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By Edward Cone  |  Posted 12-01-2004

Get Ready For the Coming Software M&A Wave

 

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: Introduction"> Oracle Corp. may soon be able to buy PeopleSoft Inc., but it can't buy Alan Heger.

Heger, the chief information officer at Russ Berrie and Co., a $330 million maker of gifts and furnishings based in Oakland, N.J., plans to remain a PeopleSoft customer. Russ Berrie is going ahead with a long-planned upgrade to its PeopleSoft enterprise resource planning software, even as Oracle's dogged pursuit of its rival raises doubts about the future support and development of PeopleSoft products.

Yet whether Russ Berrie will end up as an Oracle customer in the long term is an open question. Heger is adamant that he, not the dueling vendors, will decide his company's software strategy, and that Russ Berrie management will not be passive in the face of market turmoil. "We will not be forced to convert to Oracle," he says. "We run our company the way we want to, and we find it disconcerting that other people would have a say in our investment."

Prepare to be disconcerted. Software deals are in the news these days—and not just the long-running Oracle-PeopleSoft saga. There's also this fall's much tidier $439 million purchase of security software vendor Netegrity Inc. by Computer Associates International Inc.; the disclosure that Microsoft Corp. and SAP AG have discussed merging; and acquisition chatter surrounding Novell Inc., BEA Systems Inc. and others. (At press time, Oracle, which in November announced its final bid at $24 per share, had won support for a buyout from a majority of PeopleSoft shareholders, but PeopleSoft was continuing to resist a sale; earlier this year, Oracle cleared a court challenge on antitrust grounds.)

Could these recent examples of takeover activity mark the onset of the "massive consolidation" in the software industry long predicted by Oracle CEO Larry Ellison? Perhaps. (See "Shrink Rap," page 34.) Many analysts have been expecting consolidation for years, as the software business matures like other industries before it. But even without a rush of acquisitions, the current pace of deal-making presents enterprise software customers with both good news and bad—and makes planning for those disconcerting events a critical part of the corporate technology executive's job.

"This is a front-of-mind issue," says Vicki Silvera, vice president of information technology at Vail Resorts Inc. The $722 million operator of ski resorts uses PeopleSoft products to run its business, while the software it uses to manage its properties has changed hands twice since Vail first deployed it. "[The consolidation] we have experienced in other sectors is now standard in the software industry, and now that has expanded to the ERP market," she says. "We as customers are forced to negotiate the outcome."

While Silvera is rooting for PeopleSoft to remain independent, she's not ruling out an ongoing relationship with Oracle. "Can I see myself as an Oracle customer two or three years down the road? Possibly," she says. "You have to evaluate the functionality they offer. If Oracle took things in a direction that didn't meet our needs, we would have to look for a replacement."

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: Stay Calm"> Stay Calm

To navigate a changing landscape, customers must think ahead to possible upheavals in the marketplace when they negotiate contracts with vendors, and as they design the underlying architecture for their enterprise systems. And when changes do catch them by surprise, they need to focus on their own operational plans, and not just react to the headlines. "The first rule is not to do anything in knee-jerk fashion—that's how you hurt yourself," says Jamie Lewis, chief executive of the Burton Group, a consulting firm that advises large companies on infrastructure technologies.

Remaining calm doesn't mean doing nothing. "Boys will be boys," says Dennis Callahan, executive vice president and CIO of $6.7 billion Guardian Life Insurance Co. of America, referring to the ego clash between Ellison and recently ousted PeopleSoft Chief Executive Craig Conway. Callahan sounds sanguine, but he isn't taking any chances: When he found himself caught in the software industry's biggest turf war to date, he quickly marked his own territory. The New York City-based company is an Oracle database customer as well as one of the first companies to sign on with PeopleSoft after Oracle announced its PeopleSoft takeover bid in 2003: The company will go live on PeopleSoft financials in early 2005. "Oracle can't afford to thumb its nose at its own installed base," he says.

Callahan reviewed the terms of his PeopleSoft contract and spoke extensively with Oracle and PeopleSoft executives as the takeover rhetoric fluctuated between scorched earth and sweet talk. "I will watch the situation closely, but I don't see a loss of support if Oracle wins," he says. "We'll be okay."

Other potential users have been scared off by takeover deals. "We've had clients considering PeopleSoft who have said, 'The hell with it, we'll go with SAP,' " says Michael Doane, a senior vice president at META Group Inc. One of the moves that undid Conway at PeopleSoft was his less-than-credible assertion that the uncertainty over the Oracle offer was having no impact on prospective buyers. And Burton's Lewis says he knows of one company, which he would not name, that pulled back on the deployment of Netegrity software after the CA announcement. "If you haven't deployed yet, that's the time to stop," says Lewis. "If you are just evaluating, or on the cusp of doing it, you can rethink. And you should rethink, even if you end up going ahead with the implementation. But if you are well into a project, or in production, yanking it can cause substantial damage."

10 Big Deals
The trend toward software industry consolidation may accelerate, but change has been a constant for enterprise software customers. Some big deals through the years:
ACQUIRERTARGETYEARVALUE
OraclePeopleSoftpending$9.2 billion
Computer AssociatesNetegrity2004$439 million
PeopleSoftJ.D. Edwards2003$1.8 billion
EMCLegato2003$1.3 billion
IBMRational2002$2.1 billion
MicrosoftGreat Plains2001$1.1 billion
IBMInformix (database unit)2001$1 billion
Siebel SystemsOpenSite2000$440 million
Computer AssociatesPlatinum1999$3.5 billion
IBMLotus1995$3.5 billion
source: CIO Insight

That's where Heger finds himself. He says upgrading with PeopleSoft makes sense in light of Russ Berrie's needs and its investment of time and money in the software. "We've gotten very much better over time at understanding the tools," he says. "And we need them." The upgrade will allow everyone at the company to work over the Internet, and better support Russ Berrie's distribution facilities, including locations in China and the U.K. "An upgrade is built into our return-on-investment plan," he says. "We don't want to wait a year and then find out that nothing happens with the acquisition."

For Heger, the proposed buyout is déjà vu all over again. Russ Berrie bought its ERP software from J.D. Edwards in 2002, shortly before J.D. Edwards was swallowed by PeopleSoft. The difference is that Heger was pleased with that deal, because he believed, correctly, that PeopleSoft would support the products it was buying. His future with Oracle depends on establishing that same kind of trust. "We want a partner with skin in the game," he says.

Ironically, Heger has now cycled through his original short list of vendors from top to bottom and then from bottom to top. "Our choice came down to J.D. Edwards, PeopleSoft and Oracle, in that order," he says. Now he may end up as a customer of each of them, without ever changing his software.

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: Be Prepared"> Be Prepared

The best time to prepare for a possible change in the ownership of your software vendor is before you buy the product. "If you plan ahead and anticipate contingencies, you are not dealing with disaster," says Guardian Life's Callahan. He likes the attractive terms he got from PeopleSoft, and he believes he's getting the best software for his purposes. "We were incented to make the deal, and we do believe that PeopleSoft has been preeminent in the insurance industry for good reason." But Callahan didn't leave the future to chance. Instead, he negotiated terms that he feels will protect Guardian no matter what happens to PeopleSoft. "We have terms and conditions in our contracts to deal with acquisitions," he says confidently. "The world changes, but obligations continue."

Guardian negotiates each technology deal separately, and that strategy has paid off in the past. For example, the company uses a system for administering its variable-annuity offerings that was developed by a small vendor that PeopleSoft had at one time considered adding to its application suite. When PeopleSoft decided not to market the product, Guardian was able to go ahead with its own implementation because of the terms won by Callahan. "We had the rights," he says.

Large companies have long used their clout when dealing with small vendors offering cutting-edge products. They may lack as much influence with more established software companies, which are less likely to guarantee something such as access to source code in the event of an acquisition or bankruptcy. But customers need to press for favorable terms, especially if the trend toward larger acquisitions emerges. "Get every right you can in a contract," says Lewis. "That may not be ownership of the source code, but it can include reset provisions for the contract, or renegotiated terms."

Understanding your own needs at a particular moment is another critical element to dealing with vendor change. Vail didn't consider new financial software after the Oracle bid, says Silvera, because its recent upgrade to PeopleSoft 8.8 gives it room to grow for some time to come. "The functionality we need for our business exists in the product we have," she says. "There is a lot of functionality we have not had the opportunity to take advantage of, and even if development is stagnant for a while, I still have three years or so of business improvement built into what we've got."

But as Silvera looks ahead to possible add-ons in the future, such as a corporate performance management application, her commitment to PeopleSoft wavers. "I would have more hesitation in considering a newer module that has not established itself in the marketplace," she says. "At that point, I'd consider going with the current best of breed instead of just staying with the same company."

Support for acquired products often runs hot and cold under new owners, says META's Doane. He notes that some legacy customers of J.D. Edwards felt under-loved by PeopleSoft for a couple of years, but were mollified by more recent policies that increased spending and support. Now they find themselves wondering how well Oracle will follow through for their software. "Oracle is being very reassuring," says Doane. "Those words are not legally binding, but a maintenance contract is. Then again, maintenance contracts don't include upgrade calendars and roadmaps." In other words, don't count on the letter of the law alone to protect your investment.

Every deal is different from the deals that precede it, and CIOs need to get a handle on the specifics that pertain to any acquisition. Netegrity customers, for example, are nervous because Computer Associates has a "reputation for acquiring companies and then taking advantage of long-term support contracts while providing little in the way of product innovation and development," writes Burton's Lewis in his Weblog. One large Netegrity user responded by saying, "CA would have to prove to me that they have the cultural acumen to innovate after not doing it for such a long time. Corporate culture is extremely hard to change."

But Lewis counsels Netegrity customers to consider the CA acquisition on its own merits. "CA's reputation precedes them, but you need to look on a case-by-case basis," he says. "I think CA acquired Netegrity to gain market share, and it stands to reason they won't kill it off."

For its part, Computer Associates says it is approaching the Netegrity deal differently than it has past acquisitions. "I think our process has evolved," says Bilhar Mann, CA's vice president of product management for identity and access management tools. "We went into this acquisition with our eyes wide open and did analysis up front on what customers were concerned with. We looked at successful and unsuccessful acquisitions, talked to CIOs and other people down to the level of tech support." As a result, CA has promised no changes from the customer point of view for at least six months in terms of licensing and pricing. "Customers are unhappy if things change too rapidly," he says.

Netegrity Marketing Vice President Stephanie Feraday, who will stay on at CA, says CIOs were put at ease by careful communication from both companies. "A key problem in these deals is uncertainty about the future of the products," says Feraday, who has gone through several acquisitions. "You can ameliorate the concerns customers have by letting them know that the intellectual property, the software and the people will remain intact."

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: Design Ahead"> Design Ahead

Preparing for an uncertain future means making sure you can integrate new software and services into your existing enterprise architecture. "You need a system designed strategically to handle vendor and product turnover," says Lewis. "It's not easy, and it requires some investment." Technology-dependent financial services companies, he says, sometimes write their own abstraction layers so they are independent from products underneath. "With integration middleware, you can, to some degree, make changes without causing massive ripples across the system. The degree to which you can achieve modularity makes change easier."

For all the fear and doubt caused by vendor consolidation, changes in the industry can also represent an opportunity. At Russ Berrie, Alan Heger watched as PeopleSoft let go of many of J.D. Edwards' most talented people after it bought the company. His reaction was to swoop in and hire them himself. "We found good people, developers and consultants, who we were able to bring on board, which made us much more self-sufficient," he says. That self-sufficiency may be of ongoing value if Oracle wins ownership but doesn't win over Heger.

Resources
Book
"Harvard Business Review on Mergers & Acquisitions"

By Dennis Carey, et al Harvard Business School Press, 2001


Report
"Enterprise Applications Market Consolidations to Create Software Custodians"

By Albert Pang IDC, 2004

There are big-picture opportunities for customers, too. One way to look at consolidation is as a chance to focus on the next generation of software and services, says Doane. "While the whole world is distracted by Oracle and PeopleSoft, companies such as Salesforce.com are coming up fast," he says. "When the dust settles from this deal, everyone's going to see that the stuff in question is prehistoric." Salesforce.com offers hosted software for customer relationship management as a service, a model that, so far, has mostly been marketed to smaller companies. But Doane says such services are maturing rapidly. "If you can wait a while, even if you are a really big user, service- oriented architecture could be your next move," he says.

Guardian's Callahan wants that day to come soon. "I'm beating the drum on utility computing, on-demand computing, and pushing software companies to change to a pay-by-the-drink model that lets users scale up and down as needed, even for software we might manage in-house," he says. "IT has grown up, and the days of gigantic, gee-whiz spending are gone. Every change in the marketplace is a reminder that things are different now."

And sometimes the benefit comes from the merger itself, which is where the acquiring companies tend to focus their marketing efforts. Customers make what they will of those pitches. "If the small fish gets eaten by the big fish, you can probably end up with more resources and support in the long run," says Silvera of Vail Resorts. "But I'm not sure the customer community sees Oracle in the same way."