COM B. Burton, J. Comport

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1 B. Burton, J. Comport Research Note 1 July 2003 Commentary Consolidation: A Reality That's Not Always Good for Users Oracle's bid for PeopleSoft again raises a debate on the pros and cons of market consolidation for end users and partners. The consolidation of the market for packaged applications is shifting power from users to vendors. As is the case with most IT markets, consolidation in the packaged enterprise application market is a natural part of market evolution. Although it has been forecast for some time, the abruptness of its arrival has been triggered by the duration of the current down business cycle. Enterprises adjusting to this consolidation will see changes in the vendors in the market, as well as in the ways these vendors go to market and negotiate with their customers. The background and specific outcomes described here will help you understand these changes and use them to your advantage. Economic competition is based on Darwinian, survival-of-the-fittest forces. Innovation will only be rewarded if it enhances economic success. Superfluous innovation can quickly lead to extinction. Growing markets allow experimentation; however, slowing markets return competitors to the cold reality of price. Competing on price forces providers to examine efficiency and scale as ways to drive down average production costs. The shift toward price sensitivity and efficiency forces less-efficient providers from the market this process is known as market consolidation. IT markets have become accustomed to the consolidation that comes with market maturity. If you look at almost any IT market for example, the database management system (DBMS), networking, operating system or server areas you'll notice an inevitable consolidation that maps to the evolution and maturity of the market (see Figure 1). Gartner 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 Market Size Figure 1 Classical Market Ogive Variant High Growth Embryonic Emerging Maturity Decline Source: Gartner Research (1995) Consolidation Time Multiple markets of enterprise applications, including human capital management, supply chain management, enterprise resource planning and customer relationship management, are moving into the consolidation phase. The most recent examples of this trend toward market consolidation, the proposed acquisitions of J.D. Edwards by PeopleSoft and PeopleSoft by Oracle, have emphasized the cost benefits of scale over revenue synergy as the economic justification for these deals. Economies of scale imply that, as size increases, more products and services can be delivered at a lower average cost. For example, more customers can be served with proportionately fewer resources by a larger company than by a smaller one. Therefore, scale can become a barrier to entry into a market. This squeezes out the smaller players and prevents new entrants from gaining a foothold. Markets that consolidate are unlikely to cycle back through innovative growth phases, and innovation is more likely to start in newer, adjacent markets. For enterprise applications, these adjacent markets are likely to be centered around business services (with their more-transparent, underlying service-oriented technologies) and enterprise-enterprise collaboration enablement. For enterprise applications, the consolidation of the market that has now begun is being accelerated by users' recognition of the unique nature of these products and services. Unlike durable goods, which have established capabilities that are sustained over their lifetimes, packaged applications have initial sets of features and an expectation for a stream of enhanced functions and technology that will be provided as the applications mature. As market consolidation begins, enterprises' judgments about the future capabilities of vendors and products will shift from an assessment of their future innovation capability to an evaluation of their future viability. This is because promised innovation means nothing if the vendor isn't around to deliver it. This shift in evaluation weighting will accelerate the consolidation process. Ironically, in such a market, the enterprises end up being partially responsible for limiting the number of product choices that are available to them. Although the downward price pressure of oversupply begins the market consolidation, the power shifts from the users to the vendors as the number of vendors falls. While it does, the cost savings from scale 1 July

3 begin to increase vendors' profits, rather than increasing enterprises' price savings. Such shifts in market dynamics have both positive and negative outcomes for enterprises in consolidated markets. The Benefits of Market Consolidation In services, software and hardware, there are several customer and partner benefits to market consolidation: More-complete and, ideally, more-integrated offerings from a single vendor Fewer viability risks Increased security/vendor viability, broader service and support infrastructures, and deeper regional and vertical market offerings Reductions in training, support and application management costs, because of the presence of fewer deployed technology and product varieties For technology partners, fewer vendors for which they must provide integration or platform support For service partners, fewer technologies on which they need to retain expertise and methodologies Although acquisitions are often made with the promise and potential of these benefits, most mergers and acquisitions face challenges in actually delivering on these benefits. Specifically, many vendors find it difficult to execute on the majority of their product integration goals. The Challenges of Market Consolidation There are also challenges associated with market consolidation that affect customers and partners: The Risk of "Legacy" Status: One of the most-immediate challenges faced in a market consolidation is the possibility that current products can become legacy applications in the strategic planning of the acquiring vendor. Much of this status is driven by the motivation of the acquiring company. If a vendor makes an acquisition to complement its current strategic product offerings one example is Microsoft's acquisition of Great Plains Software the acquired product can increase in strategic importance and market visibility. In this case, product migration is unlikely to be required. However, in two scenarios, migration is more likely to be required: If a vendor makes an acquisition to supplement its strategic product offering with additional technologies or features such as IBM's acquisition of Sequent Computer Systems the acquired technology may exist for a period of time, but it will eventually be migrated into or subsumed by the core strategic product line. If a vendor is making an acquisition that is aimed primarily at increasing its market share or ongoing maintenance revenue as is the case with Oracle and PeopleSoft or Computer Associates and Sterling Software the acquired product will often be maintained for a period of time (see "What PeopleSoft Customers Can Expect if Oracle Succeeds"). However, enterprises will eventually feel pressured to migrate to other products as a result of increased support costs, decreased levels of support, or the lack of new and competitive features. In addition to additional product purchases resulting from migration, you will need to budget for additional staffing, training, implementation, deployment and maintenance costs. In the above two cases, the vendor's motivation for the acquisition and the type of technology being acquired will drive whether, how and when a product migration will be necessary. 1 July

4 Advice to Users: It's important to understand the motivation behind a vendor acquisition and to look for opportunities to use this motivation to your advantage to reduce migration costs, if migration is deemed to be the best course of action. Advice to Vendor Partners: You need to understand the strategic road map of your key partner vendors and to continually reassess your cooperative vs. competitive position with these partners. This is particularly true for smaller vendors partnering with megavendors. Fewer Vendors, Fewer Choices: With market consolidation, the number of technology, product and service options decreases. Generally, the remaining larger vendors try to provide a broad product offering to entice enterprises into a complete environment (such as a suite, software stack or hardware options). This limits and controls the choices for add-on products or services and accompanying revenue. With most suite or bundled product offerings, there are core functions and secondary functionality; with suites, not all functionality is equally deeply developed or supported. Vendors further look to expand account control through add-on products and related infrastructure stack tie-in (see "Megavendors Will 'Handcuff' Your Enterprise Architecture"). As the number of vendors decreases, and vendors' ability to use control in one market to influence competition in adjacent markets increases, regulators become increasingly interested in monitoring the degree of control allowable by a single provider. Advice to Users: You need to understand when you're becoming locked into a specific vendor's enterprise architecture and to evaluate the cost/benefit aspects of such a dependency. Advice to Vendor Partners: Vendor partners of megavendors need to remain vigilant and to gain an understanding about when they are competing with their larger partners. Smaller, best-of-breed vendors should look for complementary opportunities in which a merger would provide a higher return on shareholder value. Limited Negotiation Leverage: With fewer vendors, enterprises' ability to use competing vendor offers as leverage points during product or service negotiations decreases. This is especially true for packaged application maintenance services, where the high cost to users of switch packages translates into a high degree of vendor control over maintenance prices and service-level agreements (SLAs). In some markets (such as those for DBMSs, operating systems and development tools), Gartner encourages enterprises to support competitive products, even if this means more demands from the IT support and development teams, because this will result in more negotiation leverage with key vendors. In the business applications market, this is more difficult, because most organizations do not want or need multiple enterprise applications. However, when there is overlap from line-of-business applications or from acquired companies, the effect on negotiating leverage can be a consideration in setting the pace of consolidation to a single megavendor. Advice to Users: You should focus on leveraging competitive tension to your negotiation advantage. To ensure aggressive competition, enterprise business application users should plan to bring multiple vendors to the negotiation table during evaluations. Advice to Vendor Partners: You should generally plan to support multiple competitive partnerships. Although one vendor may be preferable to another, the ability to support different options provides a safety net for shifting to another environment if competition increases with one vendor partner. 1 July

5 Reduced Downward Pressure on Prices: As a market consolidates, it becomes more difficult for customers to negotiate for aggressive pricing. Gartner has found that pricing typically becomes fairly stable in such a market, and downward pricing pressures are reduced. During this period, we often find customers beginning to explore "build" as an option for specialized functionality, rather than abdicating the responsibility for this task in favor of a vendor. This price stability generally remains until a product or service is viewed as a commodity, at which point an aggressive commodity-based (or open-source) vendor enters the market and begins to apply downward pricing pressure on the commodity market. One example of this is Dell Computer in the midtier server market. Advice to Users: You need to constantly monitor the current market value and discount levels for products, because commoditization can result in dramatic price reductions. It is important to use competitors to negotiate pricing. Advice to Vendor Partners: You should proactively try to understand pricing changes before they happen. In addition, you should always be prepared to react with a defensive pricing strategy or with an offset product strategy in the case of a commoditization pricing scenario. The Creation of a Vendor-Controlled Market: In addition to losing some pricing and negotiation leverage, with limited competitive options, customers in a converged market are more affected by the plans of the larger vendors with respect to service offerings, migration, support, upgrade and end-of-life strategies. Advice to Users: You need to take an advocacy role with respect to your vendors ("Seven Ways to Keep Your Vendor In Check: Technology") This customer advocacy role may be a specific job function for large, strategic vendors. It's important to develop opportunities to use other advocacy means, including user groups, conferences and executive round tables, to ensure that your vendors consider you to be part of their strategic plans. Advice to Vendor Partners: As is the case with users, you should support advocates to manage major relationships. As part of this role, vendor advocates should promote the business and revenue impact that they have on partners. Although the direct benefits of this role are often difficult to quantify, revenuebased partnership justification will help keep your company on the "radar screen" of key partnerships. Increased Vendor Control of the Service Market: Slower license fee growth causes external service providers (ESPs) to become reluctant to commit resources to any but the largest products. Smaller vendors' credibility is further eroded by their inability to garner major ESP support. Economically, they must carry the burden of staffing their own teams at a time when utilization rates are falling. In addition, a consequence of reductions in license fees is a shift of service revenue away from implementations to less-profitable maintenance and upgrade projects. These projects are more product-focused (which is the strength of an application vendor's professional services) and provide less opportunity to bridge into lucrative business management services, which are an ESP strength. Independent, vendor-specific ESPs are pressured to consolidate, leaving major ESPs and independent software vendors (ISVs) as the primary forces in the services market. Advice to Users: Although service providers have less incentive to make concessions, you must aggressively negotiate project structure, SLAs, resource commitments and shared risk to complete successful projects. 1 July

6 Advice to Vendor Partners: Larger ESPs and ISVs may find opportunities for consolidation within the service markets related to consolidating product markets. In addition, ESPs will often find service opportunities in application migrations and continued support for legacy products. Bottom Line: As IT markets, such as the enterprise application markets, consolidate around fewer vendors, enterprises and vendors should expect a certain amount of disruption to their product portfolios, depending on the types and goals of the mergers and acquisitions. Enterprises and vendor partners need to be vigilant and to prepare for acquisitions and consolidations. To be in the safest position with respect to supporting a smaller independent vendor's products, you should build your strategies based on how those products complement or compete with those vendors best positioned to survive consolidation. In a consolidating market, the more these products compete, the more likely that migration will be necessary. 1 July