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Doom & gloom on the statistical scene.

DOOM & GLOOM ON THE STATISTICAL SCENE "The software marekt," Business Week has just warned us, "is downright mushy." In a lengthy story about declining growth rates in the micro software industry, BW earlier this month reported the troublesome news that buyers aren't buying and Wall Street analysts are slashing earnings estimates across the board. Result: "Software makers are worried."

What triggered this round of doom-and-gloom talk was the latest installment of a widely-quoted growth rate index published by the Software Publishers Association. The SPA this summer reported that industry-wide sales in the second quarter of 1989 grew a mere 8.8% over last year. That kind of growth might be cause for celebration in more moribund industries, but software companies have loftier expectations. Just a year ago, for example, the SPA announced a 51% jump in sales for the second quarter, and the industry reaction was a polite yawn.

How accurate is the SPA's measure of industry growth? Actually, the data itself is remarkably solid. Unlike commercial market research firms that rely on dubious samples of resellers and end users, the SPA extracts its sales numbers directly from a large collection of developers and publishers, who now include virtually all of the industry's major players (currently, 142 companies take part in the SPA's data collection program). We have a few quibbles about how the SPA massages its numbers for public consumption, but the overall quality of the database is better than any other research we've seen on this industry.

The problem is that the SPA's numbers are being used for the wrong purpose--to gauge the level of end-user demand in the current marketplace. Obviously, sales statistics will always bear some rough relationship to supply and demand. But the software business is particularly susceptible to volatile, short-term sales swings (caused by upheavals in sales channels, new product and technology introductions, rapid shifts in competitive strength, etc.) that have very little to do with end-user demand.

In the first half of this year, the software marketplace went through some particularly dramatic gyrations. The SPA's sales index makes much more sense if we apply a couple of correction factors to the data:

Correction factor #1: The Pinball Effect. Most micro software companies sell through a fairly complex network of distributors, dealers, VARs, OEMs, and other resellers. That network often acts like a giant pinball machine, bouncing inventory back and forth among resellers and gray marketers, who regularly overbuy to earn volume discounts and co-op funds. Eventually, most of what the reseller network buys ends up in the hands of real customers. But along the way, large amounts of inventory may spend literally months ricochetting through the channel. (Probably the most aggressive player of inventory pinball has been Ashton-Tate, which managed to keep up to six months of dBase inventory in motion before the big Tilt! sign began flasing.)

The trouble with inventory pinball is that the float is unpredictable. At the end of 1988, two major events--the Ingram/Micro D merger and Egghead's belated discovery of an overstocking problem--triggered a massive round of inventory belt-tightening among distributors and dealers. Resellers at all levels began looking for ways to clear their shelves and warehouses. "All the stuff from the 4th quarter came pouring back in 1989," says SPA research director Ann Stephens, who oversees the data collection program.

As a result, software companies this year have had a much harder time convincing resellers to load up on new inventory. But old inventory seems to have been selling at a relatively healty level. As an offshoot of its research program, the SPA also tracks growth rates for five major distributors; for this group, aggregate sales actually grew 33% faster in the second quarter than publisher sales. Looking at the two indexes over the past year and a half, it's clear that distributor sales (which are a slightly better measure of end-user demand than publisher sales) lost a little momentum this year--but far less than the publisher index would indicate:

Correction factor #2: The Big Wave Effect. As it happens, the first half of 1989 turned out to be an unusually rough period for the three largest companies that provide data to the SPA. Lotus didn't get Release 3.0 out until ten days before the end of the second quarter, Ashton-Tate suffered from hostile reactions to dBase IV overstocked channels, and Microsoft miscalculated the shipping date for Word 5.0 and was unable to fill orders for almost two months.

It's particularly important to take the upgrade traumas at the Big Three into account when we look at the SPA's growth index, because the index is heavily influenced by these three companies and a handful of others. In fact, just four companies generated 56% of the revenues the SPA used to create its 1989 growth index; seven others accounted for another 20%.

Thus, a temporary sales blip for a few large products ends up looking like a major collapse in "the market." (A similar effect also occurs in smaller niches that are dominated by one or two companies.) Because of the way this weighting factor works, the SPA's index really says more about the fate of a few big companies than about the industry in general. There were a good many smaller companies that grew almost explosively during early 1989, but their numbers were swamped by the waves made by The Big Three.

So what's the actual state of the market? When we adjust for reseller belt-tightening and upgrade traumas at a few big companies, the underlying level of end-user demand probably grew at a rate similar to what we've seen the last few years--that is, somewhere around 25%-40%.

Moreover, there are already signs that publishers are once again beginning to feel the effects of high demand levels. Microsoft just reported a 33% jump in revenues for the third quarter; Lotus followed close behind with a 32% rise. These numbers caught the "mushy market" theorists by surprise. But we suspect that the SPA's own third-quarter index will start to show similar evidence of a rebound. Eventually, the software industry may have to slow down to single-digit growth rates. But not for a while.
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Copyright 1989, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:outlook for software sales
Date:Oct 24, 1989
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Next Article:Footnote: why sales forecasts miss the mark.

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