A Snapshot Of The U.S. Software Industry

How vibrant is the software industry in the U.S.? We know Microsoft does well, but what about the other companies, which write software for sale?

Several such companies have IPO’d over the last 7 years, virtually all of them on the NASDAQ and in their early stages of development. Among 108 companies sampled only 4 could be found on the NYSE and 3 on the AMEX.

At the high end of the sample, 5 companies generated over $1 billion in sales in 1996, 6 companies in the midrange did between $500 million and $1 billion, and the remaining 97 companies made under $500 million.

The High End
Life is good at the high end. At the time of the sampling, among those doing over $1 billion, Microsoft dominated in every category—revenue ($11 billion), income ($3.5 billion), net profit margin (30%), stock price ($132), earnings per share ($2.62), and shares outstanding (1.2 billion). Second to Microsoft in stock price ($64.69) and earnings per share ($1.05) was Computer Associates International, a company which has grown through 50 acquisitions in the last ten years. Oracle showed more revenue ($5.7 billion) and income ($822 million) than Computer Associates but less in earnings ($0.82), and it had a considerably lower stock price ($38).

The remaining two companies, Wang and Sybase, on revenues of $1 billion still managed to take a loss.

The Midrange
Six companies in the sampling can be found in the midrange between $500 million and $1 billion. Five of the 6 companies had stocks ranging in price from $32 to $62. For 1996 Adobe Systems Inc. dominated in net income ($153 million) and earnings ($2.49), Compuware Corp in stock price ($61.75), and Informix in revenue ($939 million).

Informix shows how poor revenue is as measure of strength. Auditors have found serious discrepancies in its recording of sales; they appear to be inflated in a way that doesn’t square with reality. The company may be forced to modify its financial statements over the last two years and reduce the amount of revenue shown by as much as $250 million.

These have not been the best of times for the company. Despite a claimed income of $98 million in ’96, the stock by September ’97 was a paltry $7.69 because of its mounting problems; NASDAQ was threatening to remove the company from the market. It also had 152 million shares outstanding compared to 73 million shares for Adobe. This rather high amount of stock in play for the size of the company is a hen that’s come home to roost. It will be a parameter worth watching in order to see how Informix tackles its problems. If we see substantial increases in the number of shares outstanding, it would suggest the company is disposed to cure its woes by selling stock. Such a strategy might work if the end result is a product in the marketplace, which people buy. Otherwise, it digs the hole deeper.

The Low End
Finally, at the low end are the other 97 companies, most of which remain prepubescent and on the public dole. Out of those 97 companies, 48 of them generate less than $40 million in revenue, and 50 of them took a loss in ’96 (Fig.1). From those taking a loss, 25 managed to lose more than $5.9 million and 25 have a stock price below $4.03 (Fig.2).

Hey, We’re Supposed To Lose Money!
These tepid results cannot be excused by claiming to be normal for startups in their early stages of development. Weakness stems from an eagerness on the part of underwriters to take weak companies public, a willingness on the part of the NASDAQ to accept them, and an unrealistic enthusiasm from the company itself. It becomes the failing of many small, software start-ups to oversize their importance in an undersized niche. Where they could make a genuine contribution to the market and do well on sales of $3 million a year as a private company, they instead go public and become prey to expectations they simply cannot meet. Investors expect public companies to have an open-ended potential for growth. However, among many categories of software the market just isn’t there. The creation of consumer-quality software is a complex endeavor requiring skill, time, and extreme effort where the unforeseen regularly occurs. Industry changes can render a company’s end product superannuated before it even gets to market.

You Mean There’s More Than Writing Code?!
Another problem plaguing the bottom feeders of the software industry is their inability to become multidimensional in the tasks they perform. Making the product is one thing. All that’s needed are extremely good ideas capable of translation into software in a given amount of time, a first-rate technical staff, highly experienced management to keep programmers on the straight and narrow, a rigorous approach toward testing, and the blessings of heaven. But it also requires marketing and distribution, because most software, no matter how good it is, does not sell itself. Marketing and distribution use a completely different set of skills that are typically foreign to most companies started by technical people. A fully formed company with all these elements is not easy to achieve and is not necessarily arrived at by the expenditure of millions of dollars raised through an IPO.

However, the low end of the industry is not without its high fliers. CBT Group in Ireland sports a $76 stock price (9/22/97) from $66 million in revenue, $12.6 million in net income, and $0.81 earnings on a reasonable 19.25 million share outstanding. The company is laughing all the way to the bank. While others seek glory through the brilliance of their work, CBT Group makes something as mundane as training software. They now market a library of over 430 titles and have exclusive agreements with several of the well-known big companies.

The Software Industry Achieves Maturity
Although the importance of software in the world economy is undeniable, the data shows it’s still a tough row to hoe for a company in the industry. The 4 most widely used kinds of software for the consumer—operating system, word processor, spread sheet, and database—are highly matured areas with scores of thousands of labor years wrapped up in their development. Few if any new companies will be able to break into that market in the foreseeable future; the barriers of technology and cost are too high.

The same argument applies for many other segments of the industry, such as graphics (Adobe), software tools (Symantec), CAD/CAM (Autodesk), and the software used by programmers. Unless new companies have something extraordinary to offer, the maturity of these areas makes it difficult for them to enter the market. Consequently, new companies are forced to work the margins of the industry where typically there is far less money and far greater risk.

The Mad Dash To Lock Up New Niches
The Internet has spawned a passel of start-ups in a gold rush, the likes of which have never been seen before in this industry or probably any other. In an already energized software market that has moved at unprecedented speed for the last 18 years, the Internet has quickened the pace even more. Entirely new niches have opened in browsers, search engines, electronic commerce, advertising, and push technologies. At the same time the importance of the Internet and its potential for high return are driving the software products toward rapid maturity. A matured market always creates barriers to entry for new companies. Although the young industry superstars, such as Netscape, Excite, and Yahoo, may do well in the long run, many others, after spending heaps of money, are destined to return whence they came…dust to dust.