Special Report

Software: The New Driving Force

With Computers Becoming More Alike, the Action Shifts to Programs

Business Week

February 27, 1984

But hardware is no longer where the action is. Computers are becoming remarkably similar -- in many cases they are turning into off-the-shelf, commodity products. Now the computer wars are being fought on a new battleground: software -- the instructions that tell computers how to do everything from processing payrolls to playing video games. "Hardware is getting less and less distinguished," says Jon A. Shirley, president of Microsoft Corp., a Washington State company that writes software for personal computers. "Software is what's leading the industry."

A key reason for the change in emphasis is an overwhelming demand from customers for packaged software that will let them apply computer power to a broad range of new tasks. Increasingly, corporations are finding they do not have the resources to write the programs they need. As a result, most companies have stopped writing their own software and are instead buying standard software packages (page 92).

'A TREMENDOUS CRY'

So far, producers have been unable to keep up with the need, and there has been a severe shortage of software able to take advantage of the power of the latest machines. "We're getting the hardware [we need from the industry], but software has not moved out at the same rate," says Robert J. Metzler, vice-president of First Computer Services, the data processing arm of First Union National Bank in Charlotte, N. C. "There's a tremendous cry in the industry [for software]." The flood of personal computers pouring into small businesses and homes has created an even faster-growing new market.

The booming demand for new and better programs has quickly turned software into big business. As recently as three years ago, software was still a cottage industry, with sales totaling just $2.7 billion annually. This year -- according to estimates by Input, a California market research firm -- sales are expected to top $10 billion.

With the industry growing that fast, several once-small software companies have become sizable corporations. Management Science America Inc. (MSA), for example, the largest independent software supplier, quadrupled in size during the past three years, topping $145 million in sales in 1983. Trying to capture some of the soaring market, thousands of new companies have entered the software business in recent years; by one count there are more than 3,000 software companies now.

While over the long term a shakeout is probably inevitable, the near-term outlook for most of these companies appears extremely bright. "The upside potential has barely been tapped," says Robert M. Freeman, senior analyst at Input. He expects the market to keep growing by a dizzying 32% a year, topping $30 billion in 1988. Software sales of that magnitude would amount to half of the $60 billion hardware business expected for the same year; today, revenue from software is equal to only 27% of the value of all the computer hardware sold (chart).

Sales of software for personal computers -- the fastest-growing part of the software industry -- should rise by an astounding 44% annually over the same five years. "We're finally at the point where software applications are going to be a big moneymaker," says Jack M. Scanlon, vice-president of the Computer Systems Div. of AT&T Technologies Inc. But with the promise of such rapid market growth has come a feverish competition that is beginning to restructure the entire industry.

Until recently, nearly all software companies concentrated on a particular niche and fit neatly into one of three distinct market segments (table, page 76) that were divided along the same lines for both mainframe and personal computers. Systems software, which handles basic housekeeping operations such as controlling the printer and memory, was supplied primarily by the computer makers. They were joined by independent software companies in providing utility software, which, among other things, helps programmers write programs. And a host of other independent software companies competed in the third market: applications packages, which tell a computer how to carry out specific tasks such as accounting, payroll, or word processing.

But those distinctions are blurring:

* Consolidation. International Business Machines Corp., to move faster into applications software, in November placed all its software efforts into a single, entrepreneurial unit -- the same type of organization it used to launch the highly successful Personal Computer.

* Acquisitions. To provide a full complement of software for their computers, makers such as Hewlett-Packard, Burroughs, and Prime Computer are rushing to buy applications software companies. Other manufacturers, including Honeywell, Sperry, and Digital Equipment, are setting up joint ventures with software suppliers. Says Roger T. Hobbs, vice-president for software products and services at Burroughs Corp.: "The demands for software are increasing so rapidly that it is impossible for the manufacturer to keep up."

* Expanding product lines. Software companies are expanding product lines to maintain their competitive edge. Those that supply programs mostly for large mainframes -- MSA, Cullinet Software, and Computer Associates International, for example -- are snapping up personal computer software houses. And companies that specialize in systems software for personal computers -- among them, Ashton-Tate, Digital Research, and Microsoft -- are adding general-purpose applications software to their product lines. "Today you have to have a broad line," says Terry L. Opdendyk, president of VisiCorp. Otherwise, "the vendor is increasingly vulnerable to competition."

* New player. To grab a piece of the action, publishers and other communications companies outside the computer business -- including CBS, Dow Jones, Dun & Bradstreet, McGraw-Hill, and Simon & Schuster -- are licensing programs they then sell through their own distribution channels. "It's a very fragmented industry, but the potential is absolutely huge," says Richard W. Young, president of Houghton Mifflin Co.

* Japan's drive. To catch up with their U.S. rivals, Japanese computer makers are launching major software development efforts. Perhaps the best evidence of just how important software has become is the drive by Japan's Ministry of International Trade & Industry to change the law to boost Japan's fledgling software industry (page 96).

One result of many of these trends is that mergers and acquisitions in the industry are at an all-time high. Last year there were 146 acquisitions, valued at more than $1 billion -- up 130% from 1982 -- reports Broadview Associates, a New Jersey company handling such transactions. And this frantic pace of activity is turning the software business into a hot investment area (page 94).

To compete successfully amid all the turmoil, software suppliers are struggling to formulate new strategies. One common focus is advanced design -- especially the development of software aimed at making computers easier to use (page 93).

But just as important to the success of new software as advanced design is marketing. "You need a great product and great marketing," insists David S. Wagman, chairman of Softsel Computer Products Inc., an Inglewood (Calif.) software distributor. "For a while it was either/or in this business, but now you absolutely must have both."

Nowhere is the new attention to marketing more noticeable than in the hotly competitive personal computer business. To reach the millions of personal computer users, software companies are spending huge amounts to introduce and advertise their products. Industry watchers have dubbed this obsession with splashy promotion "the Lotus syndrome" -- a reference to the more than $1 million that Lotus Development Corp. spent over a three-month period in 1983 to launch its first product, the highly successful 1-2-3 package. "Lotus advertised so much that companies are going to be forced to step up their advertising just to be heard above the noise," says David E. Gold, a San Jose (Calif.) computer consultant.

ON A SHOESTRING

Advertising, in fact, has grown so important to software success that it has become one of the biggest barriers keeping out new companies. "The cost of technology development is dwarfed by the marketing cost; the ante has really been upped," says Rodney N. Turner, vice-president for sales at Ashton-Tate, a Culver City (Calif.) software company best known for its dBase Il package. It takes as much as $8 million to launch a new software product today, he estimates. Ashton-Tate, by contrast, was founded on a shoestring -- $7,500.

Any personal computer program must be carefully packaged and promoted. "It has to look good and has to be well supported by national advertising," maintains retailer Gregg E. Olson, a salesman at Mr. Software in Boulder, Colo. "A company that wants to sell to us has to have all their marketing elements in place to establish credibility with us and our customers."

Even companies that write software for the large minicomputers and mainframes are plowing more money into marketing. While programs for the larger systems, unlike those for personal computers, do not require heavy consumer advertising, says Martin A. Goetz, senior vice-president at Applied Data Research Inc., his company still boosted its 1984 advertising budget by 60% over last year, to about $2 million.

This emphasis on marketing comes chiefly from the need to reach a different, far broader group of potential customers. "Ten years ago, [our customer] was the data processing department, and if you had a product, you sold it to the technicians," says Robert D. Baskerville, group vice-president for product management at Computer Sciences Corp. in El Segundo, Calif. Today, he notes, a software company has "to sell to end users, and you have to emphasize more than the technical capability -- you have to really sell the benefit."

Software marketing now means beginning with detailed product planning, so that a program will better meet the needs of customers. Before Wyly Corp. even began a $20 million program to diversify into applications software, for example, it brought in all its salesmen from the field to tell programmers what customers wanted -- something most software companies had never done. "With modern software development techniques, you can produce almost perfect code, but if you don't understand the market, it could still be useless," says Ron W. Brittian, Wyly's vice-president for research and development.

Critical, too, is a reputation for good service and customer support. "To grow from a startup into a large software company is not so easy anymore; it's a question of distribution and of educating the customer in how to use the product," says Anthony W. Wang, executive vice-president at Computer Associates International Inc. Toward this end, his company recently installed a $250,000 television studio -- costing $200,000 or more a year to run -- to make training videotapes for its software customers.

READABLE INSTRUCTIONS

As competition heightens and customers become more demanding, companies selling personal computer software are providing a level of customer support far greater than anything they offered even a year ago. MicroPro International Corp., for example, has plowed $2.5 million into developing computer-aided instruction and retail-support aids for its software, which includes the best-selling WordStar. The company is also hiring journalists and other nontechnical writers to produce more readable instructions for today's less sophisticated customers. "A product is not a product until you have computer-aided instruction, it's not a product until you have video instruction, it's not a product until you have honest-to-God understandable language [in the manual]," says H. Glen Haney, president of MicroPro.

Establishing a marketing presence is especially critical to companies that provide personal computer software, because they must win space on already crowded retail shelves. Computer retailers are reluctant to take on new software without feeling confident it is a winner. "Unless we7re absolutely convinced that it's a great program, we'll wait to see how other channels of distribution do with it," says John H. Rollins, national manager for Sears Business Systems Centers, the computer retailing arm of Sears, Roebuck & Co.

One group trying hard to enter the software business may have an edge: the traditional book publishers. Because they already sell books to computer stores, the publishers "provide ready-made distribution channels," says Input's Freeman. Agrees William M. Graves, president of MSA: "There is a tremendous similarity in the microcomputer business and publishing."

'ElGHT DIFFERENT VENDORS'

No matter how they distribute their products, software companies are finding that they must offer a broader range of products than ever before. "The strategy is to offer a complete solution," asserts Robert N. Goldman, president of Cullinet. "If a customer ends up with eight different vendors, none of the software works together." Cullinet, for instance, is augmenting its data base management software with such applications as general ledger accounting and manufacturing control programs.

Broadening a software line also helps a supplier leverage the large amounts of money spent on establishing a reputation and brand recognition. VisiCorp, which gained market fame with its hit program VisiCalc, is trying to expand its applications software with its family of Visi On integrated software. Similarly, Microsoft is plunging into such applications software as word processing and financial analysis to build on its reputation as a supplier of personal computer operating systems.

The trend toward comprehensive offerings will force small companies to target well-defined market niches. There will continue to be demand for specialize packages designed for the needs of a particular industry or profession. "There will be several very large software companies," contends John P. Imlay Jr., chairman of Management Science America., "but there will be literally hundreds of small companies, with under $100 million [in sales], that have specialized market niches."

Perhaps the most fundamental change in the software industry is the blurring distinctions between the suppliers. No longer can they be neatly divided into companies that make basic systems software and those that write programs for specific applications.

Moreover, the top mainframe software companies are rushing to market with software for personal computers. And vendors serving only the personal computer market are joining with suppliers of mainframe software. VisiCorp, for example, recently teamed up with Informatics General Corp. to offer VisiAnswer, a program that allows a user of an IBM Personal Computer to retrieve information from an IBM mainframe data base. These changes resulted in large part from the growing number of customers linking personal computers to large mainframe systems.

WOOING THE SPECIALISTS

As the emphasis in the data processing industry shifts to software -- and as software companies strengthen their sales, service, and distribution -- the big-system makers, too, are scrambling to do more to provide their customers with software. "In the old days, our customer wrote his own application [software]," notes Jon Tempas, vice-president for software products at Sperry Corp.'s Computer Systems operation. Today, he says, "there's an increased expectation for hardware suppliers to provide the complete solution." That means the equipment makers will need to provide more of their own software. Sperry, for example, now writes 95% of the software it sells for its computer line.

Most of the big-system companies, however, are turning to software specialists for help, since much of the demand is for applications software finely tuned to specific industries. "I don't think there's any hardware manufacturer that can -- or should -- provide all the software," says John E. Steuri, general manager of the Information Services Business Unit, IBM's new independent software group. "We'll be more and more dependent over time on software developed outside the company." For example, in January IBM began marketing with Comshare Inc. specialized software a help executives make decisions.

The pressure to team up with independent software companies is especially strong among makers of personal computers. "Without an adequate software base, a microcomputer dies," says Eugene W. Helms, vice-president for business development at Texas Instruments Inc.'s Data Systems Group. So TI is recruiting software suppliers to adapt their best-selling programs for its Professional Computer. Perhaps the most extensive effort to sign up independent software companies was made recently by Apple Computer Inc., which courted more than 100 companies to write software for its new Macintosh computer. The California company was successful in signing up more than 80 of them.

Companies that do not move quickly to develop a broad line of software will have trouble keeping up. Consider Tymshare Inc., a computer time-sharing company. As computer prices began to drop precipitously, more and more of Tymshare's customers stopped renting computer time and purchased their own machines. Tymshare did not have any software packages to sell to its former clients. "We used to look at software as simply an in-house tool that we needed to offer time-sharing," says one Tymshare executive. That attitude, he admits, "came back and bit us in the rear end." In 1983 the California company lost $1.7 million while sales fell 3% to $288 million. Now it is engaged in a major effort to expand into applications software, through internal development and by licensing packages from other companies.

With most software companies trying hard to move in the same direction, everyone will face stiffer competition. Already, prices for personal computer software are sliding wherever similar. programs have proliferated -- in electronic spreadsheets and word processors, for example. And a big battle is under way among suppliers of the various "windowing" software packages -- software "environments" that permit the users of personal computers to display several tasks at once. VisiCorp has been forced to slash the price of its Visi On environment package from $495 to $95. "The consumer is going to force the prices down simply by demand," asserts Alvin B. Reuben, executive vice-president at Simon & Schuster Inc.'s electronic publishing division.

'FEELING THE PINCH'

As prices fall, the opportunity for a newcomer to jump in and grab quick and easy profits will all but disappear. The cost of developing and marketing new programs is mushrooming just when margins are shrinking. VisiCorp successfully launched VisiCalc in 1978 with a $500 budget. But the California company has spent more than $10 million developing its latest product, the Visi On environment. Product life is also getting shorter as new products come out faster. As a result, says Softsel's Wagman, "the stakes have gotten higher and much riskier from a development point of view."

For many companies, the risks will ultimately prove fatal. "There are companies out there that are already feeling the pinch of increased costs, new product announcements, and a changing marketplace," warns consultant Gold. Industry watchers predict that some big-name failures will occur within the next 18 months. By the end of the decade, many experts expect the software industry to have consolidated its thousands of suppliers into a few major players.

For those that make it, the future is promising. The demand by the growing army of computer users for easier-to-use software to handle an exploding variety of tasks will drive the industry to create software with far more capabilities than anything available today. "The only limit," says Stuart A. Walker, vice-president of marketing at Knoware Inc., "is the limit of new ideas."

A QUICK GUIDE TO SOFTWARE -- AND WHO SUPPLIES IT

THE BEST-SELLING PROGRAMS

DATA: INTERNATIONAL COMPUTER PROGRAMS INC., BW

GRAPHIC: Cover photo, The computer wars have shifted to a new battleground: software. Just three years ago, software was a cottage industry; this year, sales could top $10 billion. Trying to capture some of this exploding market, thousands of new companies have entered the feverish competition that is on marketing, mergers, and price-cutting. A shakeout is inevitable -- but for those companies that make it, the potential is enormous, COVER ART BY PAMELA NOFTSINGER; Picture, SHOPPING FOR SOFTWARE: TO WIN SPACE ON CROWDED RETAIL SHELVES, PRODUCERS TURN TO SOPHISTICATED MARKETING TACTICS; Graph 1, AS COMPUTERS PROLIFERATE, DATA: INTERNATIONAL DATA CORP., BW ESTIMATES; Graph 2, AS COMPUTERS PROLIFERATE THE DEMAND FOR SOFTWARE SOARS, DATA: INPUT

Copyright 1984 McGraw-Hill, Inc.