Tue - The software industry matures; from pioneering to buccaneering

I read an interesting article in Barron's this weekend, which stated that many software makers are peddling similar programs to corporate clients, fueling a sweeping industry consolidation. They then had a look at who might be bought, and who will buy.

The article is well worth reading in full, but it also stimulated my own thinking. For the last four or five years I have been talking to people about the software industry moving from pioneer to buccaneer, i.e. like more mature markets, growth generally comes via M&A than through innovation. I may actually have been onto something all along. I even flirted with the idea of setting up a buy out fund purely to focus on 'rolling up' the software sector. It could have become the KKR for the tech space. What a fool I may prove to be for not following through on this.

Since the end of 2000, according to FactSet Mergerstat, there have been more than 12,000 acquisitions in the software sector, with a combined value north of $200 billion. In the process some storied software names have been swallowed: Peoplesoft, JD Edwards, Macromedia, Veritas, SunGuard, Legato and Documentum, to name just a few. And of course there are still many left to gobble up and indeed M&A activity just keeps increasing.

So what does all this mean:
1. The big will get bigger and in not too long the corporate software sector will be owned by a handful of companies such as Microsoft, Oracle, IBM, SAP, SUN, EMC etc.
2. Those that are not already one of the above six monsters need to get on the acquisition trail fast, or they will become also-rans or cheap fodder for the bigger guys. These companies include Adobe, Siebel, BEA, Computer Associates and Sybase.
3. Corporate buyers will increasingly look to buying their software from one or two strategic big brand software suppliers and will want comprehensice corporate suites as well as universal, standards based infrastructure software, such as application servers.
4. Private equity groups will look at buying out mature software companies to fatten them or even roll a few of them up. A West Coast VC I worked with in the past, Vector Capital, is making waves and recently bought Corel and Broadvision.
5. There will be less venture money available for software start ups and innovation in general, as it will become increasingly impossible to sell coporate software unless you are a big guy.
6. Lots and lots of smaller, or less successful (corporate) software vendors will fall by the wayside over the next few years as the handful of buyers have a considerable oversupply of choice when it comes to acquisition candidates.
7. Lots of work for consultants billing themselves as experts in successfully helping you to integrate the latest software merger or acquisition.
8. Less and less software (particularly corporate software) company IPO's.
9. Lots of VC's will get left with unexitable private software companies if they do not ensure that they are sold off to one of the acquirers soon.

So, I do believe that the software industry has moved from the pioneering stage to the buccaneering phase and growth will increasingly be sought via M&A activity. I think that in the next 5 years or so the corporate software sector will have consolidated and will basically be dominated globally by around 10 major players. The key will be figuring out who the ten are going to be. I will give my views on this in a future feature.

I also believe that there is still room for smaller players to be successful in the consumer space and possibly wireless, but not for too long. I also believe that there will always be room for the next big innovator to come from scratch (eg Google), but it will be increasingly tougher and they will only come around every decade or so.