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Predictions for Software Finance in 2004

By M.R. Rangaswami, Co-founder, Sand Hill Group LLC

The software industry is very much alive these days: many companies had a great fourth quarter.

Contrary to what you might be hearing in the news, the software industry is very much alive today. The tough part is that the business has changed so dramatically from where it was even two short years ago. There is a new landscape of vendors, products and customers shaping the software industry.

Customers are more demanding than ever. They buy as they see the need for products arise – not anticipating demand as they used to. They demand a quick return on investment (ROI) for all projects. And they are tough negotiators during the contract process which has kept pricing at an all-time low.

Vendors were slow to react to these changes. But over the past two years, many adjustments have been made in their products, marketing approaches and business models in order to meet the needs of this new breed of customers.

But we still have a long way to go if we want to bring growth and excitement back to the software industry. As we face the road ahead, many executives and professionals will gather at Software 2004, the first-ever conference for the entire spectrum of software business leaders.

Speakers and attendees will discuss “A Blueprint for the Next Decade” at the event, to be held March 1 and 2 at the San Francisco Marriot. Veteran software executives and industry visionaries will deliver keynotes and hold workshops to cover the challenges and opportunities faced by the industry. More than 1,000 CEOs, VPs and VCs from the software business will be in attendance.

In addition to sessions on general management, sales, marketing, offshoring, engineering, technology, services and support, one of the most important areas of discussion will be the topic of finance. Here my predictions for what the industry leaders will tell us to expect in this area in 2004:

1) Expect Improved Company Performance.
Many software companies had a great fourth quarter. Although visibility into future performance has been poor, many vendors are expecting a better year ahead.

For many, that simply means not having a terrible year, as the economy pulls out of its recent dark days. But for other vendors, it signals better times ahead. Many of these vendors have spent the past few years genuinely adjusting their financial expectations for the today’s economic reality.

This increased awareness has allowed them to restructure their business operations to better respond to their customers. These changes will translate to a smaller degree of unpredictability and improved investor confidence in the software industry.

2) Experience a Bigger M&A Year.
Many thought that 2003 would be a big year for software consolidation. Most experts agree that there are far too many software providers competing for an ever-shrinking share of I.T. buyers’ wallets. Consolidation would be a natural next step.

However, a boom in M&A deals never materialized. Indeed, there were a handful of headline deals – the potential Oracle-PeopleSoft merger, the PeopleSoft-J.D. Edwards deal and several E.M.C. acquisitions -- but nothing like what experts predicted – or what should have happened. As vendors adjust to the new technology business climate, many will finally realize that a merger may be their only option. These realizations coupled with better market performance will likely result in a bigger year for deals.

3) Watch the IPO Window Open.
Late in 2003, a few software I.P.O.s snuck out of the gate. Deals such as Calladus Software’s helped prove that investors have not given up on the technology stocks.

In 2004, another handful of adventurous software companies will debut. SalesForce.com’s filing got the analysts excited. TCS and Google are on the verge of filing. If any of these offerings perform well, a series of other hopeful winners will follow and may spell a significantly better year in 2005.

4) Witness a Flat Year for VC.
In third quarter 2003, biotech overtook software as the largest category of venture investment for the first time in 7 years. During the same quarter, software investments were only one-sixth the level they were three years earlier.

But software still accounted for 20 percent of all V.C. investment during the third quarter of 2003. And the years of further dramatic drops are clearly in the past. Therefore, 2004 will likely see mild gains in the software investment. Importantly, if acquisition and IPO activity comes back to life this year, 2005 will undoubtedly see a boost in software V.C.

5) Look for Money-Savers to Boom.
All of the driving forces in software technology today are those which help enterprises save money or operate more efficiently. Witness the surge in asset management tools, the rise in pay-as-you-go business models, and the current boom in open source.

In 2003, software vendors also turned to offshore development and services to remain competitive. A Sand Hill Group study found that nearly nine in ten software companies will be offshoring by the end of 2004. And many are witnessing savings of up to 40 percent.

These money-saving technologies and business models will continue to drive the industry throughout the year and will represent targets for investment and acquisition for many large players.

M.R. co-founded Sand Hill Group LLC, and has been a strategic advisor to fast-growing companies such as Aspect Development and i2 Technologies. He has held global VP marketing positions at Baan Company, Avalon Software, and Oracle Corporation. M.R. was profiled on the front page of the Wall Street Journal and was recently named in Forbes" "Midas 100 List" as one of the most influential investors in technology. M.R. can be reached for article feedback at: mr@sandhill.com


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