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Software Safety Zone

Vendors bucked the bleak economic trend in 2009 and are well positioned for survival.

It may comfort CFOs who sign off on technology expenditures to know that, regardless of the recession, software vendors are likely to be stable, healthy, and good bets for survival.

While it is perhaps no surprise that the software sector, with its potential for delivering efficiencies to customers, would perform relatively well in dark economic times, it was hammered with losses in 2008, the first year of the current recession. But in 2009, when most industries were at their nadir, the sector achieved a remarkable recovery that is continuing this year.

Illustrating those events is a new report from OpexEngine, a provider of financial-benchmarking data to midsize and small software companies. The firm, for its fourth such annual report, received detailed performance information on the 2009 calendar year from 64 companies with annual revenues between $20 million and $120 million, 60% of them privately held.

The average operating margin for survey participants was 8%, compared with negative 25% in 2008. That was driven partly by a shift in focus toward short-term revenue generation, as revenues grew by 15%. And the good times may continue to roll: almost three quarters of those polled are expecting even stronger revenues in 2010.

Opex Cht

But expense-management efforts were at least as important. Total average operating expense as a percentage of recognized revenue fell from 126% in 2008 to 118% last year. (Those figures are so high largely because of two related factors. One is the presence of a few outliers in the survey data; the median operating expense ratio in 2009 was only 92%. The other factor is the performance disparity between public software companies, whose average opex ratio in 2009 was 89.5%, and the typically younger and smaller private companies, which weighed in at 148%.)

The two biggest expense areas for most software firms — sales and research and development — both declined significantly. Sales dipped from 29.1% to 24.5% of recognized revenue, while R&D went from 23.9% to 20.1%.

Worried about the prospects for revenue growth and with their sources of capital having dried up, “software companies had no choice but to become profitable,” says Lauren Kelley, CEO of OpexEngine, which this year for the first time announced the availability of its report in conjunction with the Software and Information Industry Association. “As it turned out, they did see revenue growth, and now the small and midsized software industry is pretty stable despite the recession.”

Stability is a particular key for start-up software vendors, since they must win potential customers’ trust that they will survive for the long term. “Clearly these companies are succeeding in that, or they wouldn’t be showing the revenue growth that they are,” says Kelley. Public software companies improved their operating income as a percentage of recognized revenue from negative 6.8% in 2008 to positive 11.5% in 2009, but private ones showed even greater improvement, from negative 47.7% to negative 20.4%.

But while sales costs fell, marketing headed in the opposite direction, climbing from 12% of recognized revenue in 2008 to 17% last year. That was attributable to increased use of sophisticated Internet-based marketing tools, Kelley notes. But it also drove the vendors’ ability to whittle down the bigger sales-cost bucket. “If you’re doing a good job of lead generation and qualification through the Web, you don’t need as many high-salaried salespeople who are out running up a lot of expenses,” she says. “Software CFOs should feel comfortable if their marketing ratio is creeping up, because that is what’s happening in the industry.”

The software sector also showed great improvement last year in another key performance metric, per-employee productivity. Recognized revenue per employee averaged $205,000 in 2009 for the survey participants, up 21% from the prior year. By comparison, operating expense per employee rose by only 6%.

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