## Unauthorized Windows 95 Update

# Consolidation of the PC Software Industry

by Andrew Schulman

The following text contains a section that was accidentally dropped from the "Industry Update" section in my book, Unauthorized Windows 95. This section (along with "Windows 95: Like Toasting a Bagel?") should come before the "Microsoft and the Justice Department" section that starts on p. 17 of the Update.

Note that pp. 24-25 of the "Industry Update" contain several "as noted earlier" phrases that don't make much sense without these two missing sections. On the other hand, some of the following material is now out of date.

Copyright (c) Andrew Schulman 1994-95. All rights reserved.

The dominance of applications suites, especially Microsoft Office, is one part of a larger shakeout and consolidation of the PC software industry. While there are deeper reasons for this consolidation (which we'll discuss in a few moments), it is being driven largely by the dramatic fall in PC software prices. As one example, consider Microsoft's Access database, which began life with a list price of $495 US. During a three-month introductory period, Microsoft apparently sold 750,000 copies for $99. When the introductory period expired, the price only went up to $129. As another example, there's Borland's Quattro Pro spreadsheet (recently sold off to Novell): in 1990, version 2.0 had a list price of $495 US; the street price for competitive upgrades was $99.95. By early 1994, the list price was $99.95, and the street price was down to $49.95.

This fall in PC software prices has a number of causes:

- The decline of PC hardware prices, which are ultimately driven by Moore's Law -- chip capacity doubles roughly every two years -- makes it difficult to charge high prices for general-purpose application software. As Business Week (November 8, 1993) notes, "It's hard to sell a $500 word-processing program for a $1,000 computer."

- In large part because of standard-setting by Microsoft Windows, all PC software is tending to take on the same general look, and the same core set of features. This makes software packages fungible commodities that shoppers differentiate primarily by price.

- Sales of suites are driving down PC software prices, even though it is not clear how many users actually take advantage of their application-integration features, or even run more than one application in a suite (see "Suites, Windows sales don't dominate application use," Computerworld, September 5, 1994).

- Price wars -- particularly so-called "competitive upgrades," in which anyone qualifies who ever owned some spreadsheet, or perhaps knew a guy who once thought of owning a spreadsheet -- are pushing PC software prices down further. As financial analyst Roger McNamee has pointed out (Upside, March 1993), software upgrades seem based on the business model of Milo Minderbinder in Catch-22: sell things at a loss and make it up on volume.

Once down, software prices tend to stay there. As a result, profits are simply vanishing for many PC software companies. A Business Week (November 8, 1993) article on "The Shooting War in Software" spells out the implications for the industry:

> As with hardware, a commodity mentality is taking hold. "Feature-wise, all the different vendors are hitting 85% of our requirements," says Steven D. Birgfeld, who buys software for Booz, Hamilton, Allen & Hamilton Inc. As a result, buyers are shopping for price. And increasingly, that means buying suites, which means that more and more of the market is going to the two big suite sellers, Microsoft and Lotus Development Corp. "It's coming down to Coke and Pepsi," says Goldman, Sachs & Co. analyst Rick G. Sherlund.

> Everybody else must scramble. No matter how feature-crammed their programs, they must sell them at prices that are attractive to suite shoppers.... That trend could soon lead to a shakeout and consolidation.... "I would expect the single-product companies to be acquired or merge over time, or else they'll lag and won't be players anymore," says Betty J. Lyter, an analyst with Montgomery Securities Inc.

Indeed, in the past year or so the PC software industry has seen a veritable mergers and acquisitions (M&A) fever. According to a widely-quoted report by M&A watchers Broadview Associates, the total value of M&A deals in software doubled from $2.7 billion in the first half of 1993 to $5.4 billion a year later (InfoWorld, August 22, 1994). Even if the largest deal -- Novell's $1.8 billion purchase of WordPerfect -- is removed from the picture, this still represents a 30% increase in M&A activity.

All in all, Broadview counted a total of 173 software M&As in the first half of 1994; eight of these were valued at over $100 million each. Besides the Novell/WordPerfect deal, this includes Adobe's $525 million buyout of long-time rival Aldus, and Electronic Art's $400 million acquisition of Broderbund [Note: this acquisition fell through]. Another important deal was Symantec's acquisition of CentralPoint, though this isn't in itself part of a trend, since Symantec has built its entire business on acquisitions.

The PC software industry is rapidly headed in the same direction as every other technology-based industry before it: rapid consolition to just a handful of vendors. The market shares are already those of a highly-concentrated industry, as shown in the following table from the New York Times (July 18, 1994):

                                1993 Market Share in Software
                        ----------------------------------------------------
                        Operating systems   Word processors     Spreadsheets
                        -----------------   ---------------     ------------
    Microsoft                   66.2             47.6               52.7
    Novell                      14.3             35.7*               6.6**
    Lotus                        -                3.7               37.0
    IBM                         17.3               -                  -
    Apple                        2.2               -                  -

    *Acquired from WordPerfect
    **Acquired from Borland (Quattro Pro)

    Source: Computer Intelligence Infocorp, company reports

In PC software, the Big Three are Microsoft, Novell, and Lotus. And, on most scales, Microsoft is about twice the size of its two nearest competitors combined. Lotus and Novell each have about 4,500 employees; Microsoft has 14,500. In 1993, Lotus sales were $981 million and Novell sales were $1.123 billion; Microsoft's were $3.753 billion. According to Business Week ("Is Microsoft Too Powerful?," March 1, 1993), Microsoft's sales are probably higher than those of its seven closest publicly-held rivals combined; significantly, the chart illustrating this is titled, "Microsoft and the seven dwarfs." Even financially, Microsoft holds the same position in the software industry that IBM once held in the computer industry as a whole.

While falling prices are the mechanism driving industry consolidation, there is in fact a deeper reason for this transformation. In a word, the PC software industry is maturing. What this means is spelled out in a recent book on the consolidation of the PC hardware business:

> ... the structure of the overall computer industry for hardware products is now reaching maturity, with the common characteristics of market saturation, an excess number of suppliers and heavy price competition. Most significantly, within the overall computer industry, the personal computer has itself gone a long way towards achieving the success predicted by Steven Jobs by proliferating itself into a large number of households and most businesses, but in so doing it has also reached saturation point in the U.S. market in its current desktop form. It is therefore estimated that in 1993 nearly 90 per cent of the demand for computers in the business sector represents replacement business. Thus whilst niche segments may exist for certain products, overall the demand for computers is now more like that of the car market, where competitors are selling to customers who already own one. This is not to deny the fact that many households do not yet own a personal computer, however, the likely demand for units from this segment is not going to be significant enough to boost the industry's overall situation in the short term. Growth in computer demand is mostly dependent upon the corporate sector and unlike in the early 1980s, this sector is now saturated.

> -- John Steffens, Newgames: Strategic Competition in the PC Revolution (1994), pp. 205-206.

There is an almost exact parallel in the mass-market software industry. The downside to the industry's tremendous growth in the 1980s is that the market for productivity applications like word processors, spreadsheets, databases, and presentation-graphics packages, is now saturated. How do you sell a word processor to someone who already has one (or more), and who probably uses only 10% of its features? How do you sell coals to Newcastle?

For the software industry, this is no rhetorical question. Somehow a way must be found to get a customer with a perfectly serviceable word processor to upgrade to a new version with more features they won't use -- the software equivalent of tailfins on cars -- or to try someone else's word processor for a while.

Or, a way must be found to expand the market: find someone who doesn't already have a PC and convince them that they need one and, oh, here's all this bundled software too. This is one of the major reasons why companies such as Microsoft look so favorably upon the so-called "downsizing" trend. It is also the reason for the annual ritual in which PC hardware and software companies declare that this will be the year in which massive numbers of families buy first-time computers for their homes.

Now, what role has Windows played in this consolidation of the PC PC software industry?

According to Bill Gates, there basically is no such consolidation, and Windows has produced tremendous growth for the industry:

> The positive impact of Microsoft Windows on the fortunes of the entire industry has been profound. Data from the Software Publishers Association and other sources show that in 1992, while overall sales of applications products grew only 12 percent, sales of Windows-based applications grew by nearly 100 percent. At least a dozen companies besides Microsoft have sold more than 1 million units of Windows applications, and at least seven computer manufacturers have each sold more than 1 million machines with Windows installed.

> The positive impact on small companies is even greater. A recent survey conducted by an independent research company shows that the typical software firm employs six people and generates approximately $560,000 in annual revenues. According to the survey, Windows has been responsible for the founding of more than 500 new companies and the direct creation of more than 17,300 jobs outside of Microsoft.... Windows is nothing less than a job-creating engine.

> -- Bill Gates, "Free market economics -- not intervention -- drives innovation," InfoWorld, August 16, 1993

Not everyone agrees that Windows has been so good for the industry, though. Certainly Windows applications sales are winning out over DOS applications sales. But without figures for companies that have gone out of business or had layoffs, the figures Gates cites may mean less than at first appears.

The other possibility is that Windows actually has hurt companies other than Microsoft. Bob Metcalfe (the inventor of Ethernet and the founder of 3Com) wrote an article along these lines, based on an interview with Ruthann Quindlen, a financial analyst at Alex, Brown & Sons. According to Quindlen, "Windows is killing the goose that lays the golden eggs":

> Next Ruthann admitted she had been wrong. Not wrong about Microsoft -- she was Alex Brown's analyst on Microsoft's IPO, way back in 1986 when sales were a mere $140 million. No, she regrets saying (in a Microsoft videotape even) that Windows was going to create opportunities for small PC software companies. Now it is is clear that Windows is killing small PC software companies, and -- her eyes grew dark -- the big ones too.

> Ruthann ran through some recent [1992] reports of slowing growth, earnings shortfalls, and/or falling stock prices -- Adobe, Aldus, Borland, Lotus, Micrografx, Quarterdeck, Software Publishing, Stac, Symantec, WordPerfect. Surrounded by this devastation, Microsoft reported 50 percent growth to $2.8 billion in sales for the year ending June -- and all that growth has obviously come at someone's expense....

> Well, aren't Windows apps doing well?

> "Yes, but it's hard to tell whose, which is my major point -- Windows apps all look like. And when differentiation is hard, distribution controls. And who controls distribution? Microsoft. Who else has the product breadth to say, give PowerPoint away in a Word/Excel bundle? Whose brand is reassuringly on both the Windows operating system and on its Windows apps? The only Windows apps doing well are Microsoft's."

> -- Bob Metcalfe, "Financial analyst sees a bleak future for the PC industry," InfoWorld, September 14, 1992

Naturally, everyone in Windows software business hopes that the release of Windows 95 will help both attract new customers, and convince existing customers to buy upgrades. But while the upgrade business is increasingly important, the profit margins are usually small. And the saturation of the market means that new customers are harder to come by.

Forward to "Windows 95: Like Toasting a Bagel?"

Unauthorized Windows 95: A Developers Guide to Exploring the Foundations of Windows "Chicago" by Andrew Schulman
Price: $29.99 USA/$39.99 Canada
ISBN: 1-56884-169-8; Publication Date: November 1994; Pages: 608

Unauthorized Windows: Developers Resource Kit by Andrew Schulman
Price: $39.99 USA/$54.99 Canada
ISBN: 1-56884-305-4; Publication Date: November 1994; Pages: 608

IDG Books are available at all major bookstore chains or direct from the publisher at (800) 762-2974, 8 a.m. to 5 p.m. Central.

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Unauthorized Windows 95 Update