The Future of Niche B2B Companies: Down or Out?

After the past several quarters' performance, the forecast for niche players in the B2B software industry hasn't been very optimistic. Can companies like Ariba and i2 survive a changing marketplace?

The B2B software industry has reached a curious crossroads. Ariba's quarterly revenues have dropped 67 percent from a high of $170.2 million for the quarter ending December 2000 to $55.3 million for Q4 2001. i2's revenues are nearly half of what they used to be, declining from $377.9 million for Q4 2000 to $193.9 million for the same quarter in 2001. Even WebMethods, a well-known integration and Web services supplier, has been hit, experiencing a drop of 35 percent in revenues in 2001, while companies such as Metiom and Hologix have simply shut their doors. Meanwhile, larger, more diversified software companies, including SAP, PeopleSoft and Oracle, have entered the marketplace for e-procurement, strategic sourcing and supply chain management, and they have recorded relatively steady financial performance through the last year. 

With recent evidence like this, it's no wonder that so many industry analysts are questioning whether niche B2B players can survive.   


Although the B2B industry is still relatively young (Ariba shipped its first application in 1997), the software industry is not. In fact, the first software company, Computer Usage Corp., was formed in 1955. As a result, we have years of software industry history from which to glean lessons that can shed some light on the future for suppliers of e-procurement and supply chain management automation.   


In order to highlight some of history's lessons, I chose to study one segment of the industry, database software. The database industry is a good choice for several reasons. First, it has a significant attribute in common with B2B  virtually every company can make use of the class of tools. Government agencies, banks, non-profit organizations and global manufacturers all need to purchase goods and services to run their businesses. Likewise, nearly every organization has the need to store and manage data. The largest companies have terabytes of data on customer profiles and sales order history, and the smallest companies use financial applications with an embedded database to track their accounts. 


Other reasons for choosing the database industry are that the leading suppliers have been public companies, and that database applications have been widely available for nearly 20 years. Without further adieu, let's review the highlights of the ups and downs of this industry.   


The Saga of the Database


The database industry was born in 1970 when IBM researcher Tedd Codd published an article outlining his idea for an application that could store data in tables. Codd imagined that users could access information from these tables using English-like commands, as opposed to writing code. A few short years later, Honeywell released the first database application, which customers deployed to store and manage data on mainframe computers.


To make a long story short, IBM ended up dominating the database market during the late 1970s and early 1980s, until 1979, when a feisty start-up named Oracle introduced the first commercially available relational database system, using the Structured Query Language (SQL) developed by IBM. A number of other companies sprung up to join in, including Sybase and Informix. By 1987, Oracle, Sybase, Informix and IBM were fairly well established and selling competitively to a market with a growing appetite for database software.


Like most other commercially successful software suppliers, the growth rate of revenues in the early years was in the triple digits for many companies in the database marketplace. The success of these companies didn't escape the notice of Microsoft, which was a very powerful force in the software industry at the time for operating systems and desktop applications. In 1990, Microsoft struck a deal to port Sybase's database application to its OS/2 operating system and to NT.  


By the late 1990s, Microsoft, IBM and Oracle dominated the database industry. According to IDC, the three commanded 68.2 percent of the total market in 1997, and 78.8 percent in 2000. During this time period, the market shares of the fourth- and fifth-place players Informix and Sybase slowly declined to 3 percent each. Last year, Sybase's net income oscillated each quarter between profit and loss, and IBM bought Informix for $1 billion in April of 2001, a bargain price considering that Informix's annual revenues for 2000 were $929 million.      


Even though a handful of companies have dominated the database marketplace, waves of niche companies have participated.  For example, a number of companies have offered desktop databases, including FoxPro, Claris, Wyndware, and Computer Concepts.  Microsoft bought FoxPro in 1992, Wyndware went out of business and Claris is a wholly-owned subsidiary of Apple. But revenues from desktop databases have been fairly modest overall, particularly in relation to the sales for enterprise database software.  


The twists and turns of the database industry are hardly unique; almost all other segments in the software industry have seen the rise of one to three dominant players from a sea of competitors. Microsoft (NT), Unix and Linux dominate the server operating system industry. Apple and Microsoft dominate the desktop. There used to be dozens of browsers for users to choose from; now there's Explorer and Netscape, and Netscape is beginning to fade. It used to be hard to share documents with people outside your department or your company. Now it's no problem because everyone uses Word. But does this imply that Ariba, Frictionless and Agile are soon to be toast? Don't write off the niche players just yet.


Learning From The History


1. Niche Players Can Survive Long Term


It's hard to imagine it today, but in the 1980s, Oracle was a niche player, specializing in database software. Its biggest competitor was IBM, which sold not only database applications but also operating systems and big iron. In 1991, when Oracle was a measly $1 billion in size IBM was 68 times larger.  


Oracle ran with the growth wave of the database industry throughout the 1980s, but also realized that it would have to diversify into other products to thrive. Throughout the early 1990s Oracle struggled to find the right product line to compliment its current business, offering workgroup software to compete with Lotus notes and network computers to compete against the PC. It eventually found success with financial applications, but only after several tries. The company has since gained a significant level of traction in this niche, expanding its success with its e-business suite.               


Informix and Sybase had their runs as well. Both still post revenues in the $1 billion dollar range, and that is nothing to sneeze about. For many years, these companies enjoyed strong revenue growth and increasing market share. In fact, in late 2001, Sybase was named the leading supplier of database software to the Chinese telecommunications market, with 45 percent in market share.


The one factor that diverges considerably for us today in terms of the B2B industry is that the niche players' growth has not just leveled out  it has plunged. It would appear that hype has played a much more significant role in the wildly changing revenues of the niche players for B2B than it has in the overall history of the software industry. To make matters worse, the terrorist attacks of September 2001 have introduced a whole new level of risk-aversion among consumers of software applications, impacting not just B2B but nearly every segment of the software industry.      


I'm betting that some niche players in B2B will survive and thrive long-term. With every new generation of technology, at least one company breaks through to become a leader.  If you want proof, just look at Dell for PCs and AOL in the Internet service provider marketplace. And many others will garner some market share, just as Sybase and Informix have.             


2. The Leaders Are Big and Diversified


As all investment advisors know, there's nothing more effective for reducing risk than spreading your eggs among multiple baskets. Oracle's network computer idea was a complete flop, yet the company was able to exit the market unscathed because of its healthy database revenues. Likewise, IBM tried to extend its dominance in hardware to the desktop market, and, despite its failure, it's currently eighth in the Fortune 500, with $85 billion in revenues and a commanding position in the software services marketplace.    


Being diversified has one other advantage in software: When you create a new product, you can give it away for free along with your established applications to build up market share. For example, Microsoft is well known for its success with Access, a desktop database program, partially because it bundled the program with its successful Office desktop suite. And there are practical reasons why customers would desire a bundled solution: many companies like the fact that someone else has the job of integrating the programs, and buying multiple product lines from a single supplier is less work than maintaining relationships with multiple providers. So why not buy a supply chain suite from the same company that sells you your enterprise database, if the applications are both adequate?   


Software is a very strange business to be in. The gross margins for selling copies of a program approach 100 percent, because once you've written a set of code there's almost no cost to replicating that code and sending it to a new customer. In many cases, the total cost of fulfilling a new order, even for multi-million dollar systems, is nothing more than reproducing a set of CDs and a manual or two. As a result, companies with deep pockets are in the best position to create, maintain and update software. A good application can take tens of millions of dollars to create; for a large company like Microsoft or IBM, that's a pittance.           


3.  Software Industry Leaders Build World-class Engineering Expertise


Oracle is well known in the software industry for having written every line of code that it sells. Microsoft got its expertise in database applications through its experience with the Sybase code. Once Microsoft felt comfortable in the database space, it wrote its own code completely from scratch.         


That isn't to say that these companies got it perfect the first time. Both Oracle and Microsoft (and now SAP) have reputations for shipping weak and buggy first releases of new software. But, on the other hand, these companies also have a history of pressing hard and steadily to resolve issues and release improved versions. The same can most likely be said for any leading software company.       


4. The Leaders Aren't Always First To Market


Imagine how IBM must have felt when Oracle was first to market with database products for the VMS operating system, using IBM's own Structured Query Language. Or just think how Sybase must regret its deal to allow Microsoft to port its database application to OS/2 and NT, considering the fact that Sybase now has less than 4 percent of the market and Microsoft has nearly 15 percent. On the other hand, IBM was the pioneer in database software, and, 30 years later, it's number two in the marketplace, close on the heals of Oracle. 


What can we learn from these facts? Being first doesn't always guarantee success. 


Implications for Today


It is trying for any company currently contemplating a new B2B solution to decide on an appropriate supplier, particularly when a number have suddenly closed their doors and the analysts are questioning the viability of even the best-known names. In all likelihood, some large software houses, such as SAP and Oracle, will probably command a dominant market share for B2B solutions 10 or 15 years out. In the meantime, I believe that many niche players will survive and are worth taking a chance with. You should evaluate these players just like you would any other supplier: look for financial stability, happy customers, and a willingness to develop and evolve the product line over time. And don't expect every B2B project to be a success.    


One final thought to keep in mind that is that today's niche player is tomorrow's mainstream solution. Several years ago, the enterprise resource planning (ERP) suppliers would have been considered niche players. More recently, Manugistics and Commerce One are being called single product suppliers. The next generation of niche companies includes the Nooshs, SupplySolutions and eRooms of the world. It's all part of the evolution of the B2B industry, a process that, in my opinion, has only just begun.   


Debbie Wilson created the online monthly publication Cool Tools for Purchasing and she consults with companies and government organizations on their supply chain management initiatives. She said she wishes cite her husband, Nathan Wilson, as a large source of her information for this article. He has observed the saga the software industry through his career as an engineer with a variety of firms.

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