SmoothSpan Blog

The announcement by IBM that they’re buying Cognos sent shivers through the pundit space.  Most view it in somewhat negative terms.  It’s the End of Best of Breed Software.  It’s the end of Mid-Sized Software companies.  Larry Dignan was a bit more balanced and closer to what I think is the real truth:

There is a changing of the guard underway in enterprise software.

Let’s take a look at the deal and Cognos.  Here was a company doing circa $1 billion a year in revenues.  It was acquired by IBM for a 9% or so premium.  Not a very big premium on the scale of things.  Cognos had to be eager to be bought to accept such a low premium.  Recall BEA recently rebuffed a higher premium.  A little digging into their 10K shows that Cognos grew roughly 12% versus the prior year.  The growth for the year before that was even more tepid, about 6%.  At the same time, analysts estimates are for 21.5% earnings growth this year and 13.5% growth each of the next 5 years.  What’s wrong with this picture?  We have a company struggling to deliver 12% growth in revenue, their gross margins are eroding, and the economy looks to be headed into a recession.  Meanwhile, their biggest competitors have been snapped up by Oracle and SAP, which is likely to make it even harder to grow.  I read those numbers and see a company that doubted it would be able to keep up.  So management pulled the big red life’s-to-short-to-let-this-trainwreck-happen-on-my-watch lever and sold to IBM.

How did enterprise software get so hard?  Maturation.  Most of these markets are pretty long in the tooth.  We’re way past the silver bullet feature stage.  The theory of punctuated equilibrium says it’s time for consolidation prior to the next round of innovation.  Clear the decks of excess noise.  Make the old guard lean and efficient.  Get past the idea they will do any more innovating.  This is “acquired innovation” as Chuck Philipps over at Oracle has coined it. 

But Philipps is wrong, because there is no real innovation here at all.  It’s all about slimming these old dogs down and milking their maintenance stream.  Don’t agree?  Do you really think there’s much innovation being done around Oracle’s bevy of newly acquired software?  Fusion?  Philipps latest remarks masterfully provide a much-needed escape route.  His story is that he has been saying for years that Fusion is no one thing.  The first Fusion applications will ship on schedule, but it will take years to get all the suite out.  Meanwhile, customers will continue to buy the software they’re familiar with.  He says that even if the suite was ready only 20% of customers would be ready to deal with it, so what’s the hurry?  Sounds to me like Chuck is saying they’ll ship whatever is convenient when it is convenient and declare victory and it won’t matter too much.  Even Dan Farber at ZD was skeptical about how upbeat this could be for Fusion.  No innovation going on there.  Move on, these are not the innovations you’re looking for.

Interestingly, what we are hearing from Oracle is SaaS murmurings.  After Larry Ellison had slammed it, Chuck Philipps is suddenly back talking about how Oracle is a real SaaS player for the Enterprise.  They’re going to stop Salesforce in their tracks, going for the CRM Jugular as Phil Wainewright puts it.  In fact, this was important enough that Chuck Philipps took time out to meet with Phil Wainewright and set him straight that SaaS doesn’t have to be multitenant, and that Oracle is putting it’s customers on a “stair-step to on-demand.”  Philipps’ remarks show he has spent quite a lot of time thinking and worrying about the SaaS issue.  More than should have been required when we look at the actual revenues Oracle derives from on-demand.  According to the 10K, On-demand revenues for 2007 were $557 million.  That represents just 3% of Oracle’s nearly $18B in revenue for FY2007.  Moreover, the On-demand business ran at a loss with expenses of $592 million.  Perhaps this is why Larry can’t see much profit in On-demand: his own company can’t seem to make a profit.  It may be that Philipps needs to revisit his disdain for multitenancy before the company can figure out how to get On-demand margins in line.

Why would Chuck Philipps, a busy man and a very number savvy investment banker, choose to focus on a SaaS business that isn’t doing very well after the Big Kahoona Larry himself had dismissed it?  Why roll out a new Salesforce-killing initiative?

Because the guard is changing.  Best of Breed isn’t dead, it is morphing.  The companies that are being bought aren’t really the Best of Breed anymore.  The new heir apparents all come bearing disruptive business models.  The two most important are SaaS and Open Source, and Oracle has pain from both.  It is watching SAP step up and move ahead on the innovation track with ByDesign.  It has to wonder about new SaaS companies like Workday.  This is dangerous strategic territory.  It’s territory that Big Guys are struggling to keep up with and loosing sleep over.  They want to understand what to do while there is still time.

The truth is that Oracle, IBM, SAP, and all the other big players have reason to be concerned.  Once upon a time they were the disruptors.  Quick, who were the big accounting software players before the client server revolution paved the way for the current crop?  There were a number of highly successful software companies from that old generation that vanished without a trace.  If you think it can’t happen again, watch and wait.  Software was already a low friction environment, but SaaS, Open Source, and the Internet lower the friction further.  Change can happen a lot faster than you’d think.