The Web APM Blog

Innovators are Becoming Dinosaurs

My friend and fellow blogger Bernd Harzog posted an analysis of the market opportunity created by the adoption of virtualization.   He started by speaking to the fact that: “innovations in platforms always outstrip the ability of the major management vendors to keep up with them.”  He also cited examples of market innovators being created by platform changes over the past 20 years:

• Client/Server computing – Tivoli
• Windows Servers for production applications – NetIQ
• Web application response time management – Keynote
• J2EE Web Application Management – Wily (now part of CA)
• HTTP as the standard application level protocol – Coradient, and the other web appliances
• TCP/IP as the standard transport – NetQos, Network General, and the other TCP/IP appliances

Certainly, it is gratifying to see NetIQ being mentioned as the innovative leader in Windows Server management.  Yet, it is also sad to see that the company I founded is among this same list of dinosaurs whose days of glory have since passed because their technology is either:

• Commoditized with the passage of time.  For example, while the Keynote synthetic monitoring service is still very useful in testing the availability of Web sites, there are many different service or product offerings that can do “nearly” the same function and sometimes even for free.
• Rendered dysfunctional by new platforms or technologies being deployed.  For example, Web appliances based on sniffing technology cannot determine the performance experienced by end users if the content or the application is delivered by third-party content or application delivery networks like Akamai.  [Stay tuned for a future blog posting on this subject.]  As a result, while monitoring Web application performance is still a critical need, the adoption of Web monitoring appliances will slow down because the information they provide might be flawed or incomplete.
• Degraded in budgetary priority.  For example, monitoring software focusing on a particular silo of the infrastructure.  More often than not, these silo monitoring products can no longer provide actionable information for the management of complex Web and/or virtualized applications.  Bernd’s article provides amble examples why these products won’t work in a virtualized world.  As a result their prominence on IT’s budget is slipping.

Stacking or Monopolizing?

In an article published in ZDNet entitled “Software’s Stack Wars,” Oracle’s Larry Ellison is quoted as saying that "From the operating system up to the application, we're completely responsible. We test everything together, have one set of management tools." Certainly that sounds very appealing as Oracle’s customers, according to Larry, can benefit from the better integration and "one-throat-to-choke" support arrangement "as long as we do a good job and we don't price-gouge them."  Now that’s the catch—can you put your faith and career in Oracle’s ability to execute and suppress the urge to demand a “fairer” price for answering your call when you’re in the stew?

Certainly Oracle is not alone in this game of stacking.  The other big software players like Microsoft, IBM, SAP etc. are also stacking their product offerings to the point that it is not really designed to lighten their customer’s integration and support burden, but a game of Monopoly.    The grand master of the game is certainly Microsoft.  It has broad coverage in all the pieces needed to build and deliver a business application ranging from OS, DBMS, middleware, development tools and the means to manage these components in production.   It is also signaling its intention to penetrate the business application market with its Microsoft Dynamics suite.  So far nothing for Mr. Ellison of Oracle and Mr. Kagermann of SAP to lose sleep over yet, but it is certainly making good in-roads into the SMB market that cannot afford Oracle or SAP.

In the microcosm of system management, the

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e game of stacking is also being played by the big players like BMC, Quest, IBM, HP/Mercury and CA.  One look at the “Franken Monitors” they’re putting together from the various acquired technologies, one can conclude that they are intended to dominate the management space from soup-to-nuts.  The argument for this kind of “Franken Monitor” is similar to those make by Mr. Ellison: better integration and “one throat to choke.”  Is it though?  “Franken Monitors” are horrific as far as integration is concerned (see my previous post), and furthermore, you might not dare to choke the throat especially when the throat is yours as you have become completely reliant on the “Franken Monitor” to keep your application running. 

One thing to think about—“soup-to-nuts” might make theoretical sense, but in practice, a “best-of-breed” solution based on open standards is best to mitigate any implementation and integration risks.  Moreover, you can limit your exposure to the practice of price-gouging that Mr. Ellison so kindly refrained from doing. J

Tech Ed Post-Show Musing....

I spent a week in Beantown to attend Microsoft’s Tech Ed 2006 conference.  Despite the marginal luncheon menu (dry beef, over-cooked chicken, etc.), the Mircosofties really know how to treat 11,000 of their closest friends well.  The conference culminated in a rock concert at Fenway Park (go Sox!) headlined by the San Francisco band, Train.

It's fun to loiter around a historical ball park, munching free hot dogs and drinking beer.  Of course, I don’t go all the way across the country to attend a rock concert even if it is Train. (Faith Hill, maybe, but she’s mucho cute and her music won’t make my middle-aged ears ring!)

Over the course of a week, I had a chance to talk with lots of architects, developers and system administrators.  Based on these conversations, I noted down a couple of points:

• .NET is in their hearts and minds, but few have .NET applications in production.  For those that have .NET in production, it is still too early to tell whether they are happy with it or not.
• Because J2EE is already entrenched as an application platform in most IT shops, there are going to be a lot of J2EE and .NET mixed platform issues for people to deal with in years to come.
• Security and compliance is still very big as far as IT budget is concerned.
• Active Directory is the de facto standard in most IT shops, even for those with Linux, Oracle or other non-Microsoft platforms. The market for AD extension to cover non-Microsoft platforms is hot.
• Seems like the data management space is now completely consolidated with a couple of large vendors dominating the show.
• Not much new under the sun as far as the "traditional" monitoring software is concerned.  Certainly, these silo-oriented monitoring products have to give way to the new end-to-end APM approach that my company Symphoniq pioneers in order to sufficiently address the complexity of the Web and SOA.
• When people were asked how they find out whether end-users are getting satisfactory performance, most still rely on a complaint-driven approach which means that the IT operations staff and the developers that support them are totally interrupt-driven and assume that there’s no problem if no one complaints.  This is a scary approach because ignorance can only lead to lost business or unhappy executives.

I believe Tech Ed 2007 is going to be in New Orleans, then return to Orlando for Tech Ed 2008.  Will New Orleans be ready for so many people in a year?  Time will tell.  Anyhow, I’ll see you there.  And note to Microsoft: invite Faith Hill, please!

Off to the Elephant’s Graveyard

In my previous post, I wrote about bigger system management companies acquiring start-ups to gain quick access to new markets while not having to deal with the risky, short-term financial impact of internal development.

As well as this strategy works, there are big companies whose core products stall out from a revenue growth point of view, and/or are plagued by acquisition and integration mistakes so that they cannot acquire themselves back onto a growth path.

For these companies, the latest trend is to head for the elephant's graveyard by going private using a combination of funds from leverage buy-out firms like KKR, Silver Lake Partners, and Francisco Partners among others plus debt offerings.

There are a number of reasons why going private might be attractive for the management of companies that are no longer valued as growth stocks:

• Being out of the public limelight offers management an opportunity to re-tool without having public shareholders looking over their shoulder demanding short-term fixes;
• The cost of complying with government mandates like Sarbanes-Oxley adds millions of dollars per year in additional finance and accounting spending, and management might find it useful to spend the money elsewhere;
• Investors are finicky, so once the company loses credibility with the investors and becomes yesterday’s news, no amount of hype or new development can easily bring back the depressed stock; and
• Technology-oriented private equity funds as well as lenders are flush with cash, making deals much easier to get done than before.

The one key ingredient for a private deal to work is that the elephant has to have cash-cow products so that it can generate enough cash to service the debt used to go private, and perhaps spin off cash to its private equity fund owner. 

What happen to the elephant after its visit to the graveyard varies.  My guess is that the elephant could:

• Linger on, milking its installed base and eventually fading into oblivion;
• Be purchased by another company; or
• Re-emerge (like Seagate) as a public company earning high multiples for its owners.

NetIQ, the company I cofounded over a decade ago is also heading for the elephant graveyard.  It will be merged into Attachmate—an elephant owned by a number of private equity funds including Francisco Partners.   Even though I have had little to do with NetIQ since 2003 when I started Symphoniq, the milestone still weights heavily on my heart.  I am only glad that I am not the one riding the elephant to its grim destination.

After the Kill

So what happens when a big fish makes an acquisition?  The desired result is for all the products to work magically together so that the big fish’s customers can get everything they need from soup-to-nuts—one PO, one phone call to make if something doesn’t work out splendidly, one all-encompassing console presenting with all the information one needs with a few clicks of the mouse.

Alas, wishing doesn't make it so.  While some software mergers work out, many others do not.  There are four basic possible outcomes: “Part of Beast,” “Milk and Kill,” “In-n-Out” or “Happily Ever After.”

Part of Beast

One danger is that instead of being “best of breed” as the entrepreneurs who built the product intended, the acquired product just becomes “part of beast.”  Instead of a single easy to implement and user console, the IT staff has to deal with a Franken-Monitor—something I trashed in a previous post.

Take for example the long list of products from Quest, a highly respected system management software company.  If one wants to monitor and diagnose end-to-end Web application problems, one would have to buy a long list of acquired or licensed products (each priced separately, mind you) and learn how to use each one: Foglight for operations monitoring, Xaffire if to monitor real user experience, PerformaSure to do J2EE diagnostics, AVICode (something they resell) to do .NET diagnostics, JProbe to optimize Java code, etc.

A truly long list of products indeed, but the problem is that nothing is integrated. Information collected using one tool has to be passed to another, increasing the complexity and cost of using the products.  And how much would one bet that information by one tool is not useable or garbage to the other tools?  What about the learning curve involved in figuring-out how to use all these products effectively?  Good luck!

Milk and Kill

“Milk and Kill” was the preferred strategy for the Computer Associates of old.  As the name implies, the acquirer “milks” the existing installed base of the acquired product by skimping on further investment on the product, and relies on profit from maintenance and limited professional services revenue to recoup the cost of the acquisition.

This strategy works when customers have a high cost of migration to alternate solutions, and are thus stuck with the product.   What the big fish is most concerned about in this kind of acquisition is the renewal rate of maintenance contracts.  Because of this risk, big fish will typically pay no more than one-times annual revenue in order to make the deal financially viable.

With the advent of SaaS (software as a service) and the demise of large, monolithic software, it is harder and harder to find milkable products that can be purchased at such an attractive price.

In-n-Out

“In-n-Out” is a situation where the Big Fish finds that the acquired product either does not fit in, or discovers that it bought the wrong fish.  There are lots of examples of this kind of situation.  The acquired product is generally unloaded if there is an alternate buyer, spun off, or allow to fade away.

An example that I am familiar with (to my regret) is the acquisition of WebTrends by NetIQ.  Despite the best of effort and intentions, the customers WebTrends sells to are different than NetIQ’s target customers.  As a result WebTrends was eventually spun off. 

Happily Ever After

Of course there are lots of situations where big fish and small fish live happily ever after (until the next big deal or a bigger fish shows up, that is!).  There are lots of reasons why an acquisition works and the MBA-type (disclosure: I have an MBA from Wharton) calls these “synergies.” Here are a few examples:

• The acquired product naturally complements the acquirer’s product or service offerings.  A case in point is Citrix’s acquisition of Reflectent, adding critically needed management capabilities to Citrix’s Presentation Server environment.
• The acquired product is in demand by the same buyer that buys the acquirer’s products.  A case in point is Veritas’ purchase of OpenVision’s data backup business, addressing the demand of its then existing customers’ need for data back-up solution for DEC minis.
• The acquired product offers the acquirer a way to re-ignite growth.  In this case, the acquirer has to be fully committed to taking the company in the direction of the acquiree, and overcome any not-invented-here attitude that might hamper the change in direction.  Two great examples here are BMC’s purchase of Patrol which subsequently established BMC as a leader in the system management market, and BEA’s acquisition of WebLogic that propelled BEA to greatness in the middleware market.

Unfortunately, most acquisitions do not end up in this “Happily Ever After” category.

Tune in next week for the final installment in this series, about the growing presence of buyout firms and other private equity in the world of software M&A.

Big Eats Small, So What’s New?

Part 1 of a 3-part series on software M&A

Big fish have been eating small fish since the beginning of time or at least since the Eocene epoch some 56 to 34 million years ago as evidence by the fossil record showing a bigger fish in the process of eating another fish.  Like the ancient fish pictured here, this big-eats-small phenomenon is equally true in the system management arena as I have participated in the M&A game on both the sell and buy sides.  What is new is that the number of completed deals and the combined value of those deals have been rising steadily in recent years.  I venture to guess that this increase is driven by two factors: (i) a depressed IPO market for small technology companies coupled with the risk-averse nature of established companies in investing in new technologies provides the economic fuel for the current M&A boom; and (ii) innovation in the system management space continues to be dominated by small startups instead of the more established companies.

Every established system management software company was built by having a dominating position in one market segment.  Examples include Mercury with its load testing tools, Veritas with his data backup tools, Quest with its DBA tools, etc.  Beyond that, most if not all of their products have been acquired or licensed from outside.  A segment-dominating position gives them the cash or tradable securities, sales bandwidth and organization strength to pull off a never-ending parade of acquisitions. 

The financial benefit is clear.  By acquiring products, the high-risk investment associated with developing new products or markets is no longer charged against short-term operating results.  Since most software companies no longer capitalize their R&D expenditure and write-off these costs in the quarter they incurred, acquiring versus building products has the net effect of lowering the operating expenses required to sustain the continued growth of the company and justify the higher multiples of a growth stock.

Furthermore, by acquiring products that have gone through the process of technology development and market validation, the high risk of failure is minimized.  And that’s not all.  An acquisition is always viewed as a move that delivers faster time to market and allows a larger company to leapfrog its peers.  So whenever there’s a make or buy decision in terms of new products, the bias usually favors a buy.  This is like finding the start-ups, adding money or tradable securities, and voila, instant market share and growth opportunities that the stock market can rally on. But things are not so simple…

In developing a new product or market, a heavy dose of vision and passion are needed.  Usually, the original visionaries or entrepreneurs that build these start-ups and markets will leave after an acquisition and the product that they leave behind becomes a passionless empty container of code.  As a result, for some of the larger system management software companies that were built through extensive acquisitions, they have transitioned from software companies that sell products to companies that sell products which happen to be software, any software.  A slight change in thinking that has a profound effect on the companies’ ability to innovate.

Whereas, the bigger companies favor buy versus innovate, innovation is the life-blood for start-ups.  The start-ups do not have the financial, marketing and sales prowess of the big guys, so nimbleness and inventiveness is their means of survival.  Perhaps at the end of the day, as they gained market traction, they too become feeder fish for the big fish.

Symphoniq is my 3^rd start-up in the system management space.  My first was Ecosystems, which pioneered the market for distributed system management for UNIX servers and data bases.  Ecosystems became a feeder fish for Compuware.  My second one was NetIQ focusing on managing servers based on the then fast-growing Wintel architecture.  With a frothy IPO market in the late ‘90s, we went public and grew the company quickly to profitability and over $300M in revenue.  In 2003, I and my fellow co-founders saw the need to once again innovate to meet the challenges of the emerging Web APM market.  So we left the safety of a thousand-plus employee organization to start a Symphoniq so we can address these new challenges with a clear mind and a blank slate.  Hence, the circle of start-up life continues unabated…

All About Software M&A

Given the rapid pace of M&A in the software industry today, I thought it would be useful to provide my own hard-won insights, based on my experience on both the buy and sell sides.

In this three-part series, I will cover a variety of topics, including:

* Why M&A is increasing

* Why the big boys are in the hunt for acquisitions

* Why big companies and startups need each other

* The good, the bad, and the ugly in acquisition outcomes ("Part of Beast," "Milk and Kill," "In-N-Out," and "Happily Ever After")

* The new trend towards going private (or as I call it, going "off to the elephant's graveyard")

Stay tuned over the next few weeks as this series unfolds!

UPDATE: Here are the links to the completed posts:

• Big Eats Small
• After The Kill
• The Elephant's Graveyard