What IBM's Cognos deal means

NEW YORK (Fortune) -- Tighter credit isn't stopping the world's biggest tech companies from continuing their acquisition binge. Software that helps customers understand what's happening in their businesses is, as an analyst says, "redhot."

Just this year, all three big independent public software companies in business intelligence (BI) have been snatched up by bigger players - Hyperion by Oracle (Charts, Fortune 500) for $3.3 billion in February, Business Objects by SAP (Charts) for $6.8 billion in early October, and now Cognos (Charts) by IBM (Charts, Fortune 500), for a healthy $4.9 billion. Now, all eyes are on SAS, the last remaining big player.

These three big buyers, along with Microsoft (Charts, Fortune 500), are each consolidating software services for business customers, who are tired of having to deal with armies of salespeople and systems integrators working for diverse vendors. The cry from customers is for simplicity, and the answer from the vendors has been to go and buy companies.

BI is a profitable business, and one that's growing rapidly because the core functions of reporting and analyzing corporate data are so important now that just about every function in a typical company is automated with all the many flavors of enterprise software.

If it can be measured, it is being measured, and these business intelligence software companies are the ones doing the measuring. This software helps companies understand the meaning of their most critical information, like the relationship between fares and load factors for an airline.

I called my longtime friend Bruce Richardson, the dean of enterprise software analysts, at AMR Research in Boston. Together with his colleague John Hagerty, Bruce published an amazingly prescient note to customers back in September 2005 about the prospects of industry consolidation in business intelligence.

"Don't rule out Oracle-Hyperion," it said. "If this happens, does SAP go with Business Objects? The two already have a partnership. IBM-Cognos would be an interesting fit." That's exactly how it played out. Hagerty and Richardson even got the order right!

Both Richardson and John Kordyback, a senior consultant at Chicago IT services firm Thoughtworks, say simplification is what customers crave. Kordyback believes that Microsoft, with which he frequently works, is a strong contender because it has incorporated reporting and analysis right into its Dynamics suite of enterprise software products.

Says Richardson: "Ultimately what all companies want is BI stuff that is so easy to set up and configure that we don't need somebody from IT to come in and do it for us. That would be Microsoft's market to own if they could figure out how to do it." He's not confident they necessarily can, however.

In some ways the consolidation is the last gasp of the old generation. By contrast, the cutting edge in enterprise software is software-as-a-service, represented by companies like Netsuite and Salesforce.com, which don't sell software at all but simply operate a service over the Internet. They have all a company's data already in their own databases, and increasingly offer analytical capabilities as part of their services. They can intrinsically solve the setup problem Richardson speaks about. There's no setup at all - it's just another function on the dashboard from Netsuite or Salesforce.

But so far, their customers are mostly smaller companies. Nonetheless, it wouldn't surprise me if in the near future some of these software-as-a-service players started getting bought by the big boys.

For bigger companies a plethora of products exist simultaneously, so it's very hard to switch over to an online solution like the ones Netsuite and Salesforce provide. Just about every major Fortune 500 company is already using products from all three of the major public companies that are just being sold, as well as SAS, the private software powerhouse which remains independent. That's because individual groups and departments have typically gone out and bought their own software.

IBM, as the leader in enterprise technology services, wants to be the company that can solve any company's software problems, increasingly with its own products. That's why it has acquired 38 software companies since Sam Palmisano became CEO in January 2003.

Already this year IBM has bought Watchfire, Telelogic, DataMirror, WebDialogs, and Princeton Softech. While IBM makes good margins on its software business, it also bolsters its position in the even bigger business of IT services.

But this acquisition complicates the strategic equation for IBM. It is a huge partner of SAP's. "For every dollar SAP generates in an account," Richardson explains, "IBM generates $10." That's because of the enormous difficulty of effectively installing and operating complex enterprise software systems. Now the Cognos deal, coming after SAP's purchase of Business Objects, puts them directly into competition.

One big looming question is what happens to SAS, the sole remaining large data analytics software company. SAS is private. But if CEO Jim Goodnight were to decide to sell it, estimates Richardson, it would command at least as much as the $6.8 billion SAP paid for Business Objects. But who would be the buyer, now that the majors mostly have made their play?

One possibility: Hewlett-Packard (Charts, Fortune 500), which is aggressively seeking to build its own software capabilities. Watch for it to buy SAS if it can, or else perhaps one of the other two remaining public BI companies, Informatica and Microstrategies. Both are well-respected but command smaller customer bases than the three that have already gone on the auction block.

In any case, you can bet that the investment bankers are preparing proposals. As Richardson says, "the category is redhot."