If there's an IT recovery in store for this year, the top software companies haven't felt it yet.

Nearly every major vendor ended its last quarter with a slow sales warning. Analysts say the slump signifies a combination of spending jitters and deeper issues. Fundamental changes are under way in how customers buy software, and the shift could be a rough one for the industry's traditional leaders.

The biggest challenge the big boys face is increased competition, both from each other and from the rising pack of ASPs. Siebel used to sit comfortably in the CRM market but now its customers are being wooed by SAP, PeopleSoft, Oracle and a host of fledging companies.

"There's a tremendous variety of products in every category," said Josh Greenbaum, principal of Enterprise Applications Consulting. "Customers are buying from the enterprise companies, but they're also buying from some start-ups."

This year, the ASPs went mainstream, with Salesforce.com jumping onto the New York Stock Exchange and reporting close to $100 million in revenue. Some of that total comes from tapping a new market - the small companies willing to pay the $65 monthly per-user fees for basic sales-automation products. Such companies were never going to be customers for traditional CRM vendors, where even a small deployment can carry a six-figure price tag.

But the ASPs are looking to swim upstream, and are starting to win enterprise deals. Salesforce.com signed Automatic Data Processing and SunTrust Banks for more than 2,000-seat licenses each. Both companies run Siebel in parts of their business, yet both said they didn't consider Siebel in evaluating vendors for their sales-force automation projects.

Faster, cheaper, better
DecisionOne marketing head Frank Tait spoke with Siebel and SAP two years ago when he evaluated CRM options for his IT services firm. In the midst of a business-model overhaul, DecisionOne needed a system it could implement quickly, with a clear return on investment. "From the date of the contract signing, Salesforce.com took 45 days to get our data converted and our system live. The others were in the six-month timeframe," he said. "My customization cost for Salesforce.com was under $50,000. The custom cost for the traditional vendors was ten times that."

DecisionOne now has 150 employees using Salesforce.com, and Tait plans to remain a customer for the foreseeable future. "From an analysis perspective, it's been a gold mine. It's done exactly what we needed," he said.

AMR Research estimates that hosted services account for just two percent of the application market revenue today. But forecasts they'll be the fastest-growing segment of the market over the next five years. Independent analyst Amy Wohl said she thinks the ASPs aren't yet a major factor in the market, but suspects they will be as early as next year: "Down the road, I see it as an enormous possibility."

All of the applications vendors now offer hosting, with Siebel aggressively going after the ASPs. The company said in a recent regulatory filing that it expects to invest "significantly more" in the service this year than it will recoup in revenue.

The ASPs alone aren't causing the applications leaders' slowdown though. IDC calls 2003 a year "during which vendors worked feverishly to regain solid ground." Siebel and PeopleSoft showed double-digit falls in applications revenue last year and followed it with shaky first quarters. Oracle has kept its results on track so far, but its database sales help prop up its slow-growing applications business. Only SAP has remained unscathed this year.

Grate Expectations
The problem is widespread enough that JMP Securities titled its report on this quarter's rash of earnings warnings: "Application Software: What the #%^&*1$ Happened?" Among its conclusions were that expectations were too high, and concerns about the economy had led to buying delays.

AMR Research analyst Jim Shepherd agrees with that assessment. "All the indications at the end of 2003 were that spending was up, and there's a lot of activity out there. People are evaluating projects and getting started, but when we talk to users, they're getting more nervous about the economy. Even though they did increase their IT budgets, they're not spending the money," he said. "This is one of those cases where, when the vendors say the pipelines are good but that the deals are slipping out, they're telling the truth."

The malaise has hit a broad cross-section of the software market: In addition to PeopleSoft and Siebel, shortfall warnings came from storage developer Veritas, integration specialists WebMethods, Informatica and Ascential and infrastructure software makers Sybase, Computer Associates and BMC.

JMP Securities expects the floodgates to come loose - it forecast spending will increase 50 percent in the second half of the year. Others are less optimistic. Gartner doesn't predict a return to normal growth in the software market until 2006. Citing factors such as rampant discounting, it said in a report this week that the slow growth "reflects the conditions of the software market itself more than the wider challenges in the IT industry or economy".

In any case, analysts expect companies to have to fight hard for available dollars. "With software, you're committing to a long program of spending - implementation, roll-out, upgrades. Senior management seems to be very nervous about that," said AMR's Shepherd.

The profusion of available vendors means customers can shop around, and a shift toward modular buying means fewer multi-million deals. It also means that even after a customer is won, they can keep their supplier on a string by buying piecemeal and considering other vendors for additional functionality. "The move to Web services and open standards has made that possible," analyst Wohl said. "The customer may in the end opt for sticking with a single vendor, but they can do it just a few pieces at a time."