01:56 AM

Large Legacy Costs Squeeze Software Innovation

Larry Ellison, the founder and CEO of Oracle, has executed well on a brilliant strategy to 'roll-up' the enterprise software market. Through a series of multi-billion dollar acquisitions, such as Peoplesoft, Siebel Systems, and more, he has managed to build a dominant position in enterprise software.

What he was after was their maintenance revenues. Selling a software license for an enterprise software application is but an entry into a much more lucrative revenue stream that comes from maintenance and support revenues -- these typically account for about 20 per cent of the license cost, and they are paid annually.

Oracle has operated more like a private equity fund, acquiring software companies, and aggregating a torrent of maintenance revenues. It's a brilliant strategy.

However, maintenance costs have become a large burden for companies.

Forrester Research, an IT market research firm, just released its 2010 report on "The State Of Enterprise Software And Emerging Trends." It found that the majority of enterprise software budgets is spent on maintenance and support for legacy enterprise software applications.

Larry Dignan, on ZDNet, writes:

Software represents 34 percent of enterprise technology spending, but nearly 55 percent of the applications budget is consumed by maintenance and supporting ongoing operations...

Add it up and all the talk about enterprise 2.0 and innovative corporate applications just doesn't compute. You're spending too much money on the legacy stuff.

The more that corporations spend on maintenance, the less money they have to buy innovative software. And the less innovation there is, the fewer challengers to established companies such as Oracle.

One way forward for software companies is to adopt the strategy used by Salesforce.com. It offers 'software as a service,' (SaaS). Companies can sign up for just a few seats for very little money and this relationship can later be expanded.

However, Salesforce.com is similar to Oracle, in that it has managed to dominate its sector. It recently raised $500 million in a bid to shore up that position and expand its catalog.

Software startups are caught between a rock (Oracle), and a hard place (Salesforce.com).

It will be interesting to see how this situation affects VC funding in this sector.

- - -

Please see: Salesforce $500m war chest - likely target is social media | Tom Foremski: IMHO | ZDNet.com