Software: No longer business as usual

Microsoft's eyeing free, ad-supported products while companies dump "big beast" software projects in favor of hosted.

The software industry, already reeling from consolidation, is grappling with a new problem: finding the right sales model.

The old, traditional model of selling software, either through up-front fees or long-term licenses, is increasingly under strain as both consumers and big businesses demand change.

The latest sign of turmoil: an admission by Microsoft's top executives that ad-supported Web-based services pose a risk to the company's traditional business. Other internal memos show that Microsoft is worried by the growing reluctance of consumers to spend money on software.

The business software market has been wrestling with changes for several years now. Many companies, like PeopleSoft and Siebel Systems, have been acquired. Some have simply gone out of business. And all of the big software makers acknowledge that it has become harder to sell new software licenses. Oracle, SAP and others now rely on selling ongoing maintenance contracts.

"There are some seismic shifts happening" in all areas of the software industry, said M.R. Rangaswami, an investor and software industry consultant. "It's not going to be a complete shift to open source, software-as-a-service or build-your-own. Will (this) have a major impact on the market? Absolutely."

The growing popularity of open-source software, particularly for server software like databases, has shifted strategies at Microsoft, Oracle and other large companies, which now offer free or low-cost products.

Similarly, hosted applications like that allow companies to switch to a recurring monthly charge instead of a large capital outlay have forced Microsoft, SAP and others to offer similar products.

The confluence of these factors and others is causing dramatic changes in how software is bought, said analysts and company executives. Rather than just charging customers for a CD stuffed with code, providers are increasingly turning to the Web, and to new licensing models, they said.

"Finding new revenue streams is really important so (vendors) are looking at all kinds of contract models," said Joanne Correia, an analyst at Gartner. "When markets become really mature, what happens is people fight for customer control, and that is done via contracts."

In particular, big companies are demanding the ability to buy on an annuity basis, where they pay in smaller increments rather than shell out large sums up front, analysts said.

"It's not going to be a complete shift to open source, software-as-a-service or build-your-own. Will (this) have a major impact on the market? Absolutely."
--M.R. Rangaswami, investor and software industry consultant

With tight IT budgets and slim increases projected for the coming years, corporate customers are eyeing shorter-term contracts--or no contracts at all--rather than pay a perpetual license fee and maintenance costs.

For instance, Joe Drouin, the global chief information officer of TRW Automotive, is taking a look at, which delivers its product as a Web-based service, in part because of the economics. Drouin said TRW is already an SAP customer. But for new applications, he's looking to cut costs.

"You know, you go in and you spend millions of dollars in software and hardware and you put a big beast in place...The idea (with software-as-a-service is) that you wouldn't have to do that right up front. You can pay as you go," Drouin said. "It's a very compelling model."

Microsoft faces big changes
Customers like Drouin are pushing software makers to keep pace with a rapidly changing industry. One of the most visible transformations is taking place at Microsoft, the world's largest software maker.

Bill Gates, the company's chairman, sees the shift to online services as a "sea change" on par with the company's embrace of the Web more than a decade ago.

The recent launch of Microsoft's Web-based service, along with a major reorganization in September underscored the company's stepped-up commitment to deriving revenue from services, rather than strictly software licenses.

In addition, the company has mulled the introduction of free, ad-supported products, such as Works and Money. According to an internal strategy paper, consumers' unwillingness to pay for desktop programs is forcing Microsoft's hand.

"The outlook for the packaged consumer retail software market is poor," the authors of the paper, seen by CNET, wrote. "The size of the market is shrinking, and consumers appear less willing than ever to buy software applications off the shelf."

Meanwhile, Google is expanding its array of Web-based products funded by advertising. Although Google's applications are limited to e-mail, photo-sharing and consumer-oriented services, George Colony, CEO of Forrester Research, expects to see much more.

"Google is also leading a pricing revolution," Colony wrote in a recent column. "Google's programs are free, funded through advertising and syndication. This is a prescient move. I foresee a world in which even enterprise applications like financials, ERP (enterprise resource planning), and supply chain software will be advertising-funded."

The growing viability of open-source products is already accelerating a shift in pricing models for businesses, analysts noted.

IBM, Oracle, BEA Systems and other infrastructure software providers have each shifted from a completely closed-source business and increasingly embraced open-source infrastructure software products. IBM even bought Gluecode, an open-source alternative to its WebSphere Java application server, and adopted its of monthly maintenance fees.

Open-source advocates argue that open-source software, such as databases or business intelligence tools, is cheaper than existing products. Also, by giving away software--at least, initially--open-source companies do not need to invest as much in sales and marketing, according to analysts and industry executives.

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