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A Click Ahead Of The Competition

U.S. consumer confidence is improving. But many consumers returning to the shopping aisles have a different set of expectations than they did during their pre-recession shopping trips.

Shoppers have become smartphone savvy, more aggressive about using wireless devices to comparison shop and, in some cases, even pay for their purchases. They can turn frustrated with businesses that fall behind the technological curve.

Businesses also have rapidly evolving expectations. Manufacturers, financial services firms, retailers and others want to crunch more data, more closely track customers and more seamlessly link to employee and customer wireless devices. They want better ways to manage the growing reams of electronic data that are the backbone and livelihood of their businesses.

The top enterprise software companies are poised to cash in on these trends, says Joanne Correia, vice president of the software market research team for Gartner, a research firm.

"We are in the middle of a modernization of applications that people installed in the 1990s and early 2000s that are all aged out, so that is why you see growth (in the market)," she said.

Cloud-based computing is another driver of this "replacement cycle." Cloud computing allows companies to store and access their data over the Internet, through remote, often third-party-managed locations.

For many companies, cloud technology means faster, more agile business processes, says Karl Keirstead, an analyst for BMO Capital Markets.

"Speed to market is something I hear more and more about," he said. "As you move your applications to the cloud, the speed in which you can make changes and get live and download new versions accelerates tremendously.

1. Business Enterprise software is a big market. Estimated by Gartner to hit $278 billion in sales this year, it touches on nearly every aspect of operations across a multitude of industries. Large systems integrators including Oracle (ORCL), SAP (SAP) and IBM (IBM) have traditionally presided over the top of that food chain.

But a thriving pack of competitors target niche markets within the field, with an increasing focus on cloud computing.

NetSuite's (NYSE:N)software includes the all-important areas of enterprise resource planning, customer relationship management and e-commerce. All of its offerings are cloud-based.

Salesforce.com (CRM) is the leading provider of cloud-based customer relationship management software. Ebix's (EBIX) software is geared for the insurance industry. Manhattan Associates' (MANH) software helps companies better manage their warehouses. Another firm, Synchronoss Technologies (SNCR), manages transactions such as text messages between connected devices for telecom companies and others.

Still another, the Ultimate Software Group (ULTI) focuses on human capital management, which helps companies handle everything from hiring to setting up benefits programs for employees.

For many companies, having the best-of-breed product is the difference between success and failure, says Christine Dover, an analyst for market tracker IDC.

"If I can start to pull together information about my workforce, about what is happening with my financials, I can actually improve how my business works," she said.

But the playing field is largely uneven. Some companies are growing faster than others. Many are profitable, but not all. Of the 46 companies in the sector, only three have EPS Ratings above 90; 35% of the group trades below 10 a share.

2. Market By 2016, global sales of enterprise software will grow to $359.7 billion, says Gartner. The researcher expects worldwide enterprise software sales to grow 6.4% next year, to $295.8 billion.

The replacement cycle is a big part of the growth and why companies such as NetSuite and Salesforce.com are posting quarters with year-over-year revenue growth of 30% or better, says Correia.

"People are modernizing their apps, they are investing because that is how you keep your customer," she said.

3. Climate Enterprise software makers are also benefiting from software-as-a-service systems, where customers pay per month for the software they use. This SaaS approach is fast becoming a preferred alternative to on-premise services, which require companies to prepay a large license fee.

The SaaS-based model also gives companies more flexibility with their accounting, says Correia.

"A lot of the software is moving to software-as-a-service because you can move it from a capital expense to general expense line and pay for it as you go vs. paying $5 million upfront to refresh your customer relationship management system," she said.

Mergers and acquisitions are also providing some benefit, says IDC's Dover. "There's a lot of cranky old systems out there that (companies) acquired through an acquisition so they are modernizing them," she said.

Venture fund investments in the entire sector of private software companies through the first nine months of the year reached $6.13 billion vs. $7.31 billion for the entire calendar year of 2011, says PricewaterhouseCoopers and the National Venture Capital Association.

An improving economy will likely only increase the pace of investments, says Tracy Lefteroff, global managing partner of PwC's venture capital practice.

"Once the economy picks up, you are going to see more capital expenditures at some of these companies, which is going to provide a real boost to some of these younger companies developing products to sell into that space," he said.

Software continues to dominate technology-related mergers and acquisitions. In Q3 there were 20 such deals with a cumulative value of $14.2 billion, vs. 27 deals valued at $5.9 billion in the year-ago quarter, says PwC.

The enterprise sector will likely lead M&A activity in the next 12 to 18 months, says Todson Page, a partner for PwC's transaction services practice.

"Obviously, the buzz words are cloud, applications management software, storage-related software and security — those are significant areas that are going to be hot," he said.

4. Technology Cloud computing is becoming a rallying cry in enterprise software. And several companies are trying to cash in — fast. In October, Oracle (ORCL), a leading maker of database management software, launched several in-house, cloud-based software initiatives. The company has also been acquiring cloud-based companies to quickly boost its cloud competency.

SAP (SAP), Oracle's biggest rival, has also stepped up its push into the cloud with acquisitions. It spent $3.4 billion on SuccessFactors, a maker of human capital management software and $4.3 billion on Ariba, which manages a cloud-based e-commerce market for businesses.

But SAP has challenges, says Gartner's Correia.

"They are in the manufacturing space in Europe and the U.S., which has also been hit (by economic weakness) so a lot of manufacturing is just starting to retool — it's one of the last legs when you look at an economic recovery," she said.

Salesforce.com has applied social media to help fend off rivals. The company's Chatter social media service for businesses to exchange information between departments has been instrumental in the company staying ahead of rivals, says BMO's Keirstead.

"The ability to download and use Chatter for free does make the client relationship stickier, so that has proven to be a good move on the part of (Salesforce.com Chief Executive Marc) Benioff," he said.

5. Outlook Upside: Companies rely on enterprise software to help shape and direct their businesses. Cloud-based computing, the software-as-a-service model and the need to replace antiquated systems are clear market drivers that should continue to push demand.

The public market has also warmed to newcomers. Shares for Workday, a maker of human capital management software, shot up more than 73% on its first day of trading on Oct. 12, despite having no profits.

Risks: The cloudy uncertainty of business taxes associated with the so-called fiscal cliff is an issue. Companies can't set spending budgets without knowing how much they must set aside for Uncle Sam, says Gartner's Correia.

"Not having an agreement on the debt ceiling and taxation freezes everything — it affects hiring and capital expenditures," she said.

Competition could also be a factor. Larger software companies will likely continue to push to get a bigger share of the cloud, says BMO's Keirstead.

"The mega vendors, SAP, Oracle and Microsoft in particular, become more aggressive in embracing this cloud shift and begin to get traction and slow down the growth of these pure plays," he said. "That has long been a fear."