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| Home - Industry Article - Jun 03 Issue |
Category Convergence |
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.
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