The Changing Software Landscape – Pricing and Purchasing Trends SoftSummit 2004 Ken Berryman Santa...

The Changing Software Landscape – Pricing and Purchasing Trends

SoftSummit 2004

Ken Berryman

Santa ClaraOctober 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

• IT first deployed in back-office

• EDP era

• Businesses embrace IT as a 'silver bullet'

• CIO era

• 3 - 5x GDP growth rate

• IT treated as "normal" part of enterprise infrastructure

• CxO and procurement era

• 1 - 2x GDP growth rate

Mid 1980s Late 1990s

"Adoption"

"Explosion"

"Maturation"

IT s

pen

d

IT bubble bursts

Source: McKinsey analysis

4

SOFTWARE REMAINS THE LARGEST CATEGORY OF IT SPENDINGIT-producing Industries GDP by sector$ Billions

Source:BEA, Census, Global Insights

Comm. services

Software and services

Hardware

100% = 30 69 230 422 832

31 28 23 23 24

34 36 39 39 38

28 28 28 32 33 33

7 7 8 5 5 5

33

32

1998 1999 2000 2001 2002 2003

872

Comm. equipment

5

KEY THEMES IN SOFTWARE INDUSTRY

“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

Changing customer behavior

• Increasing procurement-led scrutiny of IT purchases • More “pay as you go” and attention to rapid payback

2

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

3

Ecosystem-driven competition

• Increasing (de facto) standardization of overall IT infrastructure, including bundling of sub-categories into standard platforms

• Active fostering of global ecosystems

4

1

6

21 21 22 23 20 22 19 1712 15 14 13

28 26 23 2419

2519 18

10 127 6

SOFTWARE SECTOR MATURITY

5143

36 33 30 30 30 27 24 19 16 14

3928

60

20

0

1730

189

-1 -2-10

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1992 1993

Percent

Median EBITA margins in CPC software index

Top 20*

Smaller companies**

*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 INCSource: Compustat; CPC Software Index Model; CPC Analysis

1

7 Year rolling revenue growth CAGR in CPC software Index

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

7

NATURAL DRIVE TOWARDS CONSOLIDATION CONTINUES

37394950

19

19

13

19 76

6

6 9

9 8

11

16 1826

33

1996 1998 2001

100% = 103 135 171

$ Billions, percent

Top 1-3

Top 11-20

Top 4-10

Top 21-100

Others

Source: IDC; McKinsey analysis

Top 20 software vendors, 2003

1. Microsoft2. IBM3. Oracle 4. SAP 5. Computer Associates 6. Peoplesoft7. Veritas8. Intuit9. Symantec 10. BMC11. Adobe12. Siebel 13. Compuware 14. Novell15. Verisign16. BEA17. Axicom 18. Harte-Hanks19. Network Associates 20. Sybase

SW revenuesCompany

2003

177

34.314.3

9.78.03.32.31.81.81.71.41.41.41.41.11.11.01.00.90.90.8

8

Is your organization consolidating IT suppliers?Percent

No

Yes

Reason for reducing suppliers?Percent of respondents

Leverage volume discounts

Reduce complexity of dealing with many vendors

Reduce technical complexity of integrating products

57

45

70

Source:Morgan Stanley; customer interviews

• Customers are increasingly consolidating vendors as innovation diminishes and IT commoditizes

• Increasing cost awareness and purchasing scrutiny

60

40

Willingness to sacrifice point solution functionality to consolidate?Percent

No

Yes75

25

CUSTOMERS ARE RATIONALIZING AND CONSOLIDATING THEIR PURCHASES

2

9

ENTERPRISE DECISION MAKING IS BECOMING MORE REGIMENTED

Technology strategy

committee

Technology strategy

committee

Technology strategy committee

CIO, using purchasing to

augment procurement

skills

CIO, COO,

Finance

CIO, using purchasing to

augment procurement

skills

Purchasing, with direction

from IT

CIO, COO, Finance

Purchasing, with direction

from IT

New initiatives

Complex infrastructure

Commodity infrastructure

Size of spend

Low (<$200k) Medium High (>$1 M)

Case example – Large media technology company


10

UTILITY COMPUTING: HETEROGENEITY REMAINS A BARRIER …

Source:IDC; McKinsey

3M

idd

lew

are

and

in

fras

tru

ctu

re la

yer

H/W

la

yer

Ap

p la

yer

Early homogenous

Homogenous

Limited heterogeneous

HeterogeneousService-oriented applications

Servers Storage Network

Business-driven computing

Automated problem resolution

Automated resource management

Automated protection

11

… LEAVING CIOs SKEPTICAL ABOUT RAPID DEPLOYMENT

“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”

‘On demand’ or utility computing deployment plans Percent of respondents

Deployed/ plans to deploy in the near term

Plans to deploy internally in the longer term

No plans to adopt in the longer term

0%

14%

86%

12

NEW SERVICE/ SUBSCRIPTION BASED MODELS ARE INCREASING ACCEPTANCE$ Millions

Source: IDC 2004

Americas

2,400

20072003

6,200

CAGR = 25%

Asia Pacific

700230

2003 2007

EMEA

780

2003

390

2007

CAGR = 16%

CAGR = 30%

13

LOW-COST LABOR CHANGES DELIVERY ECONOMICS FOR MANY SERVICES


Cost$ per hour

QuantityThousands FTE

2006 Application Development cost curve

0

20

40

60

80

100

120

0 500 1000 1500

U.S.Europe

China IndiaPhilippines

Ireland

Mexico

14

COMPETITION THROUGH ECOSYSTEM IS FOCUSING ON MIDDLEWARE

IBM Oracle SAP Microsoft

Apps

OS

Database

Middleware and develop-ment tools

Linux OS/xZ/OS

WebSphere

DB2

Multiple

11i

Oracle iAS

Windows

Windows/ .Net

MS SQL

MBS for SMB

Multiple

Multiple

Multiple

Oracle Database

Netweaver

SAP ERP/SCM/CRM

Multiple

Note:Other vendors trying to establish a platform include EMC around their storage/ILM offerings

System management and security

Tivoli MultipleSystem

management server

Multiple

4

15

36

23

32

OPEN SOURCE ADOPTION CREATES ANOTHER ECOSYSTEM COMPETITOR

Availability alternative Open Source stack . . .

Apps

OS

Database

Middleware and dev tools

Linux

Apache

MySQL

Multiple

Mainstream adoption/endorsement of Linux on server side but client side expected to lagPercent unit share

2002 2007

Client Server

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)

2002 2007

16

IMPLICATIONS OF SOFTWARE THEMES

“Maturing” industry structure

• More attention required to customer satisfaction and service to maintain share

• Sustained pace of mergers and acquisitions create more industry restructuring


• Customers demand more focus on value creation and risk/value sharing

2


• More use of blended delivery models• Increasing importance of an overall service story,

including outsourcing and offshoring

3


• Increasing alignment and tiering of vendors and service providers, similar to structure in other industries

4

1

17

CONTENTS




18

WHAT IS UNIQUE ABOUT SOFTWARE PRICING?

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

“Winner takes all” dynamics

• Strong network effects• Importance of de facto standards• Pricing discipline lost in the “land grab”

Combination of these factors

makes software pricing highly

dynamic

19

SOFTWARE PRICING IS EVOLVING ALONG THREE DIMENSIONS

Geographic differentiation

• Regional licensing models allow differentiation between customer segments

• Success will depend on vendors’ ability to accurately target segments and minimize cannibalization

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

20

LONG SALES CYCLE AND SMALLER DEAL SIZES RESULT FROM GREATER SCRUTINY

Source: Robert W. Baird & Co; IDC

How long is your average buying cycle for enterprise software?Percent of respondents

Average selling price in enterprise applications$ Thousands

27

36

18

14 5

3-6 months

6-9 months

9-12 months

>12 months <3 months522

402

311

4Q/01

4Q/02

4Q/03

-23%

21

69 10 10

6

16 159 8

11

License

DEEP LICENSE DISCOUNTING IS STILL THE NORMShare of list revenuePercent

Average ~50%

0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100

DISGUISED EXAMPLE

DiscountPercent of list price

Licenses in biggest deals almost given away

0-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100

Maintenance*Average 3%

75

10 150 0 0 0 0 0 0

(all at 0)

• Sales reps “required” to sell maintenance with license

• Discounts resulted in penalty

* As per cent of license net price

22

MAINTENANCE PRICING PURSUED VIA MULTIPLE MODELS

Source: Gartner 2001 software support portfolio (October 2001); IDC 2001 support services for enterprise-level applications; Company Web sites; McKinsey analysis

Percent of license net price• BMC• HDS• Clarify• IFS• Network

Associates• Oracle• SAP

Software maintenance pricing modelPercent, N = 24 companies

Mixed models• Veritas• HP• Caldera• Linuxcare

Percent of license list price• Novell • Peoplesoft• Progress• CA• Sun• IBM• EMC• Filenet• Legato

33

29

38

• 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)

2001 DATA

• Microsoft• NCR• Sybase

23

GEOGRAPHIC PRICE DIFFERENTIATION CAN REACH NEW MARKETS

l

CONCEPTUAL

ASP: 100

ASP: 110 ASP:

140

ASP: ???

ASP: 40??

Companies are increasingly considering differentiated pricing structures to target high-growth geographies

• 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

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

24

CONTENTS




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KEY QUESTIONS FOR SOFTWARE AND SERVICES PROVIDERS

Key themes

Maturing industry structure

• What does aligning your business model around earnings rather than growth mean for pricing?

• How to respond to increasing consolidation?


• How can your pricing and licensing approach–meet customers’ cost efficiency needs?– improve perceived ROI?


• What should you do to exploit emerging go-to-market and pricing models?

Source:McKinsey


• How can pricing be used to influence customers’ platform choices?• What pricing structures can help to preserve value as open source

alternatives emerge?

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KEY QUESTIONS FOR BUYERS OF SOFTWARE AND SERVICES

Key themes

Maturing industry structure

• What is the right vendor strategy?• How can you benefit from standards and

consolidation?


• 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?


• Which of your needs would be better served by on-demand software and services?

• Have you fully leveraged offshoring and outsourcing?

Source:McKinsey


• What platforms/architectures are best aligned with your strategy? Which standards should you bet on?

• Where do open source alternatives deliver lower TCO?

The Changing Software Landscape – Pricing and Purchasing Trends SoftSummit 2004 Ken Berryman Santa...

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