A Plague of Software on the Shelf

The glut is so severe--and budgets so slashed--that demand may pick up only slowly this year

Nothing bothers John J. Doucette more than wasted money. The chief information officer at United Technologies Corp. (UTX ), parent company to Otis Elevator and Pratt & Whitney, put his department on a diet 18 months ago. One of his biggest chores: reeling in excessive software contracts. In a matter of months, UTC had cut the number of extra software licenses it bought from back-office software maker SAP to 3,500, from 10,000. "All of us are trying to run our businesses much smarter, using more intellectual capital and fewer hard assets," says Doucette.

Uh-oh. Yet another headache to dampen prospects for a tech industry recovery? You bet. Industry pundits call this one "shelfware"-- unused disks and programs gathering dust on company shelves or lying dormant on hard drives. With the excess goods sitting in customers' laps, it's the flip side of the inventory woes that vexed hardware makers last year.

After being whipped into a buying frenzy by Y2K, fear of competition from the dot-coms, and aggressive discounts dangled by software vendors themselves, many customers now find they have way too much software. In fact, only half the corporate software purchased since 1998 is currently in use, according to AMR Research Inc. Moreover, the phenomenon is industry-wide, with big players like Oracle (ORCL ), SAP (SAP ), and Microsoft (MSFT ) among the vulnerable. Analysts say it could take a year on average for their customers to make use of that excess or write it off. "A lot of us were saying last year that the good news was there's no inventory problem in software," says Merrill Lynch analyst Steve Milunovich. "Turns out there is."

The excess could compound travails for software makers already grappling with customers' much tighter technology budgets. Sure, the Goldman Sachs Software Index ticked up 4% over two days as Oracle calmed fears on June 5th that it would issue a quarterly profit warning. But the index remains just 6% above its 52-week low. And after churning out double-digit growth rates for three straight years, the industry grew a mere 1.9%, to $81.1 billion, in 2001, according to Gartner Inc. Although this year's growth rate is expected to creep back up to 5.7%, that's still not much. Analysts worry that an abundance of software already in customers' hands could slow down purchases and further delay a strong recovery for the industry. On June 3, Lehman Brothers and UBS Warburg both lowered second- and third-quarter sales and earnings estimates for a swath of software makers.

To be sure, shelfware isn't a brand new problem. Programs have often ended up unused when companies change strategy or grow dissatisfied. But the shelfware burden has grown because of the flurry of software bought during the late 1990s and 2000.

Still, don't cry too hard for the software makers. Aggressive sales tactics--which include slashing prices on software that customers may not use for several quarters--are at the heart of the problem. By selling customers licenses for software they don't need, software makers get immediate revenue. But in the process, they sap future demand. A May 30 Merrill Lynch survey of corporate tech buyers found that one-third of those saddled with shelfware are reluctant to start buying again.

The impact is being felt throughout the industry. The percentage of corporations looking to buy enterprise-resource-planning software, which does everything from analyzing financial data to tracking orders, plunged to 20% this year, according to Forrester Research Inc. That's down from 51% in 2001. Equally hard-hit has been software that helps companies arrange and analyze data, often called OLAP (Online Analytical Processing) programs. As much as 60% of some vendors' products wind up as shelfware, according to market researcher The OLAP Report. "Shelfware is a reality," says Robert M. Dutkowsky, CEO of software maker J.D. Edwards & Co.

The budget constraints most companies now live under aren't helping either. In better times, customers might be replacing shelfware with new applications to boost their productivity, but now they can't afford to. And those that might have begun adding software in anticipation of future growth are finding that what they've got is more than enough as employees are laid off and new hires are postponed. "The average company has dropped 10% to 20% of its population, so there's probably 10% to 20% excess software capacity," says Forrester analyst Laurie M. Orlov. A glut like that could be enough to extend the software industry's hangover well into next year.

By Ben Elgin in San Mateo, Calif., with Jim Kerstetter in San Mateo and Diane Brady in New York

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