Customer demand for enterprise software has fundamentally shifted from spending on new functionality to reducing IT operating expenses, according to new research by Tech Strategy Partners, a consulting services firm founded by former Credit Suisse First Boston and McKinsey & Co. thought leaders. The report, titled "Post-Bubble Demand for Enterprise Applications and Implications for the Software Industry," indicates that the top priority for enterprise customers is consolidating systems to lower operating costs, which account for 70-80 percent of their budgets. This will put greater pressure on maintenance revenues, one of the remaining sources of profitability for enterprise software vendors. The research was led by George Gilbert, former chief software strategist at Credit Suisse First Boston and Rahul Sood, previously with McKinsey & Co's North American software practice. Considered among technology's foremost authorities, Gilbert and Sood have impacted the strategic direction of leading software companies in the U.S. and abroad.

"The enterprise software industry has changed from an 'initial-sale' to a mature 'after-market' business," said Gilbert. "However, with operating and maintenance expenses comprising 80 percent of most CIOs' budgets, customers need to make the upkeep of their systems cheaper. As CIOs increase their focus on lowering operating costs, enterprise software vendors will have to slash maintenance fees and rely on innovation in order to survive."

Based on in-depth interviews with more than 40 CIOs of $1B+ companies, leading enterprise applications vendors, system integrators and industry experts, research indicates that 80 percent of CIOs are contemplating or already reducing maintenance spending. This will cause a structural shift in how software vendors deliver and price their maintenance services. At the same time, it creates opportunity for vendors to differentiate themselves with innovative services.

"While maintenance has been the mainstay of profitability for software companies, contributing to 50-70 percent of profits, this is going to change," said Sood. "Customers are dissatisfied with the value they are receiving from software vendors in return for their annual maintenance fees. Customer demand for new value-add maintenance services will force vendors to restructure their customer care organizations, drive innovation in their services, and alter maintenance pricing models."

Key findings from the study include:

  • Customer demand for enterprise software has shifted from new functionality to cutting IT operating costs. Research indicates 70 percent of customers are consolidating, standardizing and optimizing their core IT systems to reduce internal operating costs. Interestingly, most customers are focusing consolidation within a particular department or function such as finance or human resources because they don't see the value of a single enterprise-wide integrated application suite beyond the convenience of dealing with one vendor.
  • Impending shift in maintenance model from reactive customer support to proactive customer care. Customers' focus on reducing IT operating costs is likely to drive permanent structural change in the composition, delivery and pricing model of maintenance services provided by software vendors. Customers are dissatisfied with the value software vendors provide as part of the current maintenance costs for product support and upgrades. There is growing pressure from customers to separate upgrades from support and restructure pricing. There is also an increasing level of unfulfilled demand for a new class of managed customer care services.
  • Pressure on maintenance revenue and potential for growing costs represent single biggest threat to industry profitability. Maintenance has always been the industry's engine of profitability. In fact, it has come to contribute nearly two-thirds of the average software vendor's profits, since the costly sales process for new licenses takes a long time to pay off. Maintenance will come under significant pressure as customers lower pricing and renewal rates and force software companies to offer more in return. Vendors that have expensive maintenance pricing and have higher reliance on the maintenance business are most susceptible to this threat.
  • Vendor strategies within the consolidation wave. Customer consolidation of existing software investments poses a significant threat to vendors. At the same time, it offers vendors an opportunity to lock in their installed base and increase their share of IT spending. This trend will redistribute overall market spending on software to a few vendors. To survive this shake-out, vendors need to make radical changes. Top priority is to position themselves as the consolidator of their domain in their installed base. Second-tier vendors must transform themselves into vertical specialists to differentiate from the large integrated vendors. The traditional approach of harvesting the installed base and cutting investment to bare bone is not sustainable.

To access the full report, please visit www.techstrategypartners.com or contact (650) 593-3815.

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