Not so long ago, Oracle ( ORCL) CEO Larry Ellison dismissed smaller competitors, the so-called "best of breed" software companies that do just one thing but do it really well. "Best of breed only works at dog shows," he quipped imperiously. When asked about his remark six months later, the usually combative billionaire said simply: "I was wrong." Better "plumbing" and a savvy new generation of application makers have given new life to the specialized, independent software vendor, he said. To be sure, the admission was self-serving. After all, Ellison made it on the witness stand last week during the trial of the government's antitrust lawsuit. The government is trying to block Oracle's takeover of rival software maker PeopleSoft ( PSFT), claiming it will stifle competition at the highest end of the software market, leading to higher prices and a slowing of innovation. Oracle's major defense is that there's more than enough competition now -- and likely in the future -- to keep the market lively. With the first phase of the trial now concluded -- a verdict isn't expected until August or September -- Ellison's point is well worth noting, no matter what his motives. The steady march of industry consolidation hasn't stopped, but technological change and the mind-numbing complexities of running the information systems of major businesses mean there's still room for a plethora of smaller players. Sheryl Kingstone, a veteran software analyst at the Yankee Group in Boston, has been writing about the trend toward consolidation for years. Now she finds herself contradicting some of her earlier work. "The world isn't always so simple. There are contradictory trends we have to think about," she said.
That search for simplicity has fed the trend toward consolidation. In the last few years, dozens of smaller software companies have disappeared, their applications either made obsolete by technological change or swallowed by competitors seeking economies of scale, better technology or a larger customer base. But like it or not, "the real world is very complicated and fundamentally heterogeneous. All the mergers in the world aren't going to change that," said Rob Tholemeier, a long-time software consultant and industry analyst. Critical corporate data are still stored in databases and applications from a wide variety of vendors. Throwing it all out is not an option, so business intelligence companies that can help them use that data have a future, as do companies that help make the panoply of applications work together, say Tholmeier and other analysts. Some, of course, could be a good fit for an Oracle or SAP ( SAP). Others, like Mercury Interactive ( MERQ), can only survive outside the orbit of the big players, because no one would buy their critical application management services from a competitor. A peek at Oracle's shopping list,
revealed midway through the trial, is instructive. Not only does it contain application vendors like PeopleSoft and Lawson Software ( LWSN), it includes BEA Systems ( BEAS), which provides critical pieces of infrastructure and tools to tie applications together, and Business Objects ( BOBJ), whose tools allow workers to find and use critical corporate data without programming help from the IT department. It's tempting for investors to look at that list and buy accordingly. But that can be a mistake, said Aziz Hamzaogullari, a senior analyst at the Evergreen Technology fund. "We never say 'we'll buy it because it may be a target;' we ask ourselves if we want to own it." Hamzaogullari noted that rumors about companies being takeover targets can float around for years. By the time IBM ( IBM) acquired Informix, for instance, the once high flyer was sold at a bargain basement price, he said.
Also, since Ellison and company drew up their shopping list in April of 2003, valuations have soared. "I find it amusing that the market gets so excited about acquisitions Oracle and Microsoft ( MSFT)
which considered buying SAP last year might have made 14 months ago," said Richard Williams, an analyst at Garban Institutional Equities, the equities research arm of London-based Garban-Intercapital. Lawson, for example, is now trading at a forward price-to-earnings ratio of 48.6, while the S&P 500 is trading at just 19.2. "If they really wanted to buy, they would have done it a year ago," he said. Meanwhile, the industry has evolved as well. Microsoft has gone into the antivirus and firewall businesses, once the nearly unchallenged realm of independent vendors. That spells trouble for Symantec ( SYMC), McAfee ( MFE) (the former Network Associates), Check Point Software ( CHKP) and others. And then there's Web services. Once little more than a Silicon Valley buzzword, Web services is now a small, but increasingly important part of software designed by numerous companies, including Microsoft, BEA Systems, IBM, and Sun Microsystems ( SUNW). Simply put, Web services enable applications to communicate with each other via the Internet and automatically complete tasks ranging from simple consumer purchases to complex supply chain operations. Ellison said Web services make it easier to glue best-of-breed products together, giving them a new life. Web services, he said, are bringing about "a radical change," for the industry. But none of those changes will end the pressure within the software industry to consolidate. Growth has slowed, and "the big players are generating cash in excess of what they can deploy in their core business," said Evergreen's Hamzaogullari. Customers are tired of the unending complications caused by incompatible applications and the annoyance of having to guess which vendor is actually responsible for a problem.
And if the Oracle trial showed nothing else, it proved that once a major player makes an acquisition, its largest competitors feel compelled to respond. Oracle didn't get really serious about buying PeopleSoft until PeopleSoft announced its acquisition of J.D. Edwards. That, in turn, prompted Microsoft to enter ultimately unsuccessful merger talks with SAP, and forced IBM to consider buying France-based Dassault Systemes or taking a stake in other unnamed software companies to block them from being purchased by someone else. According to Ellison, M&A has become a matter of life and death: "We thought the only way we could survive and prosper was through an acquisition strategy," he said on the witness stand. The ultimate outcome is far from clear, but the Oracle-DOJ trial to date has already demonstrated one thing for certain: Like it or not, the software industry isn't getting any simpler.