Software's Thickening Red Line

By John McCormick Print this article Print

If you're about to buy software, check out the bottom line. The way things are going, lots of potential suppliers won't even be around two years from now.

The most recent fiscal three-month period just ended will be the second, third, fourth or even ninth consecutive money-losing quarter for some software vendors. Gartner Inc., the Stamford, Conn., research and consulting house, now estimates that 50% of today's software companies won't even be around by the end of 2004.

Not surprisingly, the financial stability and staying power of software vendors is now a major concern for chief information officers, especially those pressured to immediately deploy supply-chain management software, customer-relationship management packages, and other systems that promise to cut costs and boost productivity.

"We're consciously thinking about it now," says Bill Homa, vice president and CIO at Hannaford Brothers. The Northeast grocery store chain is looking to add features to its supply chain management system.

Homa and other CIOs say they're checking out their software vendors like never before. They're asking outside researchers and their internal accounting departments to help evaluate vendor financial- and market-strength. They're checking account lists for growth and calling on reference customers. And they're making contingency plans in case key vendors get bought or go bankrupt.

"The financial stability of software vendors is now the number one or number two issue on the minds of software buyers," says Joanne Correia, vice president of Gartner's software analysis team.

Correia says CIOs dealing with critical systems, such as supply chain management, are increasingly asking the research company to help them assess the financial shape of software companies. In those types of engagements, companies can't afford to be left without installation support and upgrade paths should a vendor vanish in a sea of red ink. "There's no room for error," she says.

Some of the more prominent players in the supply chain field, i2 and Manugistics, continue to string together quarterly losses. Manugistics just recorded a second-quarter net loss of $27.1 million on revenue of $74.6 million for the period ended May 31—the sixth straight quarter in which the supply chain software-maker has lost money. Meanwhile, i2 closed its second quarter on June 30; analysts were expecting i2 to post a loss of 8 cents a share for the three-month period—its ninth consecutive quarter with a net loss.

Still, both i2 and Manugistics recently signed up some impressive clients. In May, i2 said both Shaw's Supermarket, a $4 billion chain of 186 food stores across New England, and Cooper Tire and Rubber, a $3.1 billion tire maker, went live with the company's supply chain planning and optimization tool. And, last month, Kraft Foods, the $33.8-billion food giant, agreed to implement a suite of Manugistics supply chain management (SCM) software across its operations. SCM systems can be a boon to companies as they automate corporate planning, forecasting, scheduling and distribution-tracking activities.

The companies also are finding new business coming from existing customers. While the past, of course, is no guarantee of future performance, many CIOs feel more comfortable than ever doing business with companies that have served them well previously. Dave Cotteleer, manager of planning and control materials management at Harley-Davidson, a Manugistics customer, says the company recently asked Manugistics to help build an extranet that will allow Harley's suppliers to do business with the company over the Web. The decision was based partly on their existing relationship. "They were a known entity," Cotteleer says.

But whether doing business with new vendors or longtime partners, the same rules apply: Do your homework, protect your investment and plan for the worst.

Subaru of America, which recently implemented a suite of Manugistics supply chain management products, has a rigorous selection process, according to Robert Mayo, the company's CIO. Before making a commitment, the U.S. marketing and distribution arm of the Japanese carmaker develops a short list of vendors, runs performance tests, checks references, visits some of the vendor's other customers, studies the company credit history and then has its own accounting department comb through the vendor's earnings statement.

Gartner's Correia advises clients to pay particular attention to how well the vendor is funded, its cash position and whether the market that it's in is growing.

Hannaford Brothers' Homa also closely watches where his companies are investing their revenue. "You want your software vendors to reinvest in research and development. And when and if they cut people, you don't want those people coming out of R&D."

Both i2 and Manugistics have healthy cash reserves, continue to invest in R&D, and are playing in a strategic technology marketplace.

I2 says it had $473.4 million in cash and equivalents at the end of its last fiscal quarter and invests 30% of revenue in research and development. "We're pretty sure i2 will be around for the long haul," says Harley's Cotteleer.

Manugistics had $213 million in cash and equivalents at the end of its last quarter. It traditionally invests about 25% of its revenue in R&D. Subaru's Mayo says he looks for his vendors to put between 20% and 25% of revenue back into R&D. "It's a pretty good indication if the company's committed to the future," he says.

Still, CIOs must think about the unthinkable, and most are prepared for a worst-case scenario. Mayo and other CIOs make sure that project source code is put into escrow and that they develop internal expertise in the software that they're using. If a vendor can no longer support Subaru, Mayo says, the company can take care of itself.

This article was originally published on 2002-07-10
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