The prepackaged software industry covers companies involved in the design, development, and production of prepackaged operating, utility, and applications programs. The industry produces operating system and server software, computer games, office software suites, database software, applications for mobile devices, and a wide range of other software applications. The prepackaged software industry is distinct from the custom software industry, which offers programming services on demand.

Industry Overview

The software industry sells to both the corporate sector and to individual consumers. Improvements in the economy have led to increased spending from both companies and individuals. The sector also continues to benefit from the growing list of systems that rely on software. In addition to computers, software is developed for phones, cameras, game consoles, set-top cable boxes, and telecommunications products.

Overall prospects for the prepackaged software sector are good. Demand from the business world should remain strong as many companies work to automate production processes as a means of remaining cost effective and competitive. Increased regulatory scrutiny over the corporate sector is creating a demand for applications that monitor and manage corporate data. New technologies can also be expected to drive corporate software spending. Advanced forms of data content, such as audio and video, are becoming popular on the Internet and over corporate networks. Corporate spending supports a good portion of the software industry and increased spending from the business sector should translate into good sales for the sector.

The New Operating System

Microsoft's Windows commands the top position in the operating system market. On January 30, 2007, the company released Vista, the new version of Windows, as well as Office 2007, the company's latest suite of business applications.

Microsoft anticipated a decline in demand for its current products as customers waited for the newer versions to be released. In order to help counter this decline, Microsoft offered a program that allowed purchasers of new computers to upgrade to the new products at a significant discount. The plan is expected to decrease the early revenues from the new products, but it should not cause the software giant any problems in the long term.

The release may impact other areas of the software and computer products sector, however. Companies planning to upgrade to Vista may delay other software and equipment purchases until they have had a chance to integrate and evaluate the new operating system. Any slow down in demand for software caused by the implementation of Vista will probably be resolved in 2007, and business will likely start shopping for new applications and equipment to use with the new operating system by the end of the year.

Mergers and Acquisitions

The number of M&A transactions in the software sector was 29 percent higher in 2006 than in the previous years, according to a report from the 451 Group. The aggregate deal value, however, did not increase, remaining at about $34 billion. Software deals in previous years were characterized by multibillion dollar, big company transactions, but the focus has now shifted to the acquisition of smaller, less expensive companies. Typical targets in 2006 were companies such as second-tier vendors and niche companies.

Despite this trend, there were a number of big company deals in 2006. Hewlett-Packard acquired Mercury Interactive for $4.5 billion and Peregrine for $425 million. Oracle Corporation made multiple purchases, including deals for Stellent and Sunopsis. Microsoft made a small purchase, not disclosed but estimated at less than $50 million, acquiring ProClarity in order to enter the corporate performance management software market.

Hardware and equipment companies are also expanding their operations by acquiring small software firms serving specific niches. Hewlett-Packard has acquired more than ten software companies in the three years leading up to its November 2006 purchase of Mercury Interactive. The company is seeking to expand its revenue base beyond PCs and printers. In 2006, H-P expanded its software revenue 23 percent to $1.3 billion. Telecom equipment maker Cisco Systems recently acquired social-networking software maker Five Across Inc. The deal is part of a Cisco strategy of diversification. The company also recently acquired Internet security firm IronPort as well as Scientific-Atlanta, a maker of cable television equipment.

Software deals in 2006 accounted for seven percent of overall M&A spending. In contrast, the sector represented ten percent of M&A spending in 2005 and nearly 17 percent in 2004. Factors behind software industry deals in 2006 include the acquisition of new technologies and business models, as well as consolidation driven by customers wanting to deal with fewer vendors.

Outlook

Demand for software products is likely to continue at a good pace, particularly from the corporate sector. Corporate investment in upgrading and developing business systems, which was held off during the economic recession a few years ago, is likely to continue to grow. Ongoing technological developments will continue to open new markets and create new consumer products.

Sources: 451 Group TechDealmaker, Information Week, M&A Insight, New York Times, Value Line