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The Changing Software Landscape – Pricing and Purchasing Trends

The Changing Software Landscape – Pricing and Purchasing Trends. Ken Berryman. SoftSummit 2004. Santa Clara October 19, 2004. CONTENTS. Software industry themes New software pricing approaches Key questions for vendors and purchasers. IT INDUSTRY IS AT AN INFLECTION POINT. "Maturation".

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The Changing Software Landscape – Pricing and Purchasing Trends

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  1. The Changing Software Landscape – Pricing and Purchasing Trends Ken Berryman SoftSummit 2004 Santa Clara October 19, 2004

  2. CONTENTS • Software industry themes • New software pricing approaches • Key questions for vendors and purchasers

  3. IT INDUSTRY IS AT AN INFLECTION POINT • "Maturation" • IT bubble bursts • IT treated as "normal" part of enterprise infrastructure • CxO and procurement era • 1 - 2x GDP growth rate • "Explosion" • IT spend • Businesses embrace IT as a 'silver bullet' • CIO era • 3 - 5x GDP growth rate • "Adoption" • IT first deployed in back-office • EDP era • Mid 1980s • Late 1990s Source: McKinsey analysis

  4. SOFTWARE REMAINS THE LARGEST CATEGORY OF IT SPENDING IT-producing Industries GDP by sector $ Billions • 100% = • 30 • 69 • 230 • 422 • 832 • 872 • Comm. equipment • Comm. services • Software and services • Hardware Source: BEA, Census, Global Insights

  5. “Maturing” industry structure • Consolidation pressure from scale/scope economies • Entry from large adjacent players (hardware, services) • Shift from focus on top-line growth to creating sustainable operating leverage • 2 • Changing customer behavior • Increasing procurement-led scrutiny of IT purchases • More “pay as you go” and attention to rapid payback • 3 • Evolving delivery models • Introduction of “utility computing” models by mainstream vendors • Acceleration of open source deployments • Growth of BPO/ITO and ASP providers • Blended delivery with low cost/high skill labor markets • 4 • Ecosystem-driven competition • Increasing (de facto) standardization of overall IT infrastructure, including bundling of sub-categories into standard platforms • Active fostering of global ecosystems KEY THEMES IN SOFTWARE INDUSTRY • 1

  6. 1 SOFTWARE SECTOR MATURITY • Top 20* Percent • Smaller companies** 7 Year rolling revenue growth CAGR in CPC software Index • 1992 • 1993 • 1994 • 1995 • 1996 • 1997 • 1998 • 1999 • 2000 • 2001 • 2002 • 2003 Median EBITA margins in CPC software index • 1992 • 1993 • 1994 • 1995 • 1996 • 1997 • 1998 • 1999 • 2000 • 2001 • 2002 • 2003 * VRTS,SYMC,SY,SEBL,SAP,RHAT,PSFT,PMTC,ORCL,NOVL,MSFT,MFE,MACR,INTU,ERTS,CPWR,CA,BMC,ADSK,ADBE ** RED HAT INC,MACROMEDIA INC,PARAMETRIC TECHNOLOGY CORP,SYBASE INC,MCAFEE INC,AUTODESK INC,NOVELL INC,COMPUWARE CORP,ADOBE SYSTEMS INC.,SIEBEL SYSTEMS INC,BMC SOFTWARE INC Source: Compustat; CPC Software Index Model; CPC Analysis

  7. NATURAL DRIVE TOWARDS CONSOLIDATION CONTINUES • Top 20 software vendors, 2003 $ Billions, percent • Company • SW revenues • 1. Microsoft • 2. IBM • 3. Oracle • 4. SAP • 5. Computer Associates • 6. Peoplesoft • 7. Veritas • 8. Intuit • 9. Symantec • 10. BMC • 11. Adobe • 12. Siebel • 13. Compuware • 14. Novell • 15. Verisign • 16. BEA • 17. Axicom • 18. Harte-Hanks • 19. Network Associates • 20. Sybase • 34.3 • 14.3 • 9.7 • 8.0 • 3.3 • 2.3 • 1.8 • 1.8 • 1.7 • 1.4 • 1.4 • 1.4 • 1.4 • 1.1 • 1.1 • 1.0 • 1.0 • 0.9 • 0.9 • 0.8 100% = 103 135 171 177 • Top 1-3 • Top 4-10 • Top 11-20 • Top 21-100 • Others • 1996 • 1998 • 2001 • 2003 Source: IDC; McKinsey analysis

  8. 2 CUSTOMERS ARE RATIONALIZING AND CONSOLIDATING THEIR PURCHASES Is your organization consolidating IT suppliers? Percent Willingness to sacrifice point solution functionality to consolidate? Percent No • Customers are increasingly consolidating vendors as innovation diminishes and IT commoditizes • Increasing cost awareness and purchasing scrutiny No Yes Yes • Reason for reducing suppliers? • Percent of respondents • Leverage volume discounts • Reduce complexity of dealing with many vendors • Reduce technical complexity of integrating products Source: Morgan Stanley; customer interviews

  9. ENTERPRISE DECISION MAKING IS BECOMING MORE REGIMENTED • Case example – Large media technology company Technology strategy committee Technology strategy committee Technology strategy committee New initiatives CIO, using purchasing to augment procurement skills CIO, using purchasing to augment procurement skills Complex infrastructure CIO, COO, Finance Commodity infrastructure Purchasing, with direction from IT Purchasing, with direction from IT CIO, COO, Finance • Medium • High (>$1 M) • Low (<$200k) Size of spend Source: McKinsey analysis

  10. 3 UTILITY COMPUTING: HETEROGENEITY REMAINS A BARRIER … • Heterogeneous • Service-oriented applications • App layer • Limited heterogeneous • Homogenous • Early homogenous • Automated problem resolution • Automated protection • Business-driven computing • Middleware and infrastructure layer • Automated resource management • Servers • Storage • Network • H/W layer Source: IDC; McKinsey

  11. … LEAVING CIOs SKEPTICAL ABOUT RAPID DEPLOYMENT • ‘On demand’ or utility computing deployment plans • Percent of respondents • “Good concept but years away. Technology is not there, and even bigger challenge is to change developer behavior. And we definitely we have a lot of excess computing power internally” • “On Demand was a brilliant concept for selling in the boardroom, but there is no reality there yet.” • “I don’t believe it. What is the next question?” • “Most apps are monolithic and hard to rewrite for utility. This is not where we want to invest because it does not create value” • Deployed/ plans to deploy in the near term • Plans to deploy internally in the longer term • No plans to adopt in the longer term

  12. 22 • CAGR = 30% • CAGR = 16% • CAGR = 25% NEW SERVICE/ SUBSCRIPTION BASED MODELS ARE INCREASING ACCEPTANCE $ Millions • EMEA • Asia Pacific • Americas • 6,200 • 780 • 390 • 700 • 2003 • 2007 • 230 • 2,400 • 2003 • 2007 • 2003 • 2007 Source: IDC 2004

  13. LOW-COST LABOR CHANGES DELIVERY ECONOMICS FOR MANY SERVICES • 2006 Application Development cost curve • Cost • $ per hour • U.S. • Europe • Ireland • Mexico • Philippines • India • China • Quantity • Thousands FTE Source: McKinsey analysis

  14. 4 COMPETITION THROUGH ECOSYSTEM IS FOCUSING ON MIDDLEWARE • IBM • Oracle • SAP • Microsoft • MBS for SMB • Multiple • SAP ERP/SCM/CRM • Apps • Multiple • 11i • Oracle Database • Database • DB2 • Multiple • MS SQL • Middleware and develop-ment tools • Windows/ • .Net • WebSphere • Oracle iAS • Netweaver • System management and security • System management server • Tivoli • Multiple • Multiple • Linux OS/x • Z/OS • OS • Multiple • Multiple • Windows Note: Other vendors trying to establish a platform include EMC around their storage/ILM offerings

  15. OPEN SOURCE ADOPTION CREATES ANOTHER ECOSYSTEM COMPETITOR • Mainstream adoption/endorsement of Linux on server side but client side expected to lag • Percent unit share • Availability alternative Open Source stack . . . • Server • Client • Multiple • Apps • Database • MySQL • Middleware and dev tools • Apache • OS • Linux • 2002 • 2007 • 2002 • 2007 • Access to offshore low cost/high skill labor markets fuels custom software development on lower cost platforms • Strong public sector adoption • Backing/endorsements from IT heavyweights (HP, IBM, Oracle)

  16. “Maturing” industry structure • More attention required to customer satisfaction and service to maintain share • Sustained pace of mergers and acquisitions create more industry restructuring • 2 • Changing customer behavior • Customers demand more focus on value creation and risk/value sharing • 3 • Evolving delivery models • More use of blended delivery models • Increasing importance of an overall service story, including outsourcing and offshoring • 4 • Ecosystem-driven competition • Increasing alignment and tiering of vendors and service providers, similar to structure in other industries IMPLICATIONS OF SOFTWARE THEMES • 1

  17. CONTENTS • Software industry themes • New software pricing approaches • Key questions for vendors and purchasers

  18. WHAT IS UNIQUE ABOUT SOFTWARE PRICING? • “Winner takes all” dynamics • Strong network effects • Importance of de facto standards • Pricing discipline lost in the “land grab” • High pricing complexity • Hard to communicate value • Dynamic environment • Frequent innovation • Short product lifecycles • Multitude of alternative pricing models and approaches – many degrees of freedom • Products often highly customized • Multiple distribution mechanisms • Value delivered is hard to quantify and communicate • Intangible asset • Often tied to business process changes • Marginal costs perceived to be at or near zero for software – leading to extreme discounting • Combination of these factors makes software pricing highly dynamic

  19. SOFTWARE PRICING IS EVOLVING ALONG THREE DIMENSIONS • Revenue timing • Increased buyer scrutiny of deals creates strong pressure on up-front license charges • On-demand IT provisioning drives shift to more variable pricing • True “utility computing” still has limited credibility with customers • Breadth of offering • Vendors broaden offerings to drive growth in new segments • Vendors heavily rely on bundling and solution selling to increase adoption across product portfolio • Geographic differentiation • Regional licensing models allow differentiation between customer segments • Success will depend on vendors’ ability to accurately target segments and minimize cannibalization

  20. LONG SALES CYCLE AND SMALLER DEAL SIZES RESULT FROM GREATER SCRUTINY • How long is your average buying cycle for enterprise software? • Percent of respondents • Average selling price in enterprise applications • $ Thousands • 4Q/01 • <3 months • >12 months • 9-12 months • 3-6 months • 4Q/02 -23% • 6-9 months • 4Q/03 Source: Robert W. Baird & Co; IDC

  21. DEEP LICENSE DISCOUNTING IS STILL THE NORM • DISGUISED EXAMPLE Share of list revenue Percent Average ~50% • Licenses in biggest deals almost given away License 90-100 0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 Discount Percent of list price Average 3% • Sales reps “required” to sell maintenance with license • Discounts resulted in penalty Maintenance* (all at 0) 0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100 * As per cent of license net price

  22. MAINTENANCE PRICING PURSUED VIA MULTIPLE MODELS • 2001 DATA • Software maintenance pricing model • Percent, N = 24 companies • Model varies across vendors even in individual sub-markets • Mix of models used by industry • Can usually realize any given absolute price point under either model • Best choice of model depends on sales objectives, incentives, frontline discipline, and sometimes tactical factors (e.g., systems) • Percent of license net price • BMC • HDS • Clarify • IFS • Network Associates • Oracle • SAP • Percent of license list price • Novell • Peoplesoft • Progress • CA • Sun • IBM • EMC • Filenet • Legato • Mixed models • Veritas • HP • Caldera • Linuxcare • Microsoft • NCR • Sybase Source: Gartner 2001 software support portfolio (October 2001); IDC 2001 support services for enterprise-level applications; Company Web sites; McKinsey analysis

  23. GEOGRAPHIC PRICE DIFFERENTIATION CAN REACH NEW MARKETS • CONCEPTUAL ASP: 100 ASP: 110 • Companies are increasingly considering differentiated pricing structures to target high-growth geographies ASP: 140 • Stripped-down versions allow vendors to reach lower price points without sacrificing value • Single-language products can effectively target individual countries, e.g., in Southeast Asia • Country-specific price lists provide sufficient differentiation for some enterprise software products ASP: ??? ASP: 40?? How can vendors mitigate risks of cannibalizing most profitable markets? • Direct transfer of low price products • Reset of value expectations in high price markets • Creation of “good enough” alternatives for customers with high willingness to pay l

  24. CONTENTS • Software industry themes • New software pricing approaches • Key questions for vendors and purchasers

  25. Maturing industry structure • What does aligning your business model around earnings rather than growth mean for pricing? • How to respond to increasing consolidation? • Changing customer behavior • How can your pricing and licensing approach • meet customers’ cost efficiency needs? • improve perceived ROI? • Evolving delivery models • Ecosystem-driven competition • What should you do to exploit emerging go-to-market and pricing models? • How can pricing be used to influence customers’ platform choices? • What pricing structures can help to preserve value as open source alternatives emerge? KEY QUESTIONS FOR SOFTWARE AND SERVICES PROVIDERS • Key themes Source: McKinsey

  26. Maturing industry structure • What is the right vendor strategy? • How can you benefit from standards and consolidation? • Changing customer behavior • How to develop and instill best practice software sourcing process and capabilities? • How do you ensure that strategic software choices deliver the highest ROI and minimize risk? • Evolving delivery models • Ecosystem-driven competition • Which of your needs would be better served by on-demand software and services? • Have you fully leveraged offshoring and outsourcing? • What platforms/architectures are best aligned with your strategy? Which standards should you bet on? • Where do open source alternatives deliver lower TCO? KEY QUESTIONS FOR BUYERS OF SOFTWARE AND SERVICES • Key themes Source: McKinsey

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