Consolidation in the Software Industry is Hardly New: Obsess About It or Risk Losing it All
Some analysts credit [Larry] Ellison with anticipating the consolidation in the enterprise software industry and leading the charge. Ellison 'called a major shift in an entire market, which was impressive.'(1)
Anticipating consolidation? Calling a major shift? Didn't Microsoft start as a PC operating system vendor in 1975? In the eighties they owned the desktop, today they're across the enterprise. Computer Associates began with a sort program in 1976. Now its product suite offers one-stop shopping for managing the enterprise. And in 1973 SAP was selling an accounting package in Germany. Today its software automates the global enterprise from the shop floor to order fulfillment. Isn't predicting consolidation in the software industry about as prescient as predicting that the sun is going to rise in the morning?
Consolidation is common in many industries, but three factors make the phenomenon of consolidation in the software industries, (FN 2) an ongoing repeatable event. The first factor is the natural evolution of software products and industries. New software industries start by delivering solutions to niche markets. This is, however, only the evolutionary starting point. Every industry has finite growth, and niche opportunities reach their limit quickly. Once the confines are actualized, a company, to continue growing, must expand their product's capabilities by reaching into another industry to consolidate/converge additional functionality.
The second factor is software to software interconnectivity. Interconnectivity makes it so simple to converge products from one software industry to the next, it encourages consolidation. Open systems, service oriented architectures, programming interfaces and programming languages were created to facilitate the interconnection of diverse software products, making the process of expanding growth-promising functionality by consolidating products relatively simple.
The third factor: high-margin products and receptive investors, makes other industries envious of software. Margins often create huge war chests, and aggressive investors can create bank vaults that offer ready financing for acquisition-led consolidation strategies that promise opportunities for growth. Consolidation, though, is not always accomplished via acquisition. New capabilities can be built internally. The problem with this approach is that most companies find building paths into new industries difficult. It does require research, resources and focused execution. It also takes time. Many companies, failing to embrace that software lifecycles are time-compressed by intense competition and advances in technology, are caught off-guard by how quickly their industry becomes saturated.
Then there is the problem of competition for internal resources. Software companies are faced with non-stop feedback from demanding customers that have an unquenchable thirst for simplifying the complexities of information technology. And all of us know that the squeaky wheel gets the grease. This variety of challenges leaves companies without sufficient time to "build" a path, making the buy option very attractive. Buying though, is attractive in its own right because it delivers instant gratification and one-upmanship. Of course, well-heeled competitors in an effort to close the competitive gap can take the similarly expeditious buy route and the process of industry consolidation is now on a fast track.
Natural evolution, interconnectivity, available financing, and customer and competitive pressures have been fueling software consolidation for decades and there is no end in sight. Its an ongoing scenario of kill or be killed. Software companies that don't keep a current strategy for consolidating or being consolidated face extinction.
The machination of consolidation in the software industries plays out like an ongoing game of little fish, big fish. And somewhere there's always a hungrier bigger fish (or one that wants to be bigger), who is a looming consolidator. As an industry competitor in the ongoing game of consolidation there are four possible roles that can be played: consolidatee or little fish, consolidator or big fish, niche player or puffer fish (a fish with limited appeal), and odd-man out or the floating dead fish. Companies responsibly playing any of the first three roles will select viable competitive positions for their respective roles; the fourth, and the most commonly played role of the dead fish does not.
The selection, though, of a viable competitive position is not a solitary event; it is something that has to be continuously updated as an industry progresses through its lifecycle. This is because both the nature of an industry and the practicality of any competitive position are continually changing. In the introductory phase of an industry's lifecycle there could be a thousand viable positions. By the time the mature phase rolls around, (1) the number of viable positions will be amalgamated into a few based on superior functionality, price or markets served, and (2) an industry once focused on solving problem X is now resolving A through X.
This implies that the path from the introductory to the mature phase will be strewn with carnage, but there will also be some long-term healthy niche survivors and some big winners. The prospects for being victorious will be greatly improved with an understanding of the relationships between lifecycle phases, competitive positioning and consolidation.
An industry's introductory phase. In the introductory phase, an industry's early entrants lead a life of competitive luxury. Competitors are few and far between, small in size and often unsophisticated business-wise. The customers are the early-adopter types who have few expectations beyond some rudimentary solution. This leads to a situation where there can be many probable (a subset of possible) competitive positions satisfying niche needs, most of which are too small to represent viable business models. See Figure 1. (Figures did not copy correctly. Go to sandpiperinnovationpartners.com and select the articles page to download a copy of this article with figures.)
The various positions in the introductory phase may be more or less "equal" at this point, but this equality does not pertain to future value. Some positions will be:
(1) more appealing to consolidatees because they cater to the likely interests of future consolidators;
(2) better for building a path of continuous growth that could lead to a superior exit opportunity or a dominant competitive position and to assuming the role of a future consolidator; or
(3) superior for building a lasting profitable niche position.
In order to understand which competitive positions are best suited to achieving any one of these three outcomes, it's necessary to identify who the future consolidators are likely to be along with their probable motivations. The future consolidators (FC) will come from two sources: (1) current and (2) prospective competitors (PCs).
Deciding which of the current competitors are candidates for FCs may not be easy because the companies in the introductory phase are often small with limited budgets and resources. However, those companies who are led by industry experienced managers with vision, who have gained early market and technology leadership, and who have sufficient access to funds are reasonable bets. The PCs, on the other hand, may be easier to spot. They're established companies who view participating in this industry as strategically sensible, under one condition-the goodness of the industry's opportunity must be validated. Until validation occurs PCs sit on the sidelines actively or passively tracking an industry's prospects.
Once the future consolidators have been identified, the next step is to decide which positions these companies are likely to stake out. Once this has been thoughtfully estimated in a process that requires analyzing each FC's possible or known product and market strategies, the information is available for the current competitors to plan the positions of their products to be an attractive consolidatee, a durable niche player targeting a position the consolidators will probably shun, or a future consolidator who now has a fair idea of how to build a defensible position.
An industry's early growth phase. In the early growth phase life takes on a decidedly different flavor. With the industry past its validation phase, the smell of money brings competitors out of the woodwork. One of the most formidable groups are the prospective competitors, many who are now prepared to shed their prospective qualifier and make a grand entrance by acquiring a suitable competitor. PCs often have complementary products, deep pockets, big customer bases, established channels, professional service organizations, and recognized brands. Armed with these advantages, these latecomers will substantively raise the competitive bar. This process of elevating the threshold may lead to redefining the industry and will redefine what constitutes a viable competitive position (See Figure 2), and it will alter the profile of the target customer. Gone are the days when customers were few in number and happy to pay a premium for a little piece of desirable functionality. Instead, customers are increasingly numerous, and demanding more functionality. All of the changes lay the groundwork for the first wave of consolidation.
All competitors, at this point, must re-evaluate the viability and strength of their current competitive positions relative to all other competitors, including any still looming PCs, in order to assess the goodness of their situation within the modified population of role-appropriate viable competitive positions. This updated appraisal should be used to strengthen or revise a competitor's competitive position relative to their designated role. This is achieved by reinforcing the company's product strategy on some element of functionality or price, and/or fortifying or augmenting markets served
Shakeout - the later growth phase. During the latter part of the growth phase competition for the growing number of increasingly demanding customers can become so intense that no one's making money. This ignites a survival of the fittest shakeout, where the competitive bar is raised still higher. The fittest will have the strongest competitive positions on functionality and/or price and/or markets served. They'll also have the financial resources to defend their positions against competitors aggressively pricing products without regard to cost, and interlopers with crafty marketing messages and costly campaigns that dupe customer into thinking that they have the superior position.
Consolidators are now working in overdrive to secure their place as a competitor with a dominant industry position. This means that consolidatees must be working overtime to see the fruition of their objective to be consolidated. Failure to do so could turn a little fish into a floating dead fish, because the consolidatee's solution is now priced uncompetitively and/or available as a feature of a product holding a functionally superior position.
To the survivors, go the riches. Companies that survive the shakeout will hold clearly different positions (See Figure 3), that offer a promise for profitability, and they will enjoy a respite in ruthless price competition and costly hand-to-hand combat for customers. This though should not be viewed as an invitation to become complacent for two consequential reasons. First, the survivors, in anticipation of the inevitable flattening of growth that accompanies an industry's mature phase, will need to be working diligently to determine the company's next new product/industry in order to ensure continued growth. Second, survivors must support their positions against onlookers looking for openings that arise from arrogance or apathy and the actions of other survivors who will soon become frustrated by the leveling of growth and view one final round of consolidation as a means to buy revenue. Beware. Consolidation in this case is not a strategy for sustaining growth. You can consolidate mature A and B, but in the end you have mature AB, because the size of the world is constant. You can ask HP's former CEO, Carly Fiorina, about the limits of consolidation as a growth strategy.
Conclusion. Only companies that can continually stake-out and restake-out competitive positions that are valued by the inevitable consolidators, or create and reinforce the position of consolidator, or target profitable niche markets will survive. You can't avoid the underlying theme of consolidation that is constantly at work as software executives aggressively endeavor to execute strategies to secure an ongoing healthy existence, best the competition and deliver growth that will endear them to their shareholders.
1 Pimental, B. (May 6, 2005) San Francisco Chronicle.
2 The definition of an industry, as used here, is an adaptation from Michael Porter (Competitive Advantage, 1980, The Free Press, NY). It is the sum total of all companies offering products that solve a similar customer need (the direct and indirect competitors) and all other companies that exert influential forces on the success of the competitors. Defined in this way it is easy to see how the umbrella software industry is composed of many distinct software industries, and why search engine software does not compete with computer aided design software.
© 2005 Kathleen Brush, Sandpiperinnovationgroup.com
Kathleen Brush is a turnaround and strategy consultant with Sandpiperinnovationgroup.com
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