Monday, December 31, 2007

Start with Relational Databases

I'll start with relational database management systems (RDBMS) as the first part of the software industry to analyze. Here are several reasons why I've started with RDBMS:

  1. RDBMS is a large market in its own right, producing $15-16 billion worldwide revenues in 2006 according to Gartner Group and IDC.

  2. Relational databases form the foundation layer of enterprise software applications. An understanding of the RDBMS market will help in understanding the enterprise software market, and in particular to evaluate the Oracle and Microsoft growth strategies in enterprise software. Furthermore, the continuing demand for enterprise software should support continued growth in the RDBMS market.

  3. Three players (Oracle, Microsoft, IBM) have demonstrated what appear to be "winning" strategies; together, the three have consistently dominated the market over the past decade. Their successes may offer insights for other parts of the software industry.

  4. The industry leaders now face a robust and increasing threat from open source, most notably MySQL. This struggle may offer a preview into the challenges that other parts of the software industry will face due to the incursions of open source.

  5. The underlying technology itself is maturing, but is by no means mature. RDBMS vendors continue to upgrade their products and release new versions, expanding the scope, scale and types of data their systems can manage.

Monday, December 10, 2007

Vivendi Acquires Activision

Last week, Vivendi announced the acquisition of a majority share in Activision. If all goes according to plan, Vivendi's online gaming and entertainment business (most notably Blizzard Entertainment) will be merged with Activision's business. Vivendi will end up with a majority stake in the combined company, which will continue to trade under the name Activision.

The press release spells out a strategic rationale for the transaction (emphasis added):

Said Robert Kotick, Activision's Chairman and Chief Executive Officer: “This is an outstanding transaction for Activision and our stockholders, as well as a pivotal event in the continuing transformation of the interactive entertainment industry. By combining leaders in mass-market entertainment and subscription-based online games, Activision Blizzard will be the only publisher with leading market positions across all categories of the rapidly growing interactive entertainment software industry and reach the broadest possible audiences. By joining forces with Vivendi Games, we will become the immediate leader in the highly profitable online games business and gain a large footprint in the rapidly growing Asian markets, including China and Korea, while maintaining our leading operating performance across North America and Europe. Activision stockholders will benefit from significantly increased earnings power and the recurring nature and predictability of subscription based revenues, while also having the opportunity, if they choose, to receive $27.50 per share for a portion of their shares in the post-closing tender offer.”

How compelling is this rationale?

Activision asserts that the merger will give the combined company "leading market positions across all categories of the rapidly growing interactive entertainment software industry." This rationale implicitly assumes that leadership in each category is a desirable position for the company. This assumption sounds plausible, given the high fixed cost and low variable cost structure of the industry, but would be worth verifying.

Assuming that category leadership is a desirable outcome, the economic value the merger creates, as well as the level of effort required for post-merger integration, will depend in part upon whether the leading market positions would arise from economies of scale or economies of scope. The merger could generate economies of scale if Activision and Vivendi had overlapping customer bases, redundant cost structures, or underutilized assets that could be rationalized as a result of the combination (a typical rationale for, say, merging two banks with overlapping branch networks). On the other hand, the merger could generate economies of scope if Activision and Vivendi had complementary businesses that could add value to each other (a typical rationale, for, say, merging a bank with an insurance company).

Scale-based mergers generally require far more effort than scope-based mergers, but have a much greater likelihood of creating value. For example, in the retail banking industry, scale-based mergers have gradually but painstakingly created value during the past decade of consolidation, whereas scope-based mergers in financial services have proven far less durable.

In the Vivendi-Activision deal, I'd suspect most of the anticipated synergies are due to economies of scope, as the press release already implies that each company is already a leader in its respective categories.

The press release only mentions one specific economy of scope, the Asian market access that Vivendi would provide to Activision. How much value does this synergy provide? If this were the only synergy, would a transaction with Vivendi be the cheapest and best way to get better access to China and Korea? Have Activision and Vivendi already developed a plan to capture the value of this opportunity?

Do the companies have any other synergies in mind? Does Vivendi intend to extend the Activision game franchises to more fully take advantage of the subscription-based business model? Does Activision have unique product development skills or distribution channels that could otherwise increase the value of Vivendi's Blizzard Entertainment franchises? Are there other cross-sales opportunities?

I'll be curious to see whether this merger was motivated by strategic considerations, and if so, to what extent the synergies are realized, and to what extent they cover the premium that Vivendi is paying for Activision. Or whether this merger is motivated more by financial considerations (such as finding a more optimal capital structure for Vivendi's game business).

Hat tip: WoW Insider

Wednesday, December 5, 2007

Market Map - First Draft

A market map shows an overall picture of the competitors in a market. It depicts the relative sizes of major submarkets, the extent to which each submarket is fragmented or consolidated, and the market shares of the key competitors within each segment.

The following market map shows the distribution of revenues of the 50 largest public software companies. This type of chart, called a marimekko, has the form of a rectangle whose total area represents the $150 billion of combined revenues of the top 50 public software companies. Each column of the chart represents a different submarket. The area of each smaller rectangle represents the revenue that a particular company earns from a particular submarket.

A few additional comments:
  • This chart does not include the revenues from smaller software companies, nor from privately held companies, nor from other companies (such as HP, IBM, EDS, Accenture) who have significant software revenues but are classified in other categories by Google Finance. I expect to update the market map to include these revenues one submarket at a time after examining each submarket in more detail.

  • This chart shows the latest full fiscal year published for each company as of December 2007, and so the list of companies is already a bit obsolete. Several of the companies on this chart have already been acquired, or are in the process of being acquired, by other competitors.

  • Because this chart shows revenues, it will not display the unit market shares of open source / freeware competitors.

  • All the data in the above chart was sourced from Google Finance and/or annual filings with the SEC (Form 10-K for US companies; Form 20-F for foreign companies with ADRs). Within the 10-K and 20-F forms, the relevant information is usually found in a footnote with a title like "Business Segment Reporting".