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VC report: Enterprise software in the doldrums

New venture capital investment in the enterprise software industry has fallen off a cliff since the heady days.

Market Commentary
VC report: Enterprise software in the doldrums

New venture capital investment in the enterprise software industry has fallen off a cliff since the heady days and has continued to erode over the last 12 months, according to Hurwitz Group research. In the first half of 2002, investment was down by 60% with just over 80 deals representing more than $300 million, in contrast to the second half of 2001 when VC investors put together about 240 deals for about $1.1 billion.

Pockets of relative strength remain, however. VC firms continue to show sustained interest in security software, integration, and systems management start-ups. In the aftermath of September 11th, and high profile hacker attacks, investment in security comes as no surprise. Less obvious are the clusters of activity in systems management software and integration. Hurwitz Group believes that this is due to the undercurrent of opportunity that lies in allowing corporate computing environments to realize a greater return on existing IT assets - a major driver for innovation in the enterprise software industry over the next five years. Enterprises are still plagued with applications that can't talk to each other, data that is locked up in isolated silos, and under-utilized hardware capacity, but:

  • Web services promises faster and cheaper integration. Packaged, legacy, and custom applications still don't work together, driving investment in Web services technologies. Integration solution start-ups took in more than $158 million including $48 million in message-based integration, $33 million for process integration, and $39 million for XML-based integration. Two of the biggest deals were Grand Central Communication's $28 million first round funding in December 2001, and Sarvega's $9 million round in October 2001. Grand Central Communications is one of the leaders in Web services networking, providing a guaranteed messaging infrastructure for SOAP-based Web services, while Sarvega has developed an XML-based switch to smooth information flow between employees, partners, and customers.

  • New tools emerge for IT asset control and utilization. As firms try to leverage existing investments in applications, infrastructure, and data storage, VCs invested more than $225 million in new management technologies. The significant deals in this category were Masergy's $57 million first round in September 2001 and ExaNet's $17 million round in December. Masergy's network software products purport to enhance application performance using a customer-controlled outsourced infrastructure. ExaNet ExaStore is designed to overcome the scalability limitations such as capacity and bandwidth usage of today's storage software solutions.

  • Protecting IT assets from attack remains priority. Venture funding for security software topped $195 million including $135 million in network and data security, and another $45+ million in authentication and access control. Noteworthy deals were Asita Technologies $24 million round in October and Imprivata's $13.5 million round in April 2002. Asita Technologies specializes in virtual private networking software, while Imprivata develops and markets user identity and authentication technology.

For investors, it's tough to place bets on new technologies when enterprise spending is in the tank and forecasts pointing to a turnaround in corporate fortunes are pushed farther out every quarter. Today's smart investments focus on tools that help organizations clean up the technology mess they made in the late 90s. By 2004, enterprises will shift their focus from cleaning up back to using technology to create competitive advantage in the market.

Copyright 2002 Hurwitz Group Inc. This article is excerpted from TrendWatch, a weekly publication of Hurwitz Group Inc. - an analyst, research, and consulting firm. To register for a free email subscription, click here.

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