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Who's Buying IT?
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
April 16th, 2001

By Brent Holliday
Greenstone Venture Partners

"Big money goes around the world
Big money give and take
Big money done a power of good
Big money make mistakes "
- Rush, The Big Money

As the clock keeps ticking towards the end of the tech slump, I am concentrating a little harder on what the technology markets are doing. We have come to such a hard landing (kind of like the parachute not opening actually) that is gets difficult to know what your customers are really doing these days. Over the past two weeks I have been focusing on the enterprise Information Technology (IT) buying habits. The market for IT spending by small, medium and large companies is immense. But what are they spending their money on these days? A few data points:

· Most large companies (>1000 employees) spend, on average, 3-5% of revenues on IT today (for our purposes IT includes everything from networking to software to printers to systems consulting).

· Sectors that spend more on IT than average, like telecom and banking, have reduced spending the most in the past few months, according to an Information Week survey.

· GE's Jack Welch was quoted a few weeks ago saying that now is the time for GE to sprint ahead of their competitors by investing more in IT.

· Look at the stocks of the software/services IT companies:
EDS's stock is up 37% since July 2000
IBM's stock is down 14% since July 2000 (50% of its revenue is from hardware and falling fast. Software and services will dominate IBM's future)
Microsoft is down 25% since July 2000
SAP is down 30% since July 2000
Siebel is down 54% since July 2000
Oracle is down 60% since July 2000
As a portfolio, the software/services heavyweights are down 21%

· What about the hardware/networking IT companies?
Dell is down 41% since July 2000
Intel is down 57% since July 2000
Sun Microsystems is down 62% since July 2000
Cisco is down 72% since July 2000
Nortel is down 77% since July 2000
Lucent is down 86% since July 2000
3Com is down 92% since July 2000
As a portfolio, your hardware/networking portfolio is down 70%

The thing that jumps out at you 9 months after tech started its meltdown is that only the folks at EDS have options worth anything these days. The second thing that jumps out is that the market has punished the hardware and networking sectors by a factor of three over the software and services companies. It's a trend folks. Enterprises buy from these companies. The companies that are consistently missing their numbers have been punished the most. While there are a lot of things at play here (Nortel and Lucent sell to telcos as well as the enterprise; perhaps the networking stocks were far more overvalued in the run-up; etc.), the conclusion that I reach is that software and services are where the buying is still happening.

I had the good fortune to engage IT executives at large (Fortune 100) and medium companies over the past fortnight as part of a Greenstone strategy to get to the bottom of this downturn and see where the buying is still happening. We had some interesting meetings and I want to share some of the larger trends with you. If you are part of a start-up or are thinking of creating one in the enterprise IT space, hopefully this will help.

I think we can skip the background where the IT guys claim that worker productivity and overall company efficiency has been greatly enhanced by investment in IT over the past 10 to 15 years. The Internet has had a huge impact, but more on that in a minute. While we have all been living the hype of the past few years, the big companies have been building big software projects. The Fortune 100 IT exec claimed one billion spent in implementing SAP worldwide over the past 8 years. That's a billion with a 'b'. The medium sized company IT folks had similar stories, one with Peoplesoft and another with a Lotus Notes and custom billing and accounting software rollout. All of them claimed that they were seeing return on that investment in terms of efficiency gain. The Fortune 100 company has their IT shop set up as a profit center, selling services internally, and they claim to have made money on that billion dollar spend already.

Interesting sidebar on the Fortune 100 company: They spent about 2% of revenues on IT last year. That's US$480M on IT!!! About 4% of that, or US$20M was spent on e-business or Internet related stuff, like the corporate web site. If they doubled their spending on IT, assuming that the reasons for doing so would improve the company's efficiency down the road, they would be near a billion in spending. That's big dough for outside companies to get their mitts on.

Since we have a few companies in the enterprise software space (in which I include Internet-enabled software or services), I focused most of the discussion around software. As mentioned already, large-scale PC rollouts and networking expenditures are being cut most in enterprises, while software and services hang on. So, it's relevant for me to focus on software for your benefit as well.

The picture that is emerging from the enterprise is that many of the internal software systems have either been built or are will be built using the help of the big names (Microsoft, SAP, Siebel,etc.). It is more than likely that the enterprise resource planning system, the internal messaging systems, the customer relationship management systems and the accounting/billing systems are already installed or will be very soon. If you are a company just starting today that is looking to go inside the company and replace any of these systems, you will have a very hard time. I have heard many a plan talk of the ability to use the power of the Internet to deliver major software systems through the Application Service Provider (ASP) model. Core software systems are tough to swap out. The money has been spent by these companies and the employees have been trained. In other words, the switching costs are enormous. Even if your software is robust and less expensive, the enterprise is not interested. If money is being spent, the big names will eat all of the market inside the enterprise. The folks I met over the past few weeks practically stapled this message to my forehead. Software inside the enterprise is not for beginners anymore.

Connecting the enterprise inside (inside the firewall) to the outside (customers, suppliers, mobile workers, financial services, government) is a hot area right now. This is where the action is for the newer companies and the up-and-comers. Spending continues to happen here and my small group of IT executives strongly agreed. They point out that new data sharing standards like XML and its many business variations are very new, but very promising. Any manner of supply chain or external billing/account management system using the power of the new Internet standards is hot. Network security tops almost everyone's list as a key spending area. Protection of the internal operations of the company is an increasing pain as the points of connectivity to the public Internet increase in every enterprise. Mobile worker applications and infrastructure are selling well. E-learning and corporate training through the Internet are still areas that show promising return on the IT investment. Think of applications or infrastructure that map the external trends for business today: Globalization, consolidating markets, increased customer awareness and outsourcing of IT services. When you think of the medium sized enterprise, any sign of a slowing market and the need for downsizing means that the IT staff gets axed. The medium sized IT executives were acutely aware of the need for outsourced IT management and looking for ways to decrease the internal need for company guys that upgrade software and troubleshoot networks for a living.

The IT executives everywhere are swamped. Hundreds of companies try to sell them software or services every year. They cannot possibly meet every potential supplier. So, as a start-up, you have to get creative to even get in the door to make a sale. One solution is to make your product inherently viral. If your product is working for a supplier in helping it do business with its customer base, without needing to go inside the customer, then make it so that the whole chain runs smoother if everyone is connected. A little nudge from a strong supplier might get you a hundred more sales if it improves everyone's business. Think of it as a hub and spoke model, where the positive effect of your software increases with every user. A similar way into a larger enterprise is to convince a point supplier of the benefit of your software and let them sell it. For example, you sell a sophisticated account management and bill processing software for enterprises. Sell a bank on your e-business enabled software so that they can use it to standardize a large customer on their credit cards and take the expense management cost away from the enterprise. Either sell the enterprise your software after the bank sells them on it or run the expense management as a service. This real world example is how a smaller software company made a huge sale to the Fortune 100 company. They actually only sold a module that plugged into the Fortune 100's internal ERP system. They ran the rest of the expense management as a service to the bank, who in turn got a huge account with the Fortune 100 company. Everyone was happy and the smaller software company can claim a large bank and a Fortune 100 company as customers.

A final point, but is a biggie. The consensus emerging is that you need to pick a vertical industry or two and try to own them if you are a start-up. The broad horizontal application company, like SAP, Oracle or Microsoft is a pipe dream for a small company. You may get there someday. You may create a whole new class of software and dominate the world in it. But you will only get financed and off the ground in the first place if you can dominate a vertical market. The IT executives like the sales pitch from a person that knows their industry inside out. They love it when the person knows their pain. Your only problem is to convince everyone in that vertical to buy, when competition is a natural force against giving everyone the edge that your software creates. Nonetheless, you stand a better chance at revenue when you have a product that requires less adaptation.

Every industry is different and 100 IT executives from a variety of industries would give you 100 different views of the world for selling IT to them. It takes far more research and understanding of the markets to find a unique product in a hot market. It takes incredible people to build the product and sell it a million times. None of that ever changes. But today, the enterprise IT market is telling us a few new things and we had better listen if we want to make a buck in the next year or so.

Random Thoughts -

- A few weeks ago, eight to be exact, I went out on a big limb and suggested that April 15th is when you should set your investment alarm to wake up again. Based on data that I had gathered that week at a technology investment bank's annual gabfest, I thought that our downturn was a year long, starting last October. The market is smarter than all of us, but historically it predicted the good news in the industry (i.e. breaking out of a slump) 6 months before it actually happened in the real world. Therefore, I fearlessly predicted that the bottom would be around now. Since then, I have become more of a slow recovery fan. It is true that the market actually went up on bad news last week for the first time. Another sign of the bottom is when Dell, Motorola and others say that things continue to be bad and the market jumps up. So, to be a fence sitter, I will gladly take the accolades if I did in fact predict the upswing in April (1 week late but who's counting). However, I have now set my sights on early 2002 before we actually see a consistent climb out of the woods. It will take that long to work out all of the kinks in the economy, I think.

What Do You Think? Talk Back To Brent Holliday


Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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