Columns

Estimate the degree of risk

• By Tony Baer
• November 1, 2004

When buying software, should your team approach it on technical merits, or judge it as an addition to your investment portfolio? Given the mortality rate of start-ups in general, and the accelerating pace of software industry consolidation, the answer should be obvious. The issue isn’t new, though. Five years ago, after Computer Associates’ acquisition of Platinum, we commented, “It is tempting to conclude that independent software vendors are an endangered species.” A few years later, we added, “It can be a career-limiting move to buy technology that’s so far behind in market share that it could wind up orphaned and unsupported.”

Now we might stand corrected. If you decide to restrict software purchases to safe, investment-grade vendors that are large enough to survive, the recent U.S. District Court decision that seems to hand Oracle a major victory in its hostile bid for PeopleSoft blows some holes in that rationale. Prior to Oracle’s bid, PeopleSoft was a large and viable firm. Conventional logic suggests buying PeopleSoft products is safe.

But the criteria for selecting software vendors is complex. Given that there are no simple answers to the question of what is a safe investment, the first rule is to relax. Although some facts appear self-evident, such as the likelihood that giants like IBM, Microsoft and SAP will be around for a while, it was not all that long ago IBM had its own near-death experience. Consequently, you can never be 100% certain your vendor will survive. And, even if you could, you will never be able to have all your business needs supplied by top vendors alone.

Consequently, start-ups remain a fact of life. You’ll need them especially for innovative functionality that could distinguish your organization, which the household brands have not yet covered. A few examples include managing Web services, integrating content or providing innovative, real-time business performance scorecards.

Another factor to consider is longevity and inertia of software investments. In most cases, the broader the functionality and number of users served, the longer it will take to implement and decommission software. The same goes for vendors like Oracle that attempt to digest large acquisitions and installed bases.

After the recent court ruling, we spoke with several PeopleSoft customers who told us they didn’t expect any immediate impacts to the industry, especially considering that Oracle still faces numerous hurdles to its goal. Not surprisingly, none of them had any plans to change their long-term enterprise software investment strategies.

So, as the software industry metamorphoses around you, should you simply not worry and be happy? Obviously, for anyone who has signature responsibility for approving software contracts, the answer is no. Performing financial due diligence remains a given. Regardless of whether the vendor is an established giant or a struggling start-up, you must explore the financial health of the company, the satisfaction level of customers and, of course, stay aware of trends in the marketplace.

Nonetheless, even normal due diligence is not foolproof. For instance, unless you were a forensic accountant in a prior life, it is unlikely that you could have foreseen the financial problems of Peregrine Software a few years back.

All software investments carry risk. There are internal risk factors, such as the likelihood of disruption and an ability to implement. However, external risk is just as important. While the mortality rate of software vendors in the marketplace might appear to dictate taking an investment banker’s strategy toward analyzing purchases, perhaps a more appropriate approach would be that of insurance underwriter.

From an underwriting perspective, you should evaluate vendor viability on a sliding scale, estimating the degree of risk. Using this approach, it’s OK to continue working with bleeding-edge start-ups. Just make sure to have detailed change management and escape plans, and document all business logic as well as places where the software interacts with other systems.

Of course, it doesn’t hurt to hope that the brilliant start-up you’ve discovered gets acquired by a household name. However, that’s no guarantee of safety. Just ask customers of Neuvis, a start-up firm that developed a rapid development tool for Java. The technology, acquired by Rational, subsequently vanished sometime after Rational’s eventual acquisition by IBM.