Software: Getting Its Groove Back

-- Sales of integration software will surge as corporations tie together old systems

-- Corporate buyers are centralizing their spending around a few big software vendors

Jack R. Corrie has a New Year's resolution that boils down to one word: Simplify. As division chief of information technology services for the giant California Public Employees' Retirement System, Corrie has tired of managing software from dozens of different suppliers. So he's trying to concentrate his purchases on database giant Oracle Corp. (ORCL )--pushing the cost of integrating the software out of his own budget and into Oracle's lap.

In some ways, this is like buying a car rather than the parts to build one. And it's thinking like Corrie's that is reshaping the software business, which is slowly emerging from two straight years of gloom. In 2003, analysts expect that sales of all types of software, from graphic art programs for PCs to huge financial systems for corporations, will return to a semblance of health. It won't be the double-digit growth people got used to in the late 1990s. But market researcher IDC Corp. now estimates that worldwide packaged software sales will increase 6.3% this year, to $194 billion.

Any growth would be a welcome change. The software industry grew less than 1%, to $182 billion, in 2002, according to the latest IDC estimates. And other than niches like security software and so-called business-intelligence software, which analyzes data, no sector did particularly well. The entire market for corporate software grew less than 1%, to $74.9 billion, according to Gartner Group.

Topping most chief information officers' wish lists this year: technology that helps older software programs work well together. "As you talk to CIOs, you hear they've accumulated an awful lot of technology over the last 12 years," says Rick Sherlund, managing director at Goldman, Sachs & Co. "Their top priority is still cost-cutting. After that, it's integrating it all together." Sales of integration software are expected to grow twice as fast as the rest of the market, to $8.96 billion this year, according to Gartner.

It'll be industry giants such as IBM (IBM ), Microsoft (MSFT ), Oracle, and, down a notch, BEA Systems (BEAS ) that benefit the most from increased interest in integration. IBM, for example, is already the top seller of such software. And the other three companies have, in the past year, added integration to their software menus. This is making things tough for smaller integration players such as Tibco Software Inc. (TIBX ) and Vitria Technology Inc. (VITR )

Analysts expect industry consolidation to accelerate in the coming year. IBM got the ball rolling on Dec. 6, when it announced plans to buy Rational Software Corp. (RATL ), a maker of software-development tools, for $2.1 billion in cash. Gartner predicts that by the end of 2004, half the software companies in business today will disappear, mostly through insolvency. "In the next year or two, we'll see an acute consolidation of companies," agrees Bob Austrian, an analyst at Banc of America Securities LLC.

Particularly hard hit will be small e-commerce companies--once presciently dismissed by Oracle CEO Lawrence J. Ellison as "features, not companies." BroadVision Inc. (BVSN ), for instance, is deeply troubled. Sales of e-commerce software are expected to drop 8%, to $1.2 billion, this year, down 45.6% from a $2.23 billion high two years ago, according to Gartner.

Winnowing the field is just fine with customers. Recent surveys of technology buyers show they want just a handful of suppliers. It simplifies the buying process, helps them eliminate expensive integration projects, and leads to volume discounts. Corrie of CalPERS believes consolidation is a sign the software industry is growing up. "It happened with the railroads, automobiles, telecommunications, and every other industry--and now we see it in the technology industry," he says. "That's not necessarily a bad thing."

In some specialized application areas, smaller companies will continue to thrive. Sales of security software, for example, are expected to continue their steady growth, up 11% this year, to $4.9 billion, according to Gartner. Sales of design and engineering software are expected to climb 9% this year, to $9.7 billion. And, after jumping 9% in 2002, sales of business-intelligence software will increase 8% this year, to $2.81 billion, according to Gartner.

In the long run, however, the number of viable niche software markets will keep shrinking. Three years ago, among the big software companies, only IBM sold integration software. Now they all do. "The definition of a defensible niche will keep moving as the larger software companies conclude that they can do that, too," says Craig Conway, CEO of PeopleSoft Inc. (PSFT ) Of course, he jokes, if security market leaders such as Symantec Corp. (SYMC ) were available for a few hundred million dollars, rather than a few billion, he would buy them in a heartbeat.

Across the larger landscape, Microsoft Corp.--the biggest of the bigs--will continue to dominate, with planned new releases of everything from its Office desktop productivity suite to a new corporate database. Analysts expect Microsoft revenues to increase 15%, to $32.6 billion, for the fiscal year that ends June 30, while operating income hits $14.4 billion, up 21%. Some things never change.

By Jim Kerstetter in San Mateo, Calif., with Jay Greene in Seattle

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