greenbaum, principal of Enterprise Applications Consulting, in Berkeley, California. "Customers are buying from the enterprise companies, but they're also buying from some start-ups."

This year, the ASPs went mainstream, with Salesforce.com cannonballing onto the New York Stock Exchange and reporting close to $100 million in annual revenue. Some of that total comes from tapping a new market -- the small companies with a few dozen employees willing to pay the $65 monthly per-user fees Salesforce.com and its rivals charge for their basic sales-automation products. Those tiny organizations were never going to be customers for traditional CRM vendors, where even a small deployment can carry a six-figure price tag.

But the ASPs are looking to swim upstream, and they're starting to win the enterprise deals that companies like Siebel compete for. Salesforce.com signed contracts this year with Automatic Data Processing and SunTrust Banks for more than 2,000-seat licenses each. Both companies run Siebel in parts of their business, yet both said they didn't consider Siebel in evaluating vendors for their sales-force automation projects.

DecisionOne Vice President of Marketing Frank Tait spoke with Siebel and SAP two years ago when he evaluated CRM options for his IT services firm. In the midst of a business-model overhaul, DecisionOne, based in Frazer, Pennsylvania, needed a system it could implement quickly, with a clear ROI (return on investment).

"From the date of the contract signing, Salesforce.com took 45 days to get our data converted and our system live. The others were in the six-month timeframe," he said. "My customization cost for Salesforce.com was under $50,000. The custom cost for the traditional vendors was 10 times that."

DecisionOne now has 150 employees using Salesforce.com, and Tait plans to remain a customer for the foreseeable future. "From an analysis perspective, it's been a gold mine. It's done exactly what we needed," he said.

AMR Research estimates that hosted services account for just 2 percent of the application market revenue today -- but forecasts they'll be the fastest-growing segment of the market over the next five years.

Independent analyst Amy Wohl said she thinks the ASPs aren't yet a major factor in the market, but suspects they will be as early as next year: "Down the road, I see it as an enormous possibility."

All of the applications vendors now offer hosting, with Siebel most aggressively going after the ASPs with its own subscription product, Siebel CRM OnDemand. But a business model that can support a pure-play start-up (if barely -- Salesforce.com, the only public CRM ASP, has quarterly marketing budgets exponentially bigger than its profits) may not work well for an established vendor. Siebel said in a recent regulatory filing that it expects to invest "significantly more" in the service this year than it will recoup in revenue.

The ASPs alone, however, aren't causing the applications leaders' slowdown. IDC calls 2003 a year "during which vendors worked feverishly to regain solid ground." Siebel and PeopleSoft showed double-digit percentage declines in applications revenue last year, according to IDC -- and this year, both followed shaky first quarters by falling short of expectations in the second. Oracle has kept its results on track so far, but its database sales help prop up its slow-growing applications business. Only SAP has remained unscathed this year, after struggling through a few rough quarters last year.

The problem is widespread enough that JMP Securities titled its report on this quarter's rash of earnings warnings "Application Software: What the #%^&*1$ Happened?" Among its conclusions: Expectations were too high, and concerns about the economy have led to buying delays.

AMR Research applications analyst Jim Shepherd agrees with that assessment. "All the indications at the end of 2003 were that spending was up, and there's a lot of activity out there. People are evaluating projects and getting started, but when we talk to users, they're getting more nervous about the economy. Even though they did increase their IT budgets, they're not spending the money," he said. "This is one of those cases where, when the vendors say the pipelines are good but that the deals are slipping out, they're telling the truth."

The malaise has hit a broad cross-section of the software market: In addition to PeopleSoft and Siebel, shortfall warnings came from storage developer Veritas Software Corp.; integration specialists WebMethods, Informatica and Ascential Software Corp.; and infrastructure software makers Sybase, Computer Associates and BMC Software.

JMP Securities expects the floodgates to come loose -- it forecast spending will increase 50 percent in the second half of the year. Others are less optimistic. Gartner doesn't predict a return to normal growth in the software market until 2006. Citing factors such as rampant discounting, it said in a report this week that the slow growth "reflects the conditions of the software market itself more than the wider challenges in the IT industry or economy."

In any case, analysts expect companies to have to fight hard for available dollars.

"With software, you're committing to a long program of spending -- implementation, roll-out, upgrades. Senior management seems to be very nervous about that," said AMR's Shepherd.

The profusion of available vendors means customers can shop around, and a shift toward modular buying means fewer multimillion deals. It also means that even after a customer is won, they can keep their supplier on a string by buying piecemeal and considering other vendors for additional functionality.

"The move to Web services and open standards has made that possible," analyst Wohl said. "The customer may in the end opt for sticking with a single vendor, but they can do it just a few pieces at a time."

For customers, the vendors' crunch can be good news. Analysts say vendors are willing to cut deeply to land deals.

That's been the experience of Andrew Albarelle, principal executive officer of Remy, a Denver staffing firm. All of his IT purchases have gotten cheaper, he said: "You can take one (vendor) and pit them against each other, and go back and forth and back and forth until you get the number you want to pay," he said.

His company picked PeopleSoft three years ago for its ERP system. A recent upgrade to PeopleSoft's latest financials suite -- free, thanks to Remy's maintenance contract -- cut his company's operations costs 11 percent, and he's considering additional spending to buy PeopleSoft's Proposal Management application.

His experience negotiating with PeopleSoft for the new module has been good: "We're getting close," he said. "It's really good with the vendors that are willing to work with companies. When we were first looking, some of the vendors said, 'This is our price, take it or leave it.' We left it."