January 2005 Early Indications I
Early Indications is published twice monthly by John Jordan. He holds no direct financial positions in any of the companies mentioned. Questions and subscription requests should be directed to jordanjohn5(at)netscape(dot)net
What to Expect from Consolidation
Last Friday Oracle told an estimated 6,000 employees, most of them ex-Peoplesoft, that they're being terminated - via express letters. Survivors among the original 11,000 Peoplesoft employees were also being mailed the good news in the form of an Oracle employment contract. There's a certain sad irony in employees of an HR software company being treated to breakthrough techniques in layoff management. Employee issues aside, I've had a lot of questions from investment analysts, journalists, and others as to what this acquisition could mean. Here are a few thoughts.
Looking to the past, it's hard to find a consolidation that increased innovation. The United States' "Big Three" automakers, for example, were effectively a cartel for decades, and created extremely high barriers to market entry. Later, outsiders to the industry - initially the Japanese - revolutionized it beginning in the 1960s. Even now, more than 30 years later, North American operations cannot match the new offerings (such as hybrids), product quality, or financial profitability of Japanese automakers. In addition, such important innovations as all-wheel drive and anti-lock brakes were commercialized by foreign automakers, despite Chrysler, Ford, and GM's size advantage. More recently, Daimler-Benz's takeover of Chrysler has taken much longer than promised to deliver shareholder benefits, though there are encouraging signs on the North American front.
In some services industries, it's apparently possible to gain economies of scale through mergers and acquisitions, but I don't have first-hand information on customer satisfaction in the big banks or brokerages that have attempted to do so. Similarly, I don't have sufficient insight into managed care to rate US Healthcare and Aetna, but the clear winners in the Anthem/Wellpoint deal look to be a small group of top managers rather than shareholders, care providers, or patients.
In telecom, MCI plus Worldcom did not equal a win by any measure whereas SBC seems to have quietly and thus successfully swallowed Ameritech. Airlines that consolidated (USAir being a prime example) don't appear to have outperformed most airlines that grew organically. In the hardware business, Cisco has bought complements (Linksys and Airespace) rather than doing a megamerger with companies like 3Com or Alcatel. HP, on the other hand, tried to consolidate with Compaq/Digital/Tandem, but thus far few results suggest this was the best use of shareholder capital. In software, Peoplesoft appears to have made the JD Edwards acquisition pay off with access to new customers and cash flow from existing ones.
Questions to be Answered
In some ways, this consolidation is a diversification insofar as Oracle is still at its cultural and financial core a database company. It's possible that Oracle could find itself with strong traditional competition from IBM (in databases), SAP (in both large and SMB markets), and Lawson in SMB. Fighting a three-front war, as well as engaging new competitors (see below) could prove distracting, or worse. Engineering, branding, and sales decisions are all involved, and possible to get wrong.
Judging from statements of intention, it looks as though Oracle will incur development and support costs for new Peoplesoft and JD Edwards products at the same time that Peoplesoft's revenues have been soft. While prior acquisitions at other companies have imposed considerable debt loads, in this instance Oracle hasn't to my knowledge specified how much it's going to borrow to fund the $10 billion cash transaction, but expects to pay it off within two years.
Potentially to its advantage, Oracle's acquisition could raise barriers to entry, slow the pace of market innovation, and increase pricing power. At the same time, existing Peoplesoft and Oracle customers are vocally unhappy with their respective vendors' maintenance and support pricing. From the sales side, having one fewer competitor in the market may seem to make it easier to maintain pricing pressure. From the demand side, unexpected and unwelcome price changes could drive buyers to consider alternatives.
Software and Core Competencies
HR functionality in particular isn't typically regarded as a core capability, and is thus ripe for outsourcing to a Hewitt or Fidelity - who unlike Peoplesoft/Oracle both knows the HR process from the execution side and can warranty their offering in a way software vendors cannot. For Peoplesoft/Oracle to win at a potential new customer, their sales team must persuade the top management, which doesn't usually like spending time on HR questions to begin with, that the system integrator and/or in-house IT department can deliver all the available functionality; the quality of the software, whatever it is, must be filtered through a deployment team over which the software vendor has limited influence and less control.
One factor that could influence buyers in the software direction is integration. Let's say that a utility wanted to minimize overtime in field service. Connecting a time clock application with scheduling and customer service could deliver cost savings and potentially improve quality of service. If HR is outsourced, integrating (let's say) Fidelity's process outsourcing with the utility's in-house systems could be expensive and/or technically impossible. As opposed to CRM or other applications, however, HR is usually not near the top of the list of applications from which line of business managers see benefits of connection.
In something as complex and evolving as enterprise software, there's reason to believe that predictions of market consolidation will be challenged by entry by new competitors, particularly process outsourcers. With RFID, for example, most companies are avoiding heavy investment in process change as they comply with the Wal-Mart mandate with so-called "slap and ship" techniques. If Ryder or Fedex can take my RFID compliance problem off my hands, that could be pretty appealing. Assuming the third-party logistics provider can take on that role, there are fewer companies in the market for Manugistics/Manhattan/i2 licenses. More and more business processes will move to outsourcers, I believe, especially as the satisfaction level with -- and thus confidence level in -- enterprise IT organizations remains low in most companies. Salesforce.com may or may not thrive, but the company's key message - "no software" - is clearly striking a nerve.
For Oracle, one question will be how to counter that sentiment with both software and people associated with its care and feeding that can restore corporate confidence. For Oracle's existing and new customers, the question will be to what extent the merged entity can allay fears of product desupport and arbitrary price increases. From every perspective, Oracle faces a situation in which it must execute at a high level to gain the goodwill of multiple constituencies - employees, investors, customers, and integration partners - who until further notice hold it under a microscope. The final and biggest question is whether Oracle consolidated an industry past its peak and thus gained the costs and benefits of scale at a time when it may be more profitable to possess speed and agility.