point
Menu
Magazines
Browse by year:
October - 2002 - issue > Cover Feature
2002 unveils myth of shrink-wrapped software
Tuesday, October 1, 2002
ENTERPRISES HAVE SLASHED BUDGETS THIS YEAR for large application software purchases. A look at purchase intentions and adoption rates of 874 Global 3,500 firms reveals that, compared with 2001, there are fewer buyers on tap in the CRM and supply chain apps space. While more than one-third of firms will consider a CRM purchase in 2002, purchase intent has dropped by more than half from 2001 in industries like retail, energy, utilities, and financial services. Meanwhile, only one in five firms will consider a supply chain software purchase in 2002, with notable drops in interest from the retail, utilities, and distribution sectors. Moreover, procurement apps—which, in our 2001 study, was the hottest app category—experienced the steepest drop in interest, plunging from last year's 65 percent to 25 percent this year. Finally, fear of big-ticket, drawn-out installations drove down interest in ERP to a mere 20 percent of companies, falling mostly in the retail industry.


Enterprise app vendors' woes, however, are not limited to a slump in demand. In the heightened scrutiny of a post-Enron world, questionable software sales behaviors have resulted in audits and SEC investigations, criminal charges, and troubled contracts. For instance, the state of California backpedaled on its recent $95 million agreement with Oracle when an audit revealed that it had purchased more database licenses than it had employees: a $41 million overage. And the city of Toronto is trying to terminate an Oracle contract it claims is 10 times richer than needed. In both cases, Oracle sales reps are alleged to have inflated the contract and offered huge discounts to win the deal.


Despite these incidents, investors love software companies. Why? Their fabulous profit margins and to-die-for growth rates, à la Microsoft. But are these margins and growth rates sustainable, or a fragile house of cards? Forrester thinks it's the latter, because apps are configured for buyers: they aren’t shrink-wrapped. The enterprise software CD is useless to Global 3,500 companies—it must be configured to a firm's environment and connected to related processes. For example, Siebel's CRM app must link to Oracle's Order Management for agents to view orders online. That process and software combination varies from firm to firm, requiring analysis, integration software, configuration, and even custom code to make it operational.


In addition, customers realize value over time, not when the deal is signed. Users mired in multiyear ERP implementations will agree that it takes a long time to realize benefits from enterprise software. While apps like electronic procurement, order fulfillment, and project management can deliver benefits in three to six months, a companywide CRM implementation involving sales, service, and marketing often takes years to yield results.


Finally, software benefits may be fleeting, but licenses are forever. Users bought boatloads of enterprise software in recent years, much of it still unimplemented. Forrester estimates that 12 percent of tech purchases in 2000 represented overspending as the craze of the late 1990s pushed tech spending on hardware, software, and services into a $62 billion bubble of investment that is still in the process of being absorbed. Furthermore, the useful life of software changes as firms acquire and shed businesses, which can render these nontransferable licenses obsolete.



SOFTWARE WILL LOOK MORE AND MORE LIKE A SERVICE

Several current trends should concern vendors and investors enamored by today's software revenue model because Web services will diminish repeatability. PeopleSoft and SAP are breaking their own repeatable packages of software into components with their Web services initiatives. The result? Functionality micromodules will be mixed and matched with those from other vendors into an infinite set of combinations, then implemented as a service—not as a preconfigured set of process steps. Moreover, Forrester expects outsourced apps to experience a revival. Everyone agrees that the original ASP model was a failure.


Meanwhile, a quiet revolution is looming that will bring back outsourcing of everything from networks to apps. As salesforce.com and bom.com continue their growth as subscription-based hosted applications, major vendors like Oracle are offering to take over users' apps with guaranteed savings. As verified savings rack up, users will be receptive to proposals to sell them access instead of ownership, further legitimizing the delivery of enterprise apps as a service. Finally, we expect post-Enron audits will tighten. Today's post-Enron climate has watchful auditors and a wary SEC ready to crack down on any apparent sales impropriety, leaving already challenged software firms restating prior periods and shuffling management.

When downward restatements from supposedly healthy firms like MicroStrategy, Peregrine, and Computer Associates occur, rattled investors head for the exits and punish the stocks of these one-time Wall Street darlings.

NOW'S THE PERFECT TIME TO SWITCH ACCOUNTING MODELS

The public airing of software business practices and slumping sales creates a climate ripe for change. To better match client value with seller reward, vendors must stop selling licenses and taking revenue upfront. This requires three major changes among app vendors, customers, and Wall-Street analysts.


Apps vendors should seize the moment to change models. To match seller reward to buyer expense, enterprise software vendors must offer equal-payment multimonth contracts for both hosted and installed apps. For apps that can be implemented in three to six months, vendors should offer 12-month renewable contracts or longer terms to lock in prices. Vendors whose products take longer to implement should sell three-year renewable contracts. In either case, the vendor responsible for bringing the customer's software online defers billing—and the start of revenue recognition—until a mutually agreed upon portion of the software is operational.


Customers must view software “ownership” as lease-to-buy. The contract approach helps users manage their own cash flow and lets them buy access to needed software even when budgets are tight. Furthermore, firms can extricate themselves at contract boundary points from software that no longer delivers value. At the same time, buyers have the right at the end of the contract to take over ownership. This is already the practice of firms that buffer themselves from license ownership by leasing the software through a third party.


Wall Street must rethink how it values service businesses. Firms that switch revenue recognition from upfront to ratable accounting models risk Wall Street's wrath because of the transitional drop in revenue. Today's depressed software market provides an ideal time for vendors to switch to the ratable subscription model already in use by webMethods, Computer Associates, Click Commerce, webplan, and others. In the end, these companies offer more predictable revenue over time, which will help—not hurt—their stock price.



Twitter
Share on LinkedIn
facebook