Hot Topic: Enterprise Applications Market Review

After the tough year that they suffered in 2002, driven by the downturn in the economy, Enterprise Applications vendors were hoping for an upturn in the economy in 2003 to spur a revival in their fortunes. If current trends continue, our short-term forecasts suggest that Q3 and Q4 2003 will both show a decline year-on-year.

In 2002, the Enterprise Applications market saw a decline in vendor revenues of 2.5%, with a more serious decline of 15% in license revenues. Given the uncertainty in the economy, with fears over global terrorism and impending war in Iraq, these results were perhaps unsurprising.

The trends continued into the first half of 2003. Revenues were down 5% over the revenues in the first half of 2002. License revenues for the first half of 2003 were down 19% over the same period in 2002. This compares to similar drops of 6% for revenues and 21% for licenses in the first half of 2002. When we extrapolate these trends and apply seasonality, we get gloomy predictions for the second half of 2003, with the calendar year vendor revenues down almost 4% and license revenues down almost 11%.

Merrill Lynch's August 2003 survey of US CIOs shows that ERP is a top priority for half of them, but that 60% expect spending to be flat and only 13% expect an increase of >10%. We agree with Merrill Lynch's analyst team that the usual "Q4 budget flush" will happen and that 2004 is likely to show stronger software spending. In the last week of September, we will see guidance confirmed or profit warnings from a number of vendors and we will firm up our Q3 expectations and revise our Q4 estimates based on consensus forecasts.

But there are reasons for optimism. There has been a plethora of mergers and acquisitions over the last 12 months, which is likely to lead to postponement of projects, while prospective buyers wait to see what happens. When this involves a number of the biggest vendors, it can have a significant effect on the whole market. One notable absentee from the M&A circus has been SAP. In the first half of 2003, SAP has significantly outperformed the market, with a license revenue growth of 7%, compared to the market decline of 19%. In other words, it is possible to increase revenues even when the market is declining. See figure 1.

Figure 1 - SAP quarterly revenue growth compared to market growth (Dotted line is a forecast). Note: world vendor revenue includes SAP revenue.

SAP's performance is particularly impressive, given that Europe - its homeland - is having such a hard time. Fluctuations in the currency rates have rather masked the real performance in Europe. If you choose to look in US dollars, vendor revenues in Europe grew nearly 3% in 2002 and look set to grow 3% in 2003. Not bad when compared to the world situation.

True demand in Europe, though, is measured in euros. When you look at the results in euros, they are not so encouraging. In euros, vendor revenues from Europe in 2002 declined 3%, and look set to decline as much as 13% in 2003. See figure 2.

Figure 2 - Vendor revenue in Europe growth, euros compared to US dollars

Longer term we are much more optimistic. In 2004, we expect Enterprise Applications revenues to show modest growth and that 2005 will be even better. Our longer term forecasts are driven by econometrics, rather than trends. PricewaterhouseCoopers European economic forecasts for 2004 look encouraging - investment in the Big 4 countries (France, Germany, Italy and UK) is forecast to increase between 2% and 3.5%, while GDP in Western Europe is forecast to increase by 2.25%.

When compared to forecasts for 2003 - investment growth in the Big 4 countries between -1% and +2%, with Western European GDP growth at only 1.25% - 2004 looks like being better than 2003. We think this is again consistent with Merrill Lynch's analyst conclusions based on their survey that 2004 will be a better software year.

2004 is likely to be a year of getting back to business as the dust settles on the proposed Oracle / PeopleSoft takeover and the PeopleSoft / J.D. Edwards merger. As these vendors get focussed back on business, we expect results to improve.
The big message for Enterprise Applications vendors is that sales execution, and particularly getting sales and marketing initiatives synchronised, is critical. As SAP has shown, regardless of whether the market is going up or down, there is always potential for growth.

Dan Roberts

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