All software markets are finite. At some point there comes a time where, for all practical purposes, the marketplace is completely saturated -all potential customers have a version of the software product, or have made a decision on which product to buy. Once this happens the industry goes through a convulsive consolidation phase. It happens every time, in every industry, and to the best of companies.

This has happened in banking software, retail software, database software, HR software, EDI software, you name it. But if you read EHR industry commentary, it would appear that the EHR software business will go on with double-digit growth forever. However, once any software market’s growth projections begin to decline there’s a rush to the exit, typically manifesting as “cathartic” consolidation.

For customers, investors and company management, once consolidation begins, a pattern emerges depending on how the market behaves. Typically the customers are least prepared. Sometimes the companies are in denial until the bitter end.

There are several dispositive signs of pending EHR saturation. According to a survey from CapSite Consultancy, in 2009 36 percent of surveyed practices said they bought an EHR in the last 18 months; it was 40 percent in 2010 and recently 62 percent this year. One does not need a Ph.D. in mathematics from Berkeley to see the trend is unsustainable.

The second sign is the reaction of capital markets to the EHR industry. EHR companies are starting to become more attractive targets for private equity M&A, and there is very little interest in EHR companies from growth capital investors.

With no green field sales opportunity for EHR software, what do the businesses do? Well, there are some opportunities to make and sell add-ons in practice management software – most providers will need pretty deep EHR integration with PM applications to manage cost pressures and more complex billing challenges. AthenaHealth actually went retro and offers billing services. For market niche EHR vendors, like those servicing image-centric specialties, they could acquire specialty solutions (e.g. PACS) and applications to offer as add-ons. EHR companies could segue into custom development shops and consultancies, but that’s a valuation killer. And maybe EHR vendors could charge for major upgrades or technical features like PHRs or HIE portals – but this is very dicey and not something to bet the business on.

The only real proven way to address a saturating market is to consolidate. This is a very natural process and investors can benefit enormously. This is classic Business 101 stuff. Savvy investors and founders ride the growth curve, then get out of the way selling shares to less nimble investors as the growth curve flattens, then get back in just in time to benefit from a sell out in an M&A transaction. There are scads of examples.  The trick is in the timing.

For users of the software, consolidation is a mess. The vendor sells out and the support drops like a rock. There are a handful of private equity firms that purchase these companies and clean them up to sell to a strategic buyer. But once a strategic buyer gets hold of one of the companies that ran out of growth, the solution is almost always to downsize the company and milk the maintenance revenue.

Wall Street will navigate these tumultuous seas and make a decent buck. Company CEOs with vision and foresight will get out early when the getting is good. Users will bear the brunt.

With hundreds of ambulatory and inpatient EHR products in use today, it’s not hard to imagine a 90 percent consolidation over the next two to five years. This means nine out of 10 products will be gone, or on life support.

This column originally appeared on Health Data Management.

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