Sep 1 ’03

Goodbye GRAVY TRAIN

by Editor in z/Journal

What a difference 42 years makes! As a new “data processor” in 1961, I would snicker when reading Forbes’ periodic recitals of the “fallen” industries of the early 20th century. Fallen may be too strong a word; some of these industries were still active, but their days of glory and high growth were past – often long past. I never thought that I would witness the time when the glory days of the software industry would pass. However, at the start of the 21st century, as I look around at the industry, particularly the mainframe segment, it’s obvious that the gravy train has derailed.

I use the term “gravy train” to mean the days when the software industry racked up double-digit growth annually, and when Returns on Equity (ROE) of 50 percent were not uncommon. Now you have to look hard to find software companies making – let alone growing – profits. Some say that the industry’s current performance is simply a function of the economic cycle; when the economy picks up, the gravy train will start moving again, and it will soon be packed with high growth and high profit companies of all sizes. I say that they are being wishful thinkers.

THE PASSAGE OF TIME

Software became an industry on June 6, 1969, the day IBM “unbundled” (i.e., software priced separately from hardware). That was 34 years ago, a long time in an industry that moves so quickly. Just the sheer passage of time and the resultant maturity of the industry should give one pause as to how rapidly the industry will continue to grow. But this is somewhat of a philosophical point. Let’s look at something more concrete.

COMMODITY PRICING & SMARTER BUYING

A recent Wall Street Journal article tells of Verizon CIO’s mission to cut costs. Verizon slashed its computer budget by $100 million in 2002 and is looking to cut more this year. They attribute part of these savings to the fact that computers and the accompanying technology are becoming more like commodities and are being priced accordingly. Software did not climb on the gravy train because of commodity pricing – far from it! We charged premium prices. Another reason: CIOs have become smarter businesspeople and are looked to now for business results. They are dissuaded from looking at products that don’t show immediate financial results or may come with more risk than they prefer.

FEWER SELLING OPPORTUNITIES

Verizon is the product of several mergers. At least four companies are now part of Verizon, each of which was a large purchaser of software, probably from different suppliers. Now, with consolidation into one company, Verizon is eliminating duplicate products and doing so by squeezing the competitors for a better deal, resulting in fewer selling opportunities and lower prices.

STANDARDS LOWER PRICES

Verizon is squeezing hardware vendors also. Moving to computing standards makes this a lot easier. It’s much cheaper and easier to move from one Unix flavor to another than to move from MVS to another operating system. The move to standards has had a particularly negative impact on the mainframe software business. There are fewer mainframes that need software. The standard machines are cheaper and, in general, this drives the price of software down as well. Therefore, software companies are again faced with fewer selling opportunities and lower prices.

BIGGER IS NOT ALWAYS BETTER

Consolidations of the companies that provided us with multiple selling opportunities drive another nail into the coffin of the small software company. The Verizons of this world are not eager to deal with the small companies that started this industry. They much prefer to buy from the behemoths of today’s software industry. While the typical corporate CIO has always been conservative, in the 20th century you could usually find one who was willing to take a chance on a small company. Now, with CIOs earning in the high six figures, the CIO who buys from a small software company (when his boss has heard only of the giants) is truly a risk taker.

GLOBALIZATION HAS A DOWNSIDE

Globalization has many advantages. However, for a software company, it is another step in lowering prices. In the 1980s, India was simply the second largest Asian country. Now, it is a lower-cost competitor. True, India is not a major producer of software products – yet. But, its lower costs of doing business impact all producers of software.

Add them up: Time passing. Commodity pricing. The “greening” of the CIO as a businessperson. Declining selling opportunities. Computing standards. Company consolidations. Globalization. There is no way you can argue that the software industry will be back on the gravy train soon. Z