Industry Profiles: Prepackaged Software

Overview

The booming U.S. software industry took in an estimated $195 billion in sales during 2001, accounting for about half of the world’s software production. Led by the powerful Microsoft Corporation, the U.S. industry consists of many of the world’s largest software vendors, and sales abroad, including those from foreign-based holdings, represent a major revenue stream for the industry. Compared to the explosive growth the industry experienced in the late 1990s, by 2001 the weakening economy led to declining earnings and employment levels. Leading industry developments in the early 2000s included the continued focus on the Internet as a computing platform, as well as the final outcome of Microsoft’s ongoing legal battles. Although it appeared that the software giant would soon clear antitrust hurdles by settling with the federal government, the outcome could affect the way the company does business. Additionally, by 2002 scores of private antitrust lawsuits also had been waged against Microsoft, including one filed by competitor Sun Microsystems.

History of the Industry

The prepackaged software industry has its origins in a 1969 U.S. Justice Department settlement that forced IBM to sell software for its mainframe computers separately from the hardware. IBM had included basic software with the computer and additional programming was generally done in-house. With this decision, individual entrepreneurs were finally able to compete with IBM. Small software companies sprang up, usually to offer a single program or utility. Most mainframe software was licensed rather than sold, however.

For the most part, the rise of the prepackaged software industry was a direct result of the appetite for software for personal computers. PCs got off the ground in the late 1970s as computer enthusiasts bought machines by Apple Computer, Inc., Tandy Corporation, Atari, and Commodore. Software publishers such as Microsoft formed to write programming languages for them, and soon these languages were being sold to the public through retail outlets. By the end of 1979, Microsoft had already sold 1 million copies of its version of the BASIC programming language. Primitive spreadsheets and other applications began to appear as well, all of them created by small, relatively unknown companies. At this stage, prepackaged software was something of a cottage industry, with programs often written by individuals at home in their spare time. Because software program creation requires virtually no equipment, people who wrote software programs risked only their own time, and stood to gain $200,000 to $1 million if the program proved successful, as perhaps 1 percent were, as Forbes noted in 1983. These small companies were encouraged by hardware manufacturers, particularly Apple, because desirable software helped sell hardware. Visicalc, the first spreadsheet for microcomputers, was introduced in 1979. Its popularity sold many Apple computers and raised the public awareness level of PCs in general. The Apple Fortran programming language was introduced in March 1980 and led to the creation of additional software, particularly in the areas of technical and educational applications.

In 1981 IBM introduced its version of the personal computer and chose Microsoft’s DOS as its standard operating system. Other hardware manufacturers, with the notable exception of Apple, began making their hardware compatible with the IBM system, providing standardization for the industry. This development meant that the compatible computers all used MS-DOS and software that ran on one manufacturer’s equipment would run on all with minimal modification.

More than 21,000 PC software packages were available by 1983. Packaged software had garnered about $2.7 billion worth of retail sales a year as early as 1981, and the industry grew at a rate of nearly 50 percent a year. Given this record of tremendous growth, the prepackaged software industry and PCs began to attract a great deal of attention from the press and investors, and a number of successful software firms soon went public. Over $180 million in venture capital was raised by about 90 software firms in 1983, and 20 firms went public.

With sales of software for PCs growing far faster than any other segment, companies that had formerly focused exclusively on software for mainframe computers bought PC software firms, and firms that had specialized in PC systems software began to sell applications software as well. As competition rapidly intensified in the still-fragmented market, prices fell wherever similar programs existed, while the cost of marketing new software rose dramatically; it thus became much harder to launch new companies on a shoestring. Business Week noted in 1984 that “as prices fall, the opportunity for a newcomer to jump in and grab quick and easy profits will all but disappear.” The magazine noted that VisiCorp introduced Visicalc with a $500 budget in 1978, but by 1984 had spent more than $10 million developing its Visi On computing environment.

As corporations invested in personal computers at the expense of mainframe systems, methods for linking computers to share information became increasingly important. Packaged software could only be used when the computers all had the same operating system, however, and businesses often wanted to link computers that used different operating systems. This forced software companies to make heavy use of consultants and, sometimes, to custom-design solutions. Networking forced software firms accustomed to mass production of software to pay increasing attention to service. As market growth for PC software slowed to 15 percent by 1990, down from 40 percent in 1988, network applications, which run on network servers and facilitate sharing of storage space and resources such as network printers, also provided a new and lucrative niche for software publishers.

One of the most frequent complaints about early software concerned the difficulty many users experienced in running the programs. Making software easier to use became an important goal. In 1984 Apple introduced its Macintosh computer, which employed a graphic user interface (GUI), a new type of operating system that used images rather than text-based commands to control the computer and its software. Apple also issued rules for companies writing Macintosh software to ensure that all software intended for use on Apple systems would look and behave similarly and utilize many of the same commands. Macintosh proponents asserted that this made the software easier to use. As PC software became easier to use, vendors of mainframe software were forced to make their software more user friendly as well.

Despite its premium price, the Macintosh sold well, convincing many software companies that the graphic interface would do well in the far-larger IBM market as well. Microsoft, which had become the leading publisher of Macintosh software, convinced many software and hardware companies that IBM had too much power over computer standards. It persuaded them to accept its graphic interface, called Windows, as the graphic standard for IBM PCs. As software firms wrote applications for Windows, some of the standardization of the Macintosh system appeared in the PC environment.

Windows was initially released in late 1985. Early versions were slow and cumbersome and didn’t sell well. Microsoft worked to upgrade Windows, but it and IBM also began work on an operating system to replace the aging DOS. Called OS/2, the new operating system was supposed to be a more powerful graphic interface than Windows. Initial reviews and sales of OS/2 were disappointing, and a rift soon grew between Microsoft and IBM, as Microsoft wanted to move ahead with Windows while IBM backed OS/2. Finally the disagreement over operating systems led to an open break between Microsoft and IBM.

In April 1990, Microsoft released Windows 3, which brought DOS-based computers closer to the graphic standards and ease of use of Apple’s Macintosh computers. Consumers responded and purchased millions of copies for use both at home and in the office. Microsoft’s sales increased by 55 percent in 1990, reaching a total of $1.48 billion. The wide acceptance of Windows continued through the mid-1990s—and did so at the expense of Apple and IBM. After the release of Microsoft’s next major overhaul version, Windows 95, in summer 1995, sales of OS/2 continued to plummet and IBM formally announced that it would no longer attempt to compete with Microsoft in the PC operating system market. Apple’s Macintosh was relegated largely to niche markets of graphic artists, desktop publishers, and schools. By 1997, Microsoft remained the only serious player in this arena.

While low-cost software had always been available for PCs, in the early and mid-1990s there was a pronounced trend toward making the top-of-the-line products more affordable. As prices of PCs fell, the $500 or more price tags for single applications were hard for some potential buyers to swallow. At the same time, competition among software vendors mounted as software market growth slowed. Several of the leading companies, including Microsoft, Lotus, and Novell, introduced suite packages that bundled a number of their most popular products and served as a coherent unit.

In the late 1980s, as workstations and PCs became more comparable in power, an operating system called Unix assumed increasing importance. Unix, originally designed in the 1960s by AT&T for telecommunications use, had gradually become the standard for high-powered scientific and technical computers working on networks. As workstation computers made by Sun Microsystems and Silicon Graphics became popular during the 1980s, Unix slowly entered the mainstream of business and academic computing. Among Unix’s strengths was the ability to run several programs simultaneously and process large amounts of data more speedily that systems like Windows could. As a result, some PC software companies began to write programs for Unix, while Sun began to produce PCs that used Unix. Sun also sold a Unix operating system for PCs called Solaris.

Yet Unix remained a fragmented OS because so many companies created competing versions of it. In 1991, AT&T created Unix Systems Laboratories (USL) to manage the Unix operating system, and sold portions of it to various companies, including Novell and hardware companies such as Sun, Motorola, and NEC. In 1992 Novell bought USL from AT&T for $360 million in stock to take control of the Unix operating system. Novell quickly moved to widen the appeal of Unix, trying to standardize its competing versions and link its Net-Ware networking software.

Microsoft’s major entry into the networking business came with its 1993 release of Windows NT, an operating system designed for use on computer networks. While at first it wasn’t clear that NT would be a serious contender with programs like NetWare, it quickly gained market share and, eventually, would become the leading networking software.

Driven in part by the fear of Microsoft and its NT operating system, a half-dozen major Unix companies finally agreed in 1993 on a standardization scheme designed to allow Unix applications to look and function the same way on different computers. These companies—IBM, Hewlett-Packard, Sun Microsystems, Santa Cruz Operation, USL, and Univel—signed what was in effect a “peace pact.” The alliance released specifications for the Unix interface and other key elements of the operating system, while allowing companies to pursue their own variations. In the months leading up to the release of Microsoft’s Windows NT, many of these companies released new versions of Unix.

In the late 1990s the software industry was reacting to the rollout of Microsoft’s Windows 98 operating system. While the differences in the new system weren’t as dramatic as those unveiled three years earlier when it launched Windows 95, the new package spurred a modest wave of applications upgrades as software vendors sought to optimize their products for the new environment. At that time, Microsoft authored an estimated 80 percent of all U.S. operating systems in use.

Significant Events Affecting the Industry

The mid-1990s popularity of the Internet gave rise to several new categories of software, as well as another Microsoft-related saga. In 1994 the newly formed Netscape Communications Corporation introduced a graphical browser for the then-obscure World Wide Web. Netscape’s only competitor at the time was a university-authored program called Mosaic that one of Netscape’s engineers helped design. Netscape quickly became popular, in large part through free distribution, and amassed a commanding share in the browser market. Demand for other Internet-related programs likewise swelled, as businesses and private individuals sought tools to access e-mail, news groups, and even to author web pages. Both Microsoft and Netscape soon introduced more integrated products that enabled users to perform a variety of Internet tasks without needing separate applications.

Stemming partially from its competition with Netscape, whose market share plummeted as Microsoft aggressively pushed the Internet Explorer browser, Microsoft fell under increasing scrutiny of U.S. anti-trust regulators. It wasn’t the first time the operating system giant had been accused of uncompetitive behavior, but by the late 1990s the Justice Department appeared adamant that Microsoft change its practices and took the company to court. In June of 2000, U.S. District Judge Thomas Penfield Jackson ruled that Microsoft had violated antitrust laws and should be broken up into two companies. By the following June, that ruling had been reversed by the U.S. Appeals Court. Shortly thereafter, Microsoft appealed to the U.S. Supreme Court regarding the antitrust findings, but the case was returned to the appeals court. The ultimate outcome could change the way Microsoft operates, and therefore the dynamics of the larger software industry.

Beyond Web browsers, the increasing use of the Internet by businesses and consumers has led to other developments within the software industry. One major development is the use of hosted software solutions. In this scenario, programs are hosted by a third party “application service provider” (ASP) and accessed remotely for a fee by end-users as needed, as opposed to being installed locally on a user’s hard drive. This arrangement is an attractive alternative for individuals and companies that don’t wish to incur the expense and human resources required to purchase, install, maintain, and upgrade the applications they need to use. Although the initial adoption of hosted applications was slower than many industry analysts first expected, they represent a major shift in the way a wide variety of software applications are used and paid for.

Key Competitors

Microsoft Corporation, based in Redmond, Washington, was founded in 1975 by Bill Gates and Paul Allen; Gates has since emerged as one of the most visible businessmen in the United States. Microsoft currently stands as the dominant force in prepackaged software. Its first big contract came in 1981, when IBM chose it to supply the operating system of its first PC. As IBM’s PC became accepted as the industry standard, so did Microsoft’s operating system. The firm quickly began offering application packages as well, and became a major player in the Macintosh market after its release in 1984. Its Windows graphical interface, which emulated the Macintosh interface, became another standard in the IBM-compatible market. By the early 2000s, Microsoft had launched home and professional editions of Windows XP, the latest version of its popular operating system. It also had ventured into the gaming market with its Xbox video game system. In 2001 the company posted $25.3 billion in revenue and had 47,600 employees.

Despite Microsoft’s greater visibility, International Business Machines Corp. (IBM) remains a major U.S. packaged software developer. In 2001, the company’s software sales totaled $12.9 billion, and overall revenues amounted to $85.8 billion. In 1995 it purchased the Lotus Development Corporation to bolster its position in client/server and applications software. With the purchase, it not only received the one-time market leading Lotus 1-2-3 spreadsheet, but also Lotus Notes, a leading e-mail/e-business software application. Despite the fact that 2001 was a difficult year for many software companies, IBM was able to devote almost $6 billion to research and development and allot approximately $1 billion for strategic acquisitions.

Based in Palo Alto, California, Sun Microsystems Inc. is a leading manufacturer of network computing systems and Unix-based servers and workstations, with total 2001 revenues of $18.3 billion. Since it was founded in 1982 with four employees, the company has achieved explosive growth. By 2002 Sun had offices in 170 countries and employed approximately 43,700 people. Sun revolutionized Internet software by developing the Java programming language, which was used by more than 2.5 million programmers by the early 2000s. Java was designed to enable compact and platform-independent programs ideal for use with the Internet. It provided a much wider range of functions to developers than most existing Internet-related languages.

Industry Projections

While annual sales growth has slowed considerably from the period when the industry’s revenue was doubling or tripling each year, in the early 2000s the industry continued to register sales growth in the 10 to 13 percent range. According to International Data Corporation, the U.S. software market was expected to achieve revenues of $220 billion by 2002. Through 2005, especially strong growth was expected in the area of Internet security software. According to Standard & Poor’s, IDC forecast revenues in that sector to mushroom from more than $5 billion in 2000 to more than $14 billion by 2005. Additionally, IDC forecast healthy growth in the worldwide ASP market, with spending approaching the $20 billion mark by 2006.

Global Presence

U.S. software industry sales tower above those of international competitors. Through sales of software produced within its borders, the United States directly controls about 45 percent of the world’s $195 billion software market, and U.S. firms with foreign operations bring in each year tens of billions of dollars not included in that figure.

Employment in the Industry

The software industry offers expansive job opportunities and attractive wages to people with key skills. Employment in the industry nearly tripled between 1988 and 1998, rising from 86,400 workers to an estimated 259,000. By 2001 the number of industry employees exceeded 335,000. In the late 1990s the industry faced a shortage of skilled workers to populate its mushrooming new job vacancies. However, because of the weakening economy, many companies reduced their workforces in the early 2000s. This was expected to change when the economy regained strength and workers with specialized IT backgrounds once again became scarce.

Sources for Further Study

“asp and application management services markets to both reach the $20 billion mark by 2006, idc reveals.” international data corp., 27 march 2002. available at http://www.idc.com.

“computers: software.” standard & poor’s industry surveys, december 2001.

“computer software and networking.” u.s. industry and trade outlook. new york: mcgraw-hill and u.s. department of commerce, 1998.

cortese, amy. “group therapy: why ibm paid all that loot for lotus.” business week, 26 june 1995.

garber, lee. “employment in 1998: focus on y2k and the internet.” computer, january 1998.

gillmor, dan. “antitrust suits dent microsoft cash, not its monopoly.” chicago tribune, 24 march 2001.

hof, robert d. “commentary: java can be a contender—if sun lets it.” business week, 6 april 1998.

trends report 2001—trends shaping the digital economy. washington, dc: the software & information industry association, 3 october 2001. available at http://www.siia.net.