Big IT vendors turning to mergers to help take on cloud

More large acquisitions expected; users say they prefer fewer vendors but fear lock-in

Hewlett-Packard Co.'s $13.9 billion acquisition of Electronic Data Systems in late-August 2008 was one of the last big tech mergers to close before the latest recession fully arrived.

Less than a month later, HP announced plans to lay off about 25,000 former EDS workers, Lehman Brothers filed for bankruptcy, and the market fell 504 points -- all on the same day, Sept. 15, 2008.

After that miserable and operatic day, the tech industry entered a new, rarely seen era: It temporarily slammed the brakes on mergers and acquisitions.

In the first quarter of 2009, the value of tech industry deals shrank to $3.1 billion, a pittance compared to a normal quarter over the years, according to New York-based consulting firm PricewaterhouseCoopers (PwC).

Now it appears that tech mergers are back, and analysts see them continuing -- at least for the time being. Andy West, a principal in McKinsey & Co.'s merger management practice, predicts "a coming wave" of acquisitions because the number of public companies is relatively high and today's average sale price for public companies is relatively low.

West said that cross-segment acquisitions, such as a storage firm buying a networking company, are most likely. Overall, he noted, the technology market "continues to be ripe for consolidation."

But there are mixed reviews -- and some worries -- among users and analysts about latest merger trend. Users, in particular, see a risk that the mergers will stifle competition and could lead to vendor lock-in. But some also also see the emergence of cloud computing as a potential means of escape from the clutches of the growing-by-acquisition major vendors.

The pace started picking one year to the month after HP disclosed its EDS layoff plans. In back-to-back September 2009 announcements, Dell Inc. agreed to buy Perot Systems Corp. for $3.9 billion and Xerox Corp. agreed to buy Affiliated Computer Services Inc. for $6.4 billion.

And in April of this year, HP closed a deal to buy networking firm 3Com Corp. for $2.7 billion .

Tech merger spending had jumped to $21.3 billion in the 2009 fourth quarter, and the pace continued into 2010, with $19 billion in deals in the first quarter, according to PwC.

There are mixed views on what's driving the latest round of mergers, and what they mean for users.

The big vendors believe that IT managers want to deal with fewer vendors, cut back on the task of integrating multivendor products and focus on solving business problems rather than running data centers. To meet such needs, enterprise vendors are looking to buy firms that their executives believe can help them either add to or expand their menus of service offerings, networking tools, management software and business intelligence tools.

The news may not be all positive for corporate IT executives, as some observers fear that continued merger activity will lead to further market consolidation, cutting back on user choice.

"I think most enterprise software customers are engaged in a sort of cynical and highly disruptive effort to drive choice out of the ecosystem," said Alan Trefler, CEO of Pegasystems Inc., a Cambridge, Mass.-based business process management company that remains independent 27 years after its founding. "I don't think it's good for the economy, and I don't think it's good for software."

But some observers note that even a consolidated group of enterprise vendors faces a new kind of guerrilla warfare from strong providers of cloud-based applications, like Google Inc. and Amazon.com Inc. , as well as from smaller software-as-a-service (SaaS) ventures that are selling niche hosted apps.

As companies turn to applications hosted by others, infrastructure is becoming a commodity, and new services are just a click away -- preferable to having to wait through a lengthy software acquisition and deployment period.

The real value that enterprise vendors can still offer is the ability to use software and services to do the complex job of tying different systems together for large users. For instance, an enterprise vendor could link GPS-enabled sensors on all the products inside a moving railway car to BI systems connected to handheld dashboards and internal social networks. To keep up with emerging technologies, though, enterprise vendors would have to constantly remain on a path to acquire a broad range of companies.

The major acquisitions by Oracle Corp. in recent years are examples of moves aimed at both consolidating the market and increasing product scope.

For example, Oracle took a major step in cutting ERP competition -- and consolidating the enterprise applications business -- in 2005 by acquiring PeopleSoft, which had previously acquired rival J.D. Edwards.

Then this year's acquisition of Sun Microsystems Inc. extended Oracle's enterprise reach into a new area -- hardware -- as the company sought to keep up with the integrated offerings available from HP and IBM.

Customers see positive and negative aspects to the acquisition strategies of the big vendors.

Sharon Gietl, vice president and CIO of IT at The Doe Run Co. in St. Louis, a privately held metals mining, refining and recycling company, complimented Oracle on its willingness to integrate strong features of acquired products into its own.

Gietl, whose company is a major user of Oracle ERP software, also noted that the vendor's customer service operation has improved its over the past six or nine months -- a change, she added, that may have been brought on by the recession. For example, if Doe Run has a specific need that the Oracle ERP products can't fulfill, the vendor now brings in third-party apps and integrates them. "I see that as a change," she said.

She said Oracle in earlier times could be described as distant.

Gietl did express concern that continued major acquisitions could eventually significantly limit customer choice, though she did note that that services offered by cloud and SaaS providers are fast emerging as strong alternatives. In fact, Doe Run already uses a a hosted performance management HR application, Gietl said.

"In order for [major vendors] to remain competitive, they are going to have to sharpen their pencils," she said.

The one-stop shops created by large vendors like IBM, Oracle and HP are now falling under labels like "unified computing" or "converged infrastructure."

IBM is set to invest heavily in its effort to be a one-stop tech shop, announcing last month that it plans to spend $20 billion on acquisitions over the next five years -- twice the amount it has spent to buy companies over the past 10 years.

Some large vendors are also forming partnerships to help get control of corporate IT operations. For instance, Cisco Systems Inc., VMware Inc. and EMC Corp. last November announced plans to join forces to sell private clouds.

The major vendors can bundle services with high- and low-end products to offer large users comprehensive packages, said John Bender of Bender Consulting.

At the same time, he said, start-ups are working to come up with creative alternatives to the "unified computing" offerings. "You can make a very strong case that cloud computing is all about [offering alternatives]," he said.

The market most interested in cloud and SaaS products, for now, are small to midsize firms, such as The Jewish Home of San Francisco, a 900-employee health care provider.

Richard Navarro, director of IT at The Jewish Home of San Francisco, said the organization is using a SaaS tool from a start-up AccelOps Inc. for monitoring its IT systems. He said the response by the vendor to his support issues and product design needs is likely far better than he would get from a large vendor.

Navarro says he is familiar with outsourced environments run by major vendors. "One of the things that bugs me about those kinds of services is every time you want something or have a question, it costs money," he said. "That's the disadvantage I see with a more inclusive vendor."

In some ways, the move by big vendors to become all-inclusive is a decades' old story for IT -- and so is the market response.

When users feel locked into a vendor, "it seems to start a fragmentation and innovation process that disrupts the larger guys and rechanges the game," said Eric Openshaw, vice chairman and U.S. technology leader at Deloitte LLP. Thus a period of merger activity by enterprise vendors can help launch a counterforce, he added.

"A world where there is not much competition is a problem, certainly for public-sector buying -- but for anybody," Phyllis Koch, director of IT for the the city of Boynton Beach, Fla. "But I guess I'm torn. It is easier as an IT director not to have lots and lots of different product because then I become the integrator, as opposed to the company being the integrator for me."

Koch says her ability to migrate applications and to avoid vendor lock-in is helped by the emergence of SaaS products.

Boynton Beach has turned to SunGard Data Systems Inc. to run and manage its AS/400-based ERP system. As a result, Koch said she feels less locked-in because she believes it would now be easier to migrate to a different platform, such as x86.

Jo-ann Olsovsky, technology services vice president and CIO at BNSF Railway Co. in Fort Worth, Texas, said that large vendors have been strategically leveraging technology acquisition via mergers for quite some time.

"As a buyer of technology products and services, I'm not concerned as long as healthy competition remains," said Olsovsky. "We do our best to standardize and streamline the products we use, so certainly having fewer vendors can eliminate complexity in our infrastructure. Personally, I prefer vendors that focus more on a given strategy and invest to perfect the strength of their offering and overall expertise."

The pace of mergers that began in the last quarter of 2009 is expected to continue, unless the economy tanks again. Many tech vendors were able to jump back into the market because they concentrated on saving cash during the downturn, analysts said.

Sam Palmisano, IBM's CEO and chairman, told investors at a May briefing is that what seems like industry consolidation now is catch-up by vendors trying to move away from offering commodity products and instead provide high-value services. The new focus, he said, will be on solving business problems, rather than simply on integrating products.

Palmisano did stress that buying companies to gain access to new technologies doesn't eliminate the need for R&D spending. "You can't do this by assembling commodities, spray-painting them a different color and saying that's going to give you differentiation in the marketplace," he said.

The acquisition push is also showing signs of widening geographically. Israeli companies, for instance, may get a lot of attention because of their relatively high amount of R&D spending.

"Chances are, I'm going to buy a lot of technology where somebody spent a lot of [research] money already," said Fafi Musher, CEO and founder of Stax Inc., a management consulting firm in New York that specializes in mergers and acquisitions.

Rob Fisher, a PwC partner for technology transactions services, sees a "consolidation-oriented" push because of a convergence of technology. But acquiring R&D has also been a primary goal in many mergers and remains core reasons for many acquisitions.

Fisher also noted that as merger numbers grow, technology companies gain experience in the ways of acquisition. "Technology companies have become very sophisticated acquirers," he said.

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