by Frank Sparacino

Weakness in BI market

In the financial community today, there is clearly a bias against investing in the technology sector. Investors are concerned companies have not reaped material benefit from their IT investments over the last several years and future IT spending will at best remain flat as the economy contracts. The following article discusses the current state and outlook for the business intelligence (BI) software market, as well as technology trends and market share figures.

Similar to other sectors of the software market during the first quarter of calendar 2001, the publicly traded BI universe covered by First Analysis showed signs of weakness. This universe includes Actuate Software, Business Objects, Brio Technology, Cognos, Hyperion Solutions, Informatica, and MicroStrategy. License revenue, a key metric for software companies, grew 17% year-over-year on a weighted-average basis for these companies. While this is still a healthy growth rate, it is down sharply from the fourth quarter (36% year-over-year) of last year. Furthermore, we expect to see continued deterioration in second-quarter earnings reports next month. A recent pre-announcement by Cognos Inc. about its May-quarter results indicates software license revenue will be down approximately 20% from a year ago. On a positive note, we expect the second quarter to represent a bottom for the entire sector. Based on recent conversations with our field contacts, we forecast increasing sequential growth during the 2001 second half. However, we expect the growth will be modest by historical standards and more evident during the fourth quarter.

When discussing the business intelligence industry with our institutional client base (one of the three lines of business at First Analysis is public equity research), we believe it's important to understand the dynamics within a key sub-segment of the market on a detailed level, as well as assess the strategic direction of each vendor and its respective strengths and weaknesses as the market evolves. These sub-segments include extraction, transformation, and load (ETL), or data integration as it commonly referred to today, query and reporting (Q&R), and on-line analytical processing (OLAP).

Our focus below is on the Q&R, or front-end tools segment of the market, which according to IDC research will grow from $1.3 billion in 1999 to $7.0 billion in 2004. These figures represent a 39% compound annual rate of growth. We believe IDC's estimate is overly optimistic, even in a healthy economy. Economic uncertainty is clearly in the minds of customers today and has resulted in Q&R orders being delayed or significantly reduced in size. We have found this is especially true with large orders (greater than $1 million).

Strategic Shift

We believe the general IT-spending slowdown has overshadowed significant trends in the business intelligence market, which is in a state of transition (see diagram below). Up until the mid-1990s, the Q&R market was dominated by proprietary, desktop tools, with Business Objects as the most successful vendor. Since the late 1990s, the focus has shifted to an open, server-based business intelligence platform with expanded functionality (i.e. enterprise reporting and portal technology) and greater custom application development capabilities, as well as pre-packaged analytic applications, or out-of-the-box data warehouses. In addition, the Web is becoming the preferred information delivery vehicle. In our private equity and venture capital work, we have evaluated several emerging companies for investment purposes that are attempting to capitalize on these market trends.

Relative to a year or even six months ago, the marketing message of the major public vendors is increasingly focused on the changes noted above. However, existing product capabilities fall short of what the vendors have promised. With the exception of MicroStrategy, the major public vendors have yet to adequately address the transition from the client/server world and deliver true, interactive business intelligence functionality via the Web.

We believe MicroStrategy, with the recent release of MicroStrategy 7.1, has clearly differentiated its position as a business intelligence platform and Web-based, Q&R solution. Recent OEM momentum with partners such as Informatica, Annuncio, and J.D. Edwards & Co has provided early validation of MicroStrategy's new direction. As customers place an increasing emphasison a host of new factors (i.e. Web architecture, the ability to scale to thousands of users, etc.) in purchase decisions, we believe there is opportunity for new leaders to emerge in the coming years.

Market still lacks clear leader

One of the reasons we believe this strategic shift will have a material impact on the business intelligence sector is that the market still lacks an "800-pound gorilla," such as Siebel Systems in the CRM space or i2 Technologies in the supply-chain arena. According to IDC, Q&Rworldwide market share in 2000 for the top six vendors was as follows: Business Objects, 16%; IBM, 11%; Cognos, 11%; Brio, 6%; Oracle, 6%; and Actuate, 5%. We suggest using these numbers as a general guide but view the percentages with a bit of skepticism. The majority of IBM's market share is a result of reseller agreements with the major Q&R vendors such as Business Objects and Brio, not the sale of its own products. In addition, these figures do not accurately measure actual usage or penetration, which we believe is a more important indicator of future success. This is evidenced by Oracle, which typically bundles its Q&R tools for free as part of a larger transaction. However, the actual use of Oracle's Q&R tools is low.

Another way to analyze this market is to use reported financial data for the three largest Q&R vendors (summarized in the table below) and make a number of adjustments.

*Software license revenue excludes its application development tools business

There are two important points to consider when reviewing this table. First, with respect to Q&R market share, the table does not tell the full story. For both Brio and Business Objects, the numbers closely approximate revenue from their respective front-end tools. On the other hand, Cognos derives a significant percentage of revenue from its PowerPlay OLAP engine. We estimate about 50% of Cognos' revenue is attributable to Q&R. On a revenue basis, it appears that Brio is only modestly behind Cognos for the second position in the market. Second, if we further segment the market by geography, we discover in North America that Cognos is the largest vendor, with approximately $81 million in trailing 12-month software license revenue, followed closely by Business Objects ($77 million) and Brio ($71 million). Brio and Cognos derive at least two-thirds of revenue from North America while international still accounts for about two-thirds of Business Objects' revenue.

Another vendor that falls within our business intelligence universe is Actuate Software. Historically, Actuate has not directly competed with the traditional Q&R vendors. To the extent customers are searching for a Web-based reporting solution, we believe Actuate has the premier product. Because a large percentage of its prospective customer base has already purchased a Q&R tool, Actuate's challenge (thus far, met successfully) has been to differentiate itself from its perceived BI competitors. In our view, the company's strength is its Web architecture, robustness (number of reports and users), and flexibility. At the same time, Actuate's product is more complex than traditional business intelligence tools and requires significantly greater custom development time and resources. With the recent acquisition of Java-based Excel spreadsheet technology from Tidestone Technologies, Actuate continues to add basic analytic capabilities to its products and move upstream from the enterprise-reporting market, where it has established a clear leadership position.

Finally, we believe the current economic slowdown will provide extra time for companies such as Brio and MicroStrategy to restructure and reposition under new leadership. In our mind, there are strong similarities (solid technology, large and loyal installed base) between the turnaround story at Brio and the resurgence at PeopleSoft in the last 18 months, besides the fact that they both have new CEOs from Oracle. We are impressed with the quality of Brio's new management team and sense a renewed commitment from employees, customers, and partners.

Companies are still spending millions of dollars automating basic day-to-day operations and processes with ERP, CRM, and other types of transactional systems that simply capture data. One way to dramatically increase the value of these systems is to provide access to the data for reporting and analysis purposes to drive strategic decisions across all areas, including marketing ("What is the response rate and incremental revenue contribution from a particular campaign?"), finance ("What are the profit margins for each of my branches, products," and "Why are they different?"), and manufacturing ("Which suppliers provide the highest quality and on-time delivery?"). While the IT-spending boom of the late 1990's will likely never return, companies will continue to invest in technology and business intelligence solutions.

About the Author

Frank Sparacino (fsparacino@firstanalysis.com) specializes in research and investment at First Analysis, an integrated, research-driven investment firm. His area of expertise is infrastructure software, with a focus on business intelligence.