Potential changes in the wider IT world will have a significant impact on software licensing and the software market during the next 10 years and software vendors must establish more realistic margins to guarantee long-term survival in what will become an increasingly competitive market. 

Gartner analysts warn that leading application vendors will find themselves particularly challenged as IT organisations seek to reduce software charges as they have done successfully with hardware and services costs in recent years.
"Up until now the unique nature of the software market has meant that buyers had very little negotiating power after the initial purchase of a software license," says William Snyder, research vice-president at Gartner. "We expect those dynamics to change considerably over the next five to 10 years giving chief information officers (CIOs) and software procurement officers more bargaining power while potentially reducing software vendor profit margins."
Snyder says changes will result from new delivery models such as the increased use of business process outsourcing (BPO) and software as a service (SaaS); new business models such as open source offerings and third party maintenance companies; and differing demands from new, large buying centres, such as China and India.  In addition, the transition to service-oriented architectures (SOAs), combined with the emergence effective, low-cost offshore development options will enable a resurgence of procurement choices for some new applications at justifiable prices, thus reducing dependence on the giant application vendors.
According to Gartner, seven key trends will transform the software market over the next 10 years:
* Increased use of BPO: The worldwide BPO market is the fastest growing IT service segment and is expected to grow from $144-billion in 2006 to $235-billion in 2011. Many BPO providers don't use commonly available commercial applications, effectively bypassing the major software vendors and reducing the overall market opportunity for vendors in this market.  Even those providers that do use software from major software vendors have such a stronghold on the market that they likely to be able strike much better deals than the average customer.
* Increased use of SaaS: Gartner predicts that 25% of all new business software will be delivered by SaaS by 2011.  This model – in which software is managed and delivered remotely and charged as a paid service – will have a big impact on buyer-supplier relationships and on software margins. Gartner believes that many of the lock-in costs will be lower in SaaS models (customisation, for example, is usually limited to configuration in a SaaS environment). Some costs may be completely provided by the SaaS vendor and embedded in the monthly fee, for example, implementation and upgrading costs. "These cost differentials will change the dynamic between customers and suppliers," says Snyder. "Although switching SaaS providers is neither easy nor free, the notion of competition doesn't disappear after the initial purchase, enabling some level of negotiation on renewal of deals."
* Low-cost development locations combined with modular architectures: The advent of SOAs and more modular service-oriented applications, together with the availability of skills in lower-cost development environments such as India and China, means that alternative sources for new business software components are becoming more widely available. For example, an organisation might not go to an offshore provider for an entire finance or HR application but might approach them to purchase a smaller add-on module at a more competitive rate.
* The emergence of third-party support offerings: Maintenance services have been a quasi-monopoly for software vendors. For many years only the software vendor had rights to the source code of the critical components of the system. This made it impossible to go to an open, competitive market to obtain upgrades, services and support, which in turn made it impossible to negotiate maintenance fees. Now a secondary market is emerging to provide alternative maintenance services. While these companies do not provide new functionality, nor do they generally have access to source code they do offer to maintain established versions and do legal and regulatory updates, usually for half the price of established maintenance fees.
* Growing interest in open source software: The open-source software (OSS) movement is having a distinct impact on buyer-supplier relationships in the software industry.  The most direct impact involves the ability to provide higher-quality software at lower costs.  OSS is also shifting focus to the services provided which will mean more competition and lower margins. "OSS solutions will compete directly with closed-sourced products in all software markets although their influence will vary significantly one from technology market to another," says Snyder. "Although it is never going to destroy industry giants such as IBM and Microsoft, it will put pressure on traditional software margin structures as these and other large vendors endeavour to counter this competitive threat." Gartner predicts significant interest in OSS in areas such as server, operating systems, development tools and database technologies but much less maturity in technologies such as ERP and CRM.
* Emerging Chinese software companies: Many dominant foreign software vendors are struggling to enter the Chinese market where the premium prices usually charged for business applications are severely challenged by the relatively price-sensitive local market. Western companies looking at China are asking about local software packages because they see SAP/Oracle as too big or too sophisticated for Chinese operations. Gartner believes that once companies can offer pan-Asian
solutions ­ be they Western or Chinese – they will represent more credible competition and the lower prices they offer could affect the global software market significantly, creating downward pressure on margins.
* Rapid expansion of Chinese, Indian and Brazilian Markets drives demand for lower costs: One of the most potentially profound impacts on software costs and markets is the entrance of largely populated countries into the computing market. Because of their large workforces, as these countries adopt technology more broadly, there will swiftly come an inflection point at which software costs will be more problematic.  Furthermore, these countries are not held back by legacy software investments and are free to start from a "greenfield" environment using the latest and best techniques from both an architectural and economic point of view. The ability to leverage SaaS, instead of relying on purchased software licenses, gives largely populated countries entering the market even more latitude on how they will invest in software.
"Software buyers need to realise that the pendulum is beginning to swing in their favour and there are an increasing number of alternatives in today's software market," Snyder says. "We would advise IT organisations to use BPO and open-source alternatives to improve their negotiating power with software suppliers as well as employing the emergence of third-party vendors as a means to reduce higher maintenance fees on older versions of software. Costing out the possibility of using offshore skills to build application functionality as web services will also help negotiations with vendors."