Europe: Silicon Continent

The Old World is finally getting its software act together

Staid German bankers probably wouldn't think much of Black Sun Interactive's corporate culture. At the software startup's Munich headquarters, artists have nailed artificial plants to the wall "to create a feeling of surrealism," says its exuberant chief executive, Franz W. Buchenberger. A life-size puppet named Jeff sits in the conference room, ready "to take the blame for bad decisions." Workers listen to music downloaded from the Internet and hold midnight powwows in the company's online chat room, donning virtual identities called avatars, so Buchenberger is never quite sure who's speaking to him. "We don't take ourselves too seriously," he says with a laugh. "But we're serious about our business."

Buchenberger, 36, needn't worry about whether German bankers approve. Black Sun is among a new crop of European software startups that is finding a market--and money--in the U.S. When Black Sun needed funding to complete development of CyberGate, a three-dimensional browser program for the World Wide Web, Boston-based CMGVentures ponied up $4 million in venture capital. Ira Machefsky, Internet-industry analyst for Giga Information Group in Santa Clara, Calif., calls Black Sun the "leader in its area."

The new companies--building products for everything from phone-billing to 3-D graphics--hope to match the phenomenal success of Germany's SAP and Baan, based in the Netherlands. These companies are the world leaders in software that integrates computer systems across large corporations. SAP has become the world's fifth-largest software company, with revenues of $1.8 billion last year. Baan should see sales jump 62.3%, to $350 million, this year--some $80 million of it from U.S.-based customers such as Boeing Co. and Ford Motor Co.

In France, startups are challenging Steven P. Jobs's NeXT Computer Inc. in object-oriented programming. Britain excels in 3-D graphics, used in computer games, scientific modeling, and virtual-reality applications. Popular games such as Mortal Kombat and Donkey Kong Country got their starts in British boutiques that have been acquired by U.S. and Japanese software companies. "We're seeing some very strong companies with fresh ideas coming out of Europe," says Thierry Costa, international program manager at Hewlett-Packard Co.

Suddenly, the conditions look right for Europe's software startups to prosper. The influx of foreign capital is a key factor. The emergence of networked computing and the rise of the Internet also help. They have created demand for new types of software and have lowered the barriers to entering the software business. On the Net, for instance, you don't have to get shelf space in software stores. So garage-shop entrepreneurs can get hot products to market--whether they're in Bordeaux or Silicon Valley. "The chances of finding the next Netscape in Europe are just as high as in Boston or Cupertino," says Cristina M. Morgan, managing director at Hambrecht & Quist in San Francisco.

"BLEEDING EDGE." The Net also gives fledgling companies a quick way to gather up-to-the-minute market intelligence. Before Black Sun launched CyberGate in February, 1996, founders spent weeks on the Net figuring out what rivals were doing, to make sure their technology was "bleeding edge." Says Cowen & Co. analyst Brian Skiba in Boston: "Barriers to innovation around the globe are falling."

The upstarts aren't big enough to alter the pecking order in most areas of software--yet. American companies still supply three-quarters of the $100 billion packaged-software market. Europe-based companies make up about 18%, according to International Data Corp. (IDC) in Framingham, Mass. With thousands of new software companies, though, "Europe will slowly start to gain market share," predicts Anthony Picardi, IDC's group vice-president for worldwide software.

Granted, an earlier crop of European software companies that showed promise never delivered. Many of the startups of the 1980s starved from a lack of funding or were snapped up by larger American and Japanese companies. The lucky ones became national or regional players, but they rarely developed the critical mass, marketing talent, or gumption to tackle the U.S. market. This time, the companies are getting money and managerial tips from U.S. venture backers, and they're much more aggressive about jumping into the U.S. market. They're also picking promising niches.

Take telecommunications, for example. Germany's LHS Communications Systems is winning big deals with U.S. carriers for innovative billing products. LHS--backed with $10 million in venture capital from General Atlantic Partners, based in Greenwich, Conn.--got a head start in advanced billing because the Europe-spanning GSM digital cellular standard created a broad market for new billing systems. Now, LHS has pushed into the U.S. with contracts from BellSouth Corp. and Pacific Bell Mobile Services, a subsidiary of Pacific Telesis. The $56 million startup is looking at $15 million in U.S. sales this year--a fivefold increase over 1995.

FRENCH SPECIALTY. Pacific Bell chose LHS software because it was first to deliver "real-time" billing capability. Current industry practice is to calculate the billing for calls on a monthly basis. That's not good enough if, say, a rental-car company wants to include cellular-phone charges in the bill when the car is returned. The runner-up system, from a U.S. company, "would have taken 6 to 12 months to match LHS," says Hamid Alipour, Pacific Bell's billing-systems director.

Another hot niche is object-oriented software, a specialty of French programmers. Paris-based Business Objects became the hottest tech stock offering of 1994 on NASDAQ when its market capitalization soared to $225 million on the end of the first day of trading. The company, whose products help locate and analyze information in databases, saw sales double, to $60.6 million, last year. Profits soared 239%, to $8 million. Its stock is trading near $100, up from $17.50 at the initial public offering.

All told, 10 European software companies have gone public on NASDAQ since 1992, raising $665 million. One of the biggest hits was Baan, which started trading at 16 in 1995. Before the IPO, venture capitalist Bill Grabe at General Atlantic paid $21 million for a chunk of Baan that is now worth $400 million. There are a half-dozen companies now ready to follow Baan into the public market and more in the pipeline. "Baan and Business Objects are just the tip of the iceberg," says Gartner Group's Helmut Gumbel.

One after another, U.S. technology investors have been piling into Europe. In February, Hambrecht & Quist hosted its first conference on European growth companies; half of the 40 companies presented were software startups. Cowen sponsored a similar conference in April, featuring a dozen more software debutantes.

Price is a big attraction for U.S. investors. Early-stage investments in European software companies are still relatively inexpensive compared with those of their U.S. counterparts. A runup has lifted the valuation of U.S. software companies sky-high for early-stage investors. By contrast, the supply of potential investors in European companies is still smaller than in the U.S., so European startups cannot command the same kind of pre-IPO valuations their U.S. counterparts can. Bernard Liautaud, co-founder and CEO of Business Objects, for example, fought for weeks with Paribas European Investment in August, 1990, over the valuation of the company, settling for a sum well below what he might have received in Silicon Valley from venture investors. When the company was introduced on NASDAQ in September, 1994, investors immediately bid up the price from $17.50 to $29.50. The offering was oversubscribed 20 times.

In addition to their new American friends, European software makers have other advantages. European software engineers have always been strong in complex systems management programs and in manufacturing software. More important, software makers have always been quick to adapt such products to the global market because their home markets are so small.

SAP, for instance grabbed the attention of multinationals by creating products that linked worldwide operations. Its R-2 package was the first that could automatically adjust for differences in tax and accounting rules around the world. "A minute after midnight at the end of a quarter, you hit one keystroke and consolidate for the whole quarter," says John R. Luongo, CEO of Vantive Corp. in Santa Clara, a leader in customer-service software.

GETTING BIG BREAKS. Europe's software industry has also gotten a lift from the emergence of global standards in the information-technology industry. The ascent of Baan, a powerhouse in complex software used by large manufacturers, is a case in point. Its fortunes grew rapidly during the 1980s in Europe because it excelled in so-called open systems that help enterprises link their databases. That paved the way for its big break--a $20 million contract from Boeing in June, 1994. Now, U.S. sales make up 34% of its total revenues.

Contracts with big U.S. customers can give startups a quick boost. France's ILOG made its mark in design software when Chrysler Corp. decided to use its program. Now, Chrysler design engineers use ILOG's tools to simulate the seat height, dashboard, and door layout of a car before they commit to a final concept. Says Chrysler design engineer John Mrozowski: "We can paper the wall with 10 or 15 iterations of a particular design, whereas before we had to choose between one or two." Last month, Sun Microsystems Inc.'s software subsidiary, SunSoft, chose ILOG to help develop a bridge between Sun's popular Java language and the widely used programming language C++.

London-based Superscape already has racked up an impressive list of multinational customers, including Northern Telecom, Southwestern Bell, Electronic Data Systems, and Motorola. The last is adopting Superscape's software to build virtual assembly lines for training purposes. Motorola executives say they are particularly happy about the startup's eagerness to please. When the company wants to add new levels of complexity to the lines, Superscape goes back to the drawing board and redesigns the program. Says Sanjiv Patel, Motorola's manager of advanced manufacturing technology: "They've given us tremendous support."

SHOPPING SPREE. Increasingly, U.S.-based technology giants are shopping in Europe for bits and pieces of software. Microsoft Corp., for example, has been on a European shopping spree. In October, 1994, it bought a British company, NextBase, for its computerized road atlas. Four months later, it snapped up another British outfit, RenderMorphics, and built its 3-D graphics into Windows 95 so users could enjoy more exciting games. Last July, Microsoft acquired a network-management system from Britain's Network Managers Ltd. and will integrate the technology into its BackOffice software. And Microsoft also relied on France's Nat Systems to co-develop programming languages sold under the names Quick Pascal and Quick C++.

The acquisitions by Microsoft and other blue-chip U.S. software makers in Europe speak volumes about the quality and creativity of European software developers. So does the commitment from America's leading venture capitalists. Just a few years ago, smart money would have bet against any European software company with global ambitions. Now, the first group of winners already has beaten the odds. It may not be long before Europe serves up its next software surprise.