Application server software giants regroup

BEA, IBM, Oracle and Sun have made millions selling Java-based application server software--but now they're finding it harder to eke out a profit as their base products become commodities.

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A once-profitable market for a key piece of e-commerce software is cooling, forcing big software makers to rethink their strategies.

In the past three years, BEA Systems, IBM, Oracle and Sun Microsystems have made millions of dollars selling Java-based application server software to big companies to run e-commerce and other Web site transactions. It's crucial under-the-hood software that's become a standard piece of e-commerce infrastructure.

Now these software makers are finding it harder to eke out a profit, especially on their low-end application servers. Why? Because of a glut of me-too products, indistinguishable to buyers, along with brutal competition from very low-cost, or no-cost, alternatives. That's the same problem that database makers--including Oracle--faced years ago.

As a result, the software makers are turning to a new strategy to make money. They load up customers with free application servers, bundled into other products, and then sell new add-on products at high prices. The companies are also relying on the booming market for top-of-the-line application servers that manage transactions and Web server traffic.

Oracle, which hopes a revamped application server will translate into a profitable high-growth product, will announce a new application server this week that has many of the add-on features built in.

"The bottom end of the (application server) market is going to fall out. There's no market for a $5,000" application server, Forrester Research analyst Chris Dial said. "But there is a market for the more top-end, esoteric, difficult component architectures by BEA Systems and IBM."

Application server makers have all hitched their future to the Java programming language as a standard way to build their software, meaning buyers can easily modify it and write new applications.

But Java has been a blessing and a curse for application server software companies. Because Java defines a standardized way to build software, it also means there's little room to differentiate products, especially at the low end of the market. The result? Buyers see little or no difference between one maker's application server and any other on the market, erasing any competitive edge.

"The rigid compatibility tests for (Java) have made it hard for someone to make a profit on just the application server," said Gartner analyst Mark Driver. "If they're good and fast enough, then what (else) do you do?"

Open-source application servers from Apache, JBoss and other companies are further cutting into profits for application server makers. Such companies sell their products for very low prices or even for free, sometimes charging only for customer support.

Application server prices, in turn, have been driven down to the point that it's difficult for technology makers to turn a profit selling standalone products, especially in the most popular area of the market where products sell for $5,000 or less.

The trend toward these products becoming commodities has been "happening for a while and will continue to happen. And as it does, the vendors need to do something else to differentiate themselves," said Richard Freyberg, a senior vice president of technology at Charles Schwab, which uses both BEA and IBM application servers.

Bargain basement
In response to the trend--and to drive sales--Hewlett-Packard, Sun and IBM are offering deals on application servers bundled with their Unix operating systems or with server hardware. Gartner estimates that by 2004, most operating systems will come bundled with a basic application server.

Companies are also beginning to sell new application server add-on features, such as support for wireless devices, which allow companies to create Web-based software and services accessible on PCs, cell phones and handhelds. Other new add-on features include personalization software, which allows Web sites to profile Internet surfers and target information based on their interests.

Gartner analyst Yefim Natis says customers must apply the right type of application server to the right project--or suffer grave consequences: wasted costs, missed opportunities or failed projects.

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Although it's still too early to tell whether buyers will respond with big orders, analysts and software executives expect that the application server market still has big potential for growth through sales of those special-purpose add-ons and high-end products.

At the low end of the market, bargains abound for buyers. HP earlier this month announced it would give away its core application server for free, while charging customers for advanced features and add-on technology. Sun recently announced plans to integrate and merge its iPlanet application server into its Solaris operating system, essentially making them one product. HP in the future is also expected to do the same with its application server and HP-UX operating system.

"IBM, Hewlett-Packard and Sun are trying to leverage their combination of hardware and operating systems and become a single-stop shop," Driver said.

Oracle doesn't have an operating system in its arsenal, but it will package its application server with its database and business software that allows companies to manage their finances, sales and marketing.

Microsoft has bundled application server features with its server version of Windows for several years.

Additional bells and whistles, such as wireless support, are becoming more important to some buyers, while others worry more about reliability, speed and support for the latest Java standards in the core application server software.

"Stability, ease of deployment, and ease of management (are the) most important for us," said Eric Yu, head of development for Centerprise Services, which uses IBM's Websphere application server to offer banking services to financial institutions. "The more fancy add-ons, such as wireless, we're not using."

Larry Podmolik, chief technology officer for Chicago-based consulting firm Leapnet, said he has interest in "layered features like wireless and portal servers, personalization servers, and integrated commerce packages that handle credit card transactions. But we're not quite there yet."

Still, wireless is expected to be a driver of sales in the future, and some companies are already heavily invested in wireless technology. Schwab, for example, uses the wireless software to allow customers to wirelessly trade stock on their handheld devices, Freyberg said. "It's a necessary product offering for our retail base. A substantial number of traders use wireless today."

Old refrain
This isn't the first time in the software business that highly profitable products from multiple makers have reached a state of parity. In the 1990s, database software makers fought commodity pressures by selling add-on features, such as the ability to replicate data, at high prices. At the same time, they slowly trimmed the prices on database management software. Similarly, many software development and database management tools, which once commanded high prices, are given away free or sold at a low cost to help drive demand for companies' more expensive and profitable products.

But the commodity trend in the application server business has happened blindingly fast. In just over three years, the software has gone from high-margin profit savior to generic widget.

"That's not to say full-service application servers are free," said Illuminata analyst James Governor. "But price pressure is definitely downward. Basic Java application servers may not be coffee or steel, but they are definitely now commodity components."

The trend has had a Darwinian impact on technology makers. There are now just six main players in the application server software market, down from a high of more than 50 companies in 1998. A recent study by market analysis firm Giga Information Group predicts that for the year 2001, BEA will hang onto its market share lead with 36 percent, followed by IBM with 34 percent, Sun with 7 percent, Oracle with 5 percent, and HP and Sybase with 4 percent each.

"There's a lot of growth and huge potential in the market, but the definition of an application server is changing," said John Magee, senior director for Oracle's 9i product marketing. "Java is not enough anymore...Companies are really looking for a platform to deal not only with Java, but wireless, portals, integration and Web services."

Application servers came into vogue as more businesses moved their systems online for e-commerce. The servers can send messages between computing processes or determine when to compensate for a part of computing infrastructure that stops working.

Many analysts describe application servers as a sort of operating system for the Web, so it's only natural that the technology would eventually become a standard piece of operating system and database software. That's great for HP, Sun, IBM, Oracle and Sybase, which can bundle application server software with other profitable products. But BEA, whose main product is application server software, appears more vulnerable.

Gartner's Driver said BEA needs to expand its software line in the next few years to stay competitive.

BEA executives assert that they have added new products to their lineup and believe they can maintain the market dominance.

"We are confident that customers recognize we're the market leader and we're on the short list," said John Kiger, BEA's director of product marketing.

BEA Chief Executive Alfred Chuang said he's not worried about application servers becoming commodities because his company's share of the market is still profitable, even if prices drop. He likens the application server market to the consumer operating-system market, where Microsoft still makes a killing, even though each copy of Windows XP sells for only about a hundred dollars.

BEA historically has been faster than its rivals in delivering support for new Web standards and new technology, Forrester's Dial said, but IBM and others are closing the gap.

"Without question, BEA is still ahead in the pack, but what is happening is that they have less in the lead in standards support and technology," Dial said. "IBM is making ground on them with an improving product."