Suddenly, A Mushy Software Market

Corporate buyers aren't buying. Some fear that spells trouble for other tech sectors

June E. Drewry typifies today's frugal tech buyer. Drewry, the chief information officer at AON Corp. (AOC ), must make sure the Chicago insurance brokerage has the software it needs to stay ahead of rivals. But she figures she can do the job just fine without hiking her software budget. Besides, she says, "there's nothing new out there that is the latest and greatest answer to your prayers."

Drewry's ambivalence goes a long way toward explaining the woes suddenly afflicting the $200 billion corporate software industry. This month, more than 20 companies, from Siebel Systems (SEBL ) and Veritas Software (VRTS ) to Computer Associates International (CA ), have stunned investors with warnings that second-quarter sales and earnings will fall far short of expectations. Only Germany's SAP (SAP ), which reported a 15% hike in software license revenues, seems to have escaped the storm, thanks to its size and to CEO Henning Kagermann's strategy of diversifying its product lineup.

The bloodbath is prompting worries that the industry's brief, two-quarter rebound has already fizzled. Companies like Siebel Systems Inc. and PeopleSoft Inc. had started to benefit as companies started to boost spending for the first time since 2001. But just as quickly as many projects started up, they were shut down or delayed in the second quarter. Market researcher Gartner Inc., which once forecast 5% sales growth for 2004, now expects just 3%. Buyers cite a variety of reasons, ranging from rising costs to worries that the economy is losing steam. "We can always go slower on a project," says Dan Barth, chief information officer of Oklahoma Publishing Co. "It's nice for us, but unfortunate for [software makers]."

And it's not just software makers. Some are starting to fear the entire tech industry could be headed for another bust. After all, on July 13, industry bellwether Intel Corp. (INTC ) jangled nerves when it said inventories grew 15% in the second quarter after an 11% increase in the quarter before. What's more, if companies are buying less software, they probably don't need more PCs or servers.

But the corporate software market has problems that aren't likely to spread to other parts of tech. For starters, the industry is overcrowded -- something one can't say for PC makers, which consolidated in the 1990s. There are still hundreds of software outfits vying for corporate dollars. And corporations that once bought from a laundry list of suppliers are limiting their spending to a handful. "It's costly to support multiple products," says Phil Zwieg, vice-president of the Society for Information Management. As a result, Gartner analysts expect as many as half of today's software companies to disappear within two years. The winners are likely to be big companies with diverse software portfolios, including SAP, Microsoft (MSFT ), Oracle (ORC ), and IBM. Proof is in the numbers: along with SAP, which is garnering an ever bigger share of the software pie, Oracle Corp. is reporting strong sales. On July 14, it expressed optimism about the second half of the year, and said it expected revenues in its current fiscal quarter to increase 6% to 9% from a year ago.

Perhaps the strongest sign that the weakness will continue is the disturbing falloff in license revenues reported by several companies. At PeopleSoft and Siebel, they fell an estimated 9% and 16%, respectively. License revenues are a good indicator of both customer interest and long-term prospects. Even when companies are still spending, they're looking for cheaper options like open-source ware, sold by few traditional software makers.

Will corporate spending pick up again? "It's never going to be like it was," says Jean Balgrosky, CIO at San Diego-based Scripps Health. That's good news for a handful of companies, but a sign for most that Darwinian forces are about to sweep the sector.

By Jim Kerstetter in San Mateo, Calif., with Roger O. Crockett in Chicago, Ben Elgin in San Mateo, and Andrew Park

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