Information Technology Ecosystem Health and Performance by bau17118

VIEWS: 99 PAGES: 41

									               Information Technology
                     Ecosystem
               Health and Performance




Dr. Marco Iansiti, Ph.D.
Professor of Business Administration
Harvard Business School


Gregory L Richards
Managing Director, Keystone Strategy, Inc




Boston, MA
November, 2005
Information Technology Ecosystem Health and Performance


                                   Abstract


        The purpose of this paper is to understand the health and wellbeing of the
Information Technology industry. This goal is accomplished by introducing the
concept of an Information Technology “ecosystem” which is the large network of
firms that drive the delivery of information technology products and services. At the
beginning of the 21st century the Information Technology ecosystem went through a
deep recession and retrenchment. About the same time Microsoft Corporation
entered into a Consent Decree with the US Department of Justice that resolved their
multi-year antitrust dispute. The data shows that since this time, the Information
Technology ecosystem has regained its health, competitiveness, productivity, and is
delivering significant levels of innovation from both new market entrants as well as
incumbent market leaders such as Microsoft.




                                          2
Table of Contents .............................................................. Page
Overview ...................................................................................................... 4
I The IT Ecosystem ........................................................................................ 4
  Ecosystem Roles and Structure ..................................................................... 6
II Ecosystem Health and Competitiveness.......................................................... 9
  A Robustness.............................................................................................. 9
  B Productivity ............................................................................................11
     IT Productivity ........................................................................................11
     IT Recovery and Impact on US GDP ...........................................................12
  C Innovation and Niche Creation...................................................................14
III Rapid Innovation in the IT Ecosystem in 2005: .............................................16
  A Platform Diversity....................................................................................17
     The Growth of New Middleware Platforms....................................................17
     New Integrated Platforms .........................................................................22
  B Innovative New Business Models................................................................28
     Google: Performance-based Advertising......................................................28
     eBay: auctions between anonymous peers ..................................................31
     Salesforce.com: Corporate applications as a service .....................................34
  C Rapid innovation changes the focus of competition .......................................35
IV Conclusion: IT is healthy and competitive .....................................................36
Appendix A: Goldman Sachs Technology Indices Constituents .............................37




                                                       3
Overview
       This paper provides a compendium of data and analysis aimed at
understanding the current health of the information technology ecosystem. By “IT
ecosystem” we refer to the network of organizations that drives the creation and
delivery of information technology products and services.

       The IT ecosystem began the 21st century by entering a deep recession,
exacerbated by excessive investments and business failures in the Internet, Software
and Telecommunications industries. At around the same time, Microsoft Corporation
and the US Department of Justice entered into a Consent Decree (“Consent Decree”)
that resolved their multi-year antitrust dispute.

       In order to assess the health and competitiveness of the IT ecosystem since
these events, the first half of this paper reviews three crucial IT ecosystem metrics:
productivity, robustness, and innovation. Innovation has special importance within
the IT industry, and as such we continue with a fourth analysis of specific product
and company case examples that highlight significant new developments across
hardware, software, and services.

        Our analysis indicates that since this period of retrenchment, the IT
ecosystem has regained its health, rebounding from its recession and delivering
significant levels of innovation. Drawing from a variety of public and proprietary
data, including market value indicators, productivity measurements, and return on
invested capital metrics we find that with respect to the three critical indicators of IT
ecosystem health, robustness, productivity, and innovation, the IT ecosystem is
strong in all three of the most important sectors of Hardware, Software, and
Services.

        More detailed analysis of individual ecosystem domains is consistent with this
overall picture, and showcases striking examples of innovation, diversity, and
increased competitiveness in a variety of settings. A broad set of software platforms
and middleware, ranging from the Linux operating system to the Apache Web
content delivery platform, continue to capture increasing market share and
important market positions. Web browsers are becoming more diverse through the
success of new entrants such as Firefox. Traditional software firms are showing
recovering productivity numbers. Additionally, new software driven services like
Google and eBay are exhibiting stunning growth through innovative business models.
Lastly, the introduction of popular new devices, ranging from smart phones to music
players, is combining hardware, software and content solutions in innovative ways to
deliver new converged experiences to customers.

        In summary, the strong recovery of the IT ecosystem, as indicated by
significant improvements in productivity, innovation, and diversity provides
persuasive evidence of the sector’s health, robustness, and competitiveness.


I The IT Ecosystem
       The IT industry today consists of a rapidly evolving and massively
interconnected network of organizations, technologies, products and consumers. In
contrast with the vertically integrated environment of the 1960s and 1970s, today’s



                                           4
industry is divided into a large number of segments producing specialized
components, systems, and services. The degree of interaction between firms in the
industry is truly astounding, with hundreds of organizations frequently involved in
the design, production, distribution, or implementation of even a single product.

        This network of organizations can be compared to a biological ecosystemi.
Like its biological counterparts, the IT ecosystem is characterized by a large number
of participants who depend on each other for their mutual effectiveness and survival.
Because the performance of individual firms and the utility of individual products
depends so much on the performance of other firms and products in the ecosystem,
understanding the IT ecosystem requires the development of ways to characterize
the collective health of the setting.

       The boundary of the IT ecosystem is difficult to define. The organizations
that influence the value of a single IT product or service are many and dispersed
across numerous traditional industries, ranging from software application developers
to venture capital firms. Some of the most important domains of the ecosystem are
depicted below in Figure 1. A domain is a specific group of organizations in an
ecosystem that shares common characteristics and solves similar problems for its
customers.

         For the purpose of this analysis, we restrict our focus to the “core” domains
shown in Figure 1. The market opportunity map of Figure 1 shows the size of the
market in Billions of dollars to scale across the horizontal axis for some of the most
important sub-sectors of IT hardware, software, and services. Figure 1 also
illustrates the market share along the vertical access of the constituents of each of
the sub-sectors It is important to understand that the sectors of the IT ecosystem
shown in Figure 1 are not isolated from the rest of the economy, but instead interact
with it in crucial ways. Among the causes of the poor health of the IT ecosystem
after the economic downturn in 2001, for example, are the performance of sectors
like banking and telecommunications that are beyond the scope of our current
analysis.ii
                                                                                                                                     Internet and Media
                               Hardware $969B                          Software                                            ISP                      Services $693B

                  $226B             $507B             $236B                                $167B                          $245B        $86B $84B $136B                                                                         $473B
                                                                                                                                                           Digital
                                                                                    App Dev




                  Micro-                                                                                                                                                                                                    Consulting
                processors
                                                                                                        ERP, CRM, SCM




                                                                                                                                                                              US Hardware Channels
                                                                                                                                     Internet Content Providers




                                                                                                                                                                                                     Hardware Support
                                                                  Security Middleware, DB, Storage




                             PC’s & Workstations
                                                     Mobile
                                                    Handsets                                                                                                                                                             Development and
                                                                        Windows




                                                                                                                        Wired Data                                                                                          Integration
                                                                                                                         (Cable,
                                                                                                                                                    Film and Recorded Music




                                                                                                                        DSL, Dial-
Market Share




                                                                                                                           Up)
                                                                                                        Gaming Office




                                    Server
                  Other                             WMA/MP3
                  Semi-
                conductor
               Components      Printers / Storage
                                                                                                                                                                              US Software Channels


                                                                                                                                                                                                     Software Support
                                                                                                 Unix




                                                    Consumer                                                                                                                                                            Process Mgmt and IT
                                                    Electronics
                                                                                                        Other




                                                                                                                                     Other
                                                                  Other




                             Networking Equipment                                                                        Wireless
                                                                   Other




                                                                                                                          Data



Figure 1: Core Domains of the IT Ecosystemiii



                                                                                                        5
       It is also worth noting that Software, an important segment of focus in the
Consent Decree, represents a very small vertical slice of the overall IT ecosystem.
Even more striking is the smaller size of the operating system market, at $23 Billion,
compared to over $2 Trillion for the broader IT industry. Despite its smaller size,
operating systems and other platform domains have broad importance to many other
players in the ecosystem.

Ecosystem Roles and Structure

        Although they depend on each other, not all members of an ecosystem are
the same. Perhaps most importantly, not all members of an ecosystem perform
similar roles. Two critical and distinct roles are application providers and platform
providers.

        Some ecosystem participants compete by providing a product that is used
directly by an end customer to solve a set of problems. This is what we define as an
“application.” For example, in the physical world, an application of concrete is a
bridge or an office building. In the IT ecosystem, Intuit’s Quicken financial
management products or SAP’s enterprise resource planning suite represent software
applications, because their primary purpose is to be used directly by end customers.

        In other cases, members compete by providing “platforms.” A platform is a
set of tools or components that provide building blocks for application providers. A
platform for bridge building might include standard formulations for concrete with
reliable strength and rigidity characteristics. Examples of platforms in IT include
Microsoft Windows and Red Hat Linux. Windows and Linux are complemented by
extensive tool sets and are used by millions of developers to more easily write end
user applications.

       Platform providers perform a critical role in an ecosystem – they deliver
consistent and reliable components that make application providers more productive.
The tools and building blocks they provide to ecosystem members make it easier to
create powerful applications that in turn benefit end-users. In doing so, platform
providers can act as “Keystones” to their ecosystems, generally enhancing
innovation and productivity.iv The term Keystone is drawn from biology, where a
“Keystone species” performs a function that is critical to the health of the whole.

        In the IT ecosystem, the vast majority of organizations provide applications.
The relatively few platform providers form crucial “hubs” in the ecosystem, in that
their tools and components are typically used by many of the organizations providing
applications. In this way, platform providers effectively connect many application
providers to each other and end users, defining critical common interfaces, as well as
reusable components.

       Operating systems are possibly the most crucial platform for the building of
applications. The stability and reliability of these platforms is of fundamental
importance to the many participants that build upon them. Since 1999, companies in
the IT sector are relying increasingly on more than one operating system to support
their applications. In an analysis performed by Keystone Strategy, Incorporated,
that included a sample of thousands of ISVs, the percentage of ISVs deploying their



                                          6
software for more than one operating system platform (self reported by the ISV in a
questionnaire) increased from 41% to more than 50%. This in turn would suggest
that the value of supporting multiple platforms, such as Linux, Unix and the Mac OS,
is exceeding the cost of support, leading to a more varied and competitive
ecosystem.


                100%

                80%
                                                 ISVs Supporting Multiple
   Percentage




                                                 Platforms
                60%
                                                 ISVs Supporting Single
                40%                              Operating System
                                                 Platform
                20%

                 0%
                       1999 2001 2002 2003


Figure 2: Growth in ISV Support for Multiple OS Platforms 1999-2003v
        Further analysis indicates that operating system adoption is increasing in
diversity. Linux is a well-known example of an operating system platform that was
created initially by Finnish programmer Linus Torvalds and was developed almost
entirely in “open source” software circles. Linux has evolved into a comprehensive
operating system with a growing application set. Deployment of Linux as a platform
for servers continues to grow. Additionally, Linux is starting to make inroads into the
desktop market.

       The figures below show that the percentage of software application vendors
supporting the Linux operating system has grown appreciably from 1999 to 2002.
Support by application vendors for an operating system is a crucial component of the
success of the operating system as a platform. Without applications, the operating
system provides little value to the ecosystem or its customers. Growing support by
applications vendors provides much greater opportunity and choice for customers to
take advantage of the platform’s benefits.




                                             7
                   6%


                   5%
  Percentage




                   3%


                   2%


                   0%
                        1999      2000          2001        2002

Figure 3: Growth in Support Among ISVs for the Linux Platform 1999-2002vi
       With additional applications vendors supporting the Linux operating system,
customer adoption of the platform is also on the rise. The Linux operating system
has traditionally provided a platform for server computing applications, as
distinguished from client or personal computer applications. As shown below, Linux
is gaining traction in the personal computer market as well. The worldwide
shipments of PC’s that run the Linux operating system has grown from 3.5% in 2001
to an estimated 5.6% in 2005 – a marked gain in market share.


                   6%


                   5%
      Percentage




                   3%


                   2%


                   0%
                        2001   2002      2003        2004    2005E


Figure 4: Growth of PCs that Ship with the Linux Platform 2001-2005(E)vii




                                                 8
        The IT ecosystem is evolving rapidly, and an increased number of platforms
are providing alternatives to Microsoft Windows. New middleware platforms like
IBM’s WebSphere and BEA’s WebLogic are adding to this trend. This implies that the
structure of the IT ecosystem is becoming increasingly open and competitive, with a
growing number of application providers supporting multiple platforms.


II Ecosystem Health and Competitiveness
        What makes a business ecosystem healthy? In this question, we seek
measures of the extent to which a business ecosystem fosters the durable growth of
opportunities for its members and improves the benefits it delivers to its customers.
It is not acceptable for an ecosystem to simply generate or supply new products or
business models, if the entire ecosystem vanishes or collapses after the first
disruptive change in the environment, or if the ecosystem ceases to innovate for its
customers.

        To assess the health and competitiveness of business ecosystems in the
sense we seek, we use three aspects of the ecosystem health inspired by our
biological metaphor and expressed in terms of our ecosystem analogy: robustness,
productivity, and innovation (or niche creation).viii We first explain and analyze these
three crucial measures of business ecosystem health and competitiveness for
companies in the hardware, software, and services domain in aggregate. We then
include a fourth analysis of specific product and company case examples in order to
highlight the particular importance of innovation in the rapidly changing IT
ecosystem. From these four analyses we conclude that the IT ecosystem has
rebounded from the retrenchment of the recession and regained competitiveness
since the time of the Consent Decree.

A Robustness
        In order to provide durable benefits for its members and customers, a
biological ecosystem needs to persist in the face of environmental changes.
Therefore, a healthy business ecosystem should be robust to perturbations and
disruptions. This robustness can be assessed in a variety of ways. One way is to
analyze the sustainability of value in the ecosystem. The persistence or recovery in
the value of the constituent firms after a major disruption can be used as an
indicator of the ecosystem’s robustness.

        Another approach to robustness,ix developed elsewhere, is a measure of
financial betas and firm survival rates. A healthy ecosystem will promote the survival
of a diverse set of firms, including those that populate a variety of niches, through
inevitable disruptions. This diversity provides greater choice and reliability to the
customers that depend on a business ecosystem.

       Many analysts track the overall value and health of the IT ecosystem through
market indices. For example, the Goldman Sachs Technology Composite Index
(GSTI) provides a modified capitalization-weighted index based on a universe of
technology related stocks. This index covers the primary domains of the IT
ecosystem by aggregating the performance of six component indices: the Hardware
Index (GHAx), the Semiconductor Index (GSMxi), the Software Index (GSOxii), the




                                           9
Services Index (GSVxiii), the Multimedia Index (GIPxiv), and the Internet Index
(GINxv).
        Review of the GSTI (see Figure 5) indicates that the IT ecosystem appears to
be in broad recovery from the significant IT recession in 2001 and 2002.
Specifically, the GSTI nearly doubled from its lows in September 2002.


                $75

                $60
   US Dollars




                $45

                $30

                $15

                 $0
                   Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar-
                    01 01 02 02 03 03 04 04 05

Figure 5: Market Recovery of Technology Sector (GSTI) 2001-2005xvi
        The IT ecosystem recovery seen in the overall value metric above also spans
all of the primary sectors addressed by the Consent Decree. If we look at each of
the sectors in the index individually (see Figure 6), all show recovery from their lows
in late 2002. This synchronized recovery is yet another indicator that the industry is
an ecosystem composed of a tightly interconnected group of firms.


                $350
                $300
                                                                         GHA, Hardware
                $250                                                     GSM, Semiconductor
   US Dollars




                $200                                                     GIP, Multimedia
                $150                                                     GIN, Internet
                                                                         GSO, Software
                $100
                                                                         GSV, Services
                 $50
                  $0
                       Mar-01

                                Mar-02

                                         Mar-03

                                                  Mar-04

                                                           Mar-05




Figure 6: Market Recovery of Tech sub-sectors 2001-2005 (GSTI)xvii


                                                                    10
       In summary, despite a significant shock and retrenchment, these analyses
indicate that the IT ecosystem exhibits robustness across all segments. This
robustness ensures a reliable source of valuable products for IT customers.

B Productivity
       In conservation literature on biological ecosystems, the term “productivity” –
how effectively the ecosystem converts raw materials into living organisms - is a
widely used measure of ecosystem health and how it benefits those who use it. This
measure is a very good analog to total factor productivity analysis used routinely in
economics. In biological ecosystems the set of inputs do not change significantly
over time, and productivity need not necessarily show continuous improvement.
Successful business ecosystems are strikingly different: They are constantly subject
to new conditions - new technologies, new processes, new demands, and new
competition. By analogy then, measures of productivity should capture not only the
productivity of the ecosystem today, but also increases in productivity -
improvements in the effectiveness of the business ecosystem in converting the “raw
materials of value creation” into lowered costs and new products through innovation.


IT Productivity
       Improvements in productivity show that an ecosystem is able to produce
more with the same or less input. In the long run, real earnings in a business
ecosystem are tied to productivity gains.xviii We normally think of the IT industry as
providing the engine for productivity gains across the US economy. Improvements in
productivity within the IT ecosystem are equally important measures of the health
and competitiveness of the IT industry.

       Output per hour of all persons – or labor productivity – is the most commonly
used productivity measure. Labor productivity is the ratio of the output of goods and
services in dollars to the labor hours devoted to the production of that output. Other
productivity metrics such as Multifactor Productivity, or MFP, relate output to a
combination of inputs used in the production of that output, such as labor, capital,
energy, and materials. Labor productivity and productivity growth is a particularly
important measure of the health of the IT ecosystem since it provides an indication
of the real earnings growth accruing to the ecosystem. The plot below shows Labor
Productivity in the hardware, semiconductor, and software domains of IT.




                                         11
                                        250
   Output Per Hour, Constant 1997 $'s




                                        200                                   Software Publishers


                                        150                                   Semiconductor
                                                                              Manufacturers
                                        100
                                                                              Computer /
                                                                              Peripheral
                                        50                                    Manufacturing


                                          0
                                              1987 1990 1993 1996 1999 2002

Figure 7: Growth in IT Sector Labor Productivity 1987-2002xix
        The Bureau of Labor Statistics has no available data from years 2002 to 2005
at the time of this writing for the industries plotted in the graph above. Still, we can
extend the trend with another indicator of software labor productivity: Revenue per
Employee. According to Softwaremag.com, this metric, as applied to the top 500
companies (by revenue) in the Software domain, was at $202,587 for 2001,
$156,774 for 2002 and $176,909 for 2003. Viewing the 2001 number in light of the
pre-recession activity, employee productivity has seen an increase of almost 13%
from 2002-2003.

IT Recovery and Impact on US GDP
        The IT sector provides growth in real earnings of the broader US economy by
driving productivity gains in other industries. The IT industry also makes a significant
direct contribution to US economic growth. This is demonstrated by a measurement
of the annual percentage changes in the Real Value Added by various industry
groupsxx to the U.S. GDP (see Figure 8). Real Value Added is the change in
contribution of labor and capital to the National (Real) GDP (expressed as a
percentage). When the change in Real Value Added of a domain exceeds the growth
rate of the GDP, that domain is contributing more and growing faster than the
broader economy as measured by the GDP.




                                                                        12
               20%

               15%                                     GDP

               10%                                     Goods Producing
  Percentage




                                                       Industries
                5%
                                                       Services Producing
                                                       Industries
                0%
                                                       ICT
               -5%

               -10%
                       2001   2002    2003    2004

Figure 8: The Recovery in Net Contribution (to GDP) Growth Rates for US
Industries 2001-2004 (note: IT-producing industries recovery) xxi
       The chart above shows the annual growth rates of US GDP, and percentage
changes in net contribution to the GDP of Goods Producing Industries, Services
Producing Industries and “ICT-producing industries” (those that produce IT related
goods and/or services). ICT stands for Information Communications Technology and
includes the following components:

                •   Computer and electronic products within the durable-goods manufacturing
                    industry group;
                •   Publishing industries (include software), and information and data
                    processing services within the information group; and
                •   Computer systems design and related services within professional and
                    business services group.xxii

       The ICT-bar shows that the IT industry has increased its contribution to the
US GDP more than three times faster than the other industry groups. In 2004, for
instance, goods producing and service producing industries increased their Real
Value Added by 3.1% and 5.1% respectively, whereas the ICT group increased its
Real Value Added by 14.7%.xxiii

      In summary, as measured by growth in labor productivity and contribution to
the broader GDP, the productivity of the IT ecosystem is again growing across
hardware, software and services. Growing productivity indicates that the health and
competitiveness of the IT ecosystem has improved and will continue to improve in
coming years.




                                                 13
C Innovation and Niche Creation

       Robustness and productivity do not completely capture the health of a
business ecosystem. Both in ecological and business literature, it is important that
systems also exhibit variety or diversity — that they support many different species
or types of organizations. Innovation, or Niche Creation, is the critical mechanism by
which business ecosystems increase diversity over time. This diversity results in new
alternatives and choices for the customers that depend on a business ecosystem. In
the analyses of Innovation that follows, we will first look at broad indicators of
innovation across the IT ecosystem, and we will then review specific cases of very
rapid innovation in products and business models that have resulted in significant
growth and changes in the competitive landscape.

        The return on venture capital is a good measure of the effectiveness of
investment in innovation and niche creation. Venture capital is the primary source of
funding for start-up activity in new ecosystem domains. Venture capital investment
on its own (or the number of new firms created) is not necessarily a good indicator in
this context, because we are interested in meaningful, sustainable innovative niches.
Return on venture capital investment is a much better indicator of sustainable
innovation and niche creation than overall investment levels.

        The return on venture capital investments in the IT sector has improved
significantly from its lows in 2001. The figure below shows the IRR (internal rate of
return) for venture capital investments based on the year of formation of the
companies receiving investment (note that 2004 data, while showing a decline,
actually reflects a lack of sufficient elapsed time since the formation of companies to
accurately determine rate of return). Increasing returns in venture capital will attract
additional investment dollars and bodes well for the future of innovation in the IT
ecosystem.

               200%

               150%
  Percentage




               100%                                   Hardware/Systems
                                                      Software/Services
               50%                                    All Companies


                0%

               -50%
                      1992 1995 1998 2001 2004


Figure 9: Recovery of Returns on US Venture Capital Invested in IT
Companies (dollar-weighted return on vintage year companies) 2001-
2004xxiv



                                                 14
       Another leading indicator of the future prospects of innovation is the valuation
new firms receive from investors. As returns and investment activity rise in the
venture financing markets, valuations received by companies also rise – more dollars
chasing the same number of good investment opportunities results in an increase in
median valuations. The chart below shows that the median value that investors
ascribe to companies receiving investments has risen by more than 30% from 2003
to 2004. Rising valuations have a cascading positive effect; as entrepreneurs receive
higher valuations from investors, more entrepreneurs start companies because of
more readily available capital to fund their efforts.


                         $30

                         $25
   Millions US Dollars




                         $20

                         $15

                         $10

                         $5

                         $0
                               1998   1999   2000   2001   2002   2003   2004

Figure 10:  Recovery of US Venture Capital Median Valuations for IT
Companies 1998-2004 xxv
        Further evidence of a recovery in venture capital can be found in the growth
of availability of new funds for investment. Investments in US Venture Capital Firms
have also risen since 2003 (see Figure 11).




                                                           15
                         $75

                         $60
   Billions US Dollars




                         $45
                                                           Funds Invested
                                                           Funds Remaining
                         $30

                         $15

                          $0
                               2001   2002   2003   2004

Figure 11: Recovery of VC Funds 2001-2004                  xxvi




        Investments in Information Technology represent the majority of Venture
Capital Investment. Over 58% of all venture capital investment flows into IT related
businesses. As a result, new IT firms will likely benefit more than other industries
from the depicted backlog of Venture Capital monies. Within IT investments,
software garners a large share of the total investment (46% xxvii) and thus an
examination of new niche development in the software sector may provide valuable
insight into the competitiveness of the ecosystem.

        In summary, at an aggregate level it appears that venture capital, one
important innovation source of the IT ecosystem, is recovering from the
retrenchment at the beginning of the decade. As this recovery continues, innovation
will produce more valuable offerings and greater choice for IT customers. In the next
section we highlight specific case examples of the magnitude of impact that
innovation has within the IT industry.


III Rapid Innovation in the IT Ecosystem in
2005:
       While innovation (niche creation) is an important measure of health in any
business ecosystem, it takes on even greater importance within IT. The IT industry’s
pace of innovation has historically produced very rapid changes in the competitive
landscape as new alternatives emerge. In this section we will focus on several
ecosystem domains that were central to the Consent Decree and highlight how
innovation has proliferated since the time the Consent Decree was entered.

       We start by looking at software platforms for Internet content delivery and
Web browsing where innovation from newcomers is changing the competitive
landscape in a market where Microsoft Internet Explorer once held greater than 95%



                                                     16
share. Next we will review combined hardware, software and content platforms for
music delivery as an illustration of rapid adoption of information technology
impacting the broader music industry. We will continue to discuss multimedia players
where intense competition continues. And lastly we will discuss the convergence of
mobile devices that now incorporate music, cameras, phone capabilities, email and
web browsing in a variety of hardware form factors. In each case, innovation
continues to drive the rapid growth of new product capabilities, business models, and
alternatives for consumers.

A Platform Diversity
       Earlier in our analysis, we discussed the role of the operating system
platforms from Microsoft (Windows) and Redhat (Linux). In recent years, the IT
ecosystem has witnessed the emergence of a variety of competitive, innovative
hardware and software platforms, including middleware, such as the Apache web
server and the Firefox web browser, and “converged” mobile device platforms for
mobile wireless applications. These platforms build on the opportunity presented by
the Internet to provide new choices for developers building applications and for end
consumers.

        Before we look at competitive platforms, it is also important to note that
innovation is also coming from established platform market leaders. This is
significant because innovation from market leaders is a sign of a healthy ecosystem.
For example, in the PC operating system market, Microsoft is planning to launch the
latest version of their operating system called Windows Vista in 2006. Windows
Vista includes innovations for both end users and ISV’s.

        For end users, Windows Vista focuses on improvements in operating system
fundamentals such as security, deployment, manageability and performance. Some
of the specific innovations include anti-malware features, network access protection,
and an improved user interface. For example, “virtual folders” are a new information
search concept that Microsoft is introducing with Windows Vista. A virtual folder is
essentially a saved search that is automatically run when a user opens the folder. A
user could, for example, create a virtual folder for “stock trades.” When opened, the
folder would reveal all documents that contain the phrase “stock trades.”

       Additionally, with the launch of Windows Vista, Microsoft is also releasing a
new developer API called WinFX. The purpose of WinFX is to make application
development easier for ISV’s and allow them to tap into the new features of Windows
Vista. Past launches of new operating systems have resulted in significant effects in
the ecosystem, a pattern that should be repeated with Windows Vista.

The Growth of New Middleware Platforms
         The Internet has seen the emergence of several other Keystone platforms in
critical middleware domains. This diversity has increased the number of options open
to software developers and users alike. Two of the most important of these
platforms, among a diverse array of offerings, are Apache and Firefox.




                                         17
Web Server Platforms: Apache
       The Apache HTTP Web server is one of the earliest open source software
developments in Internet history. Developed by a group of volunteer programmers
and based on the National Center for Supercomputing Applications (NCSA) HTTP
daemon, Apache saw its first public release in April of 1995. Subsequent new
versions of Apache maintained by the open source Apache Foundation now form the
most popular Web server. Apache supports Microsoft’s Windows OS in addition to
Linux and all UNIX-like operating systems. The success of the Apache Web server is
shown below by the dominant proportion of websites that rely on it in Figure 12.
   Total Active Web Sites (Millions)




                                       20

                                       16

                                       12                                                                                     Apache
                                                                                                                              Microsoft
                                        8                                                                                     Other

                                        4

                                        0
                                                     Jul-01



                                                                       Jul-02



                                                                                         Jul-03



                                                                                                            Jul-04
                                            Jan-01



                                                              Jan-02



                                                                                Jan-03



                                                                                                  Jan-04



                                                                                                                     Jan-05




Figure 12: Growth in the Diversity of Web Server Platforms 2001-2005xxviii
       One of the purposes of the Consent Decree focused on fostering the
opportunities for growth of middleware platforms such as Apache. The Apache Web
server plays a crucial role in the delivery of the user interface of many new
applications that rely on the Internet for their distribution and HTML for their primary
user interface. Apache’s sustained success over the past five years, as a platform for
the delivery of applications, highlights how innovation has created vibrant
competition in a critical platform area of the IT ecosystem.

Web Browser Platforms: Firefox
        The Consent Decree also focused on competition in the Web browser domain.
In this domain Netscape and AOL have revitalized their offerings. Most importantly,
new organizations like Opera and the Mozilla Corporation (Firefox) have made rapid
inroads. Today’s browser market comprises many players, both incumbents and
newcomers. The new alternatives and revitalized offerings have a very respectable
foothold of nearly 16% market share in a market where Microsoft’s Internet Explorer
once held 95% of the market.xxix Market Share here implies usage share, which is the
percentage of visitors to a group of websites that use a particular browser.xxx




                                                                                                           18
                100%

                80%
   Percentage




                60%
                                                          IE
                                                          Non-IE
                40%

                20%

                 0%
                       2001   2002   2003   2004 Apr-05

Figure 13: Improvement in the Market Share of Alternative Browsers 2001-
2005 xxxi
        Microsoft, Netscape and AOL have been in the browser market since the
middle of the 1990s and have participated in direct and indirect competition for
market share ever since. The activity in this category seems to center on product
and feature evolution, with all three companies working on releasing newer versions
of their browsers with improved emphasis on features such as ease of use, security
and privacy.

       Even more striking is the discovery that the majority of the share gains since
the Consent Decree have come from newcomers. The Mozilla Corporation, which
maintains and releases the open source Firefox browser, and Opera Software are
among the most prominent newcomers. Figure 14 shows that Firefox now holds
over a 10% share.




                                               19
         Netscape,   AOL , 0.85%    MSN, 0.67%
           0.92%
   Mozilla,                        Opera, 0.41%
   3.81%                                                IE
                                                        Firefox
   Firefox,
                                                        Mozilla
   10.28%
                                                        Netscape
                                                        AOL
                                                        MSN
                                                        Opera
                                   IE, 83.07%




Figure 14:      Diversity of Browser Platform by Percentage of Users, April
2005xxxii
       The success of these newcomers in Web browsing is based on innovative
features and exemplifies the competitiveness of many middleware markets. For
example, the Opera Web browser from Opera Software in Norway has been
developed for a broad range of hardware including smart phones, personal digital
assistants and interactive television. It includes unique competitive features such as
voice-activated commands.xxxiii As a result, Opera has gained significant traction in
the mobile computing world – mobile phones using the Opera platform include
Nokia’s 6600 smart phone, Sony-Ericsson’s P900, and Motorola’s A920.xxxiv Opera
has also gained popularity in the UK and China mobile computing markets.xxxv,xxxvi
Innovation has led to end user adoption, and Opera’s usage share went from 0.40%
in 2002 around the time of the Consent Decree, to 1.03% in early 2005. xxxvii

       Similarly, the adoption of Firefox grows out of its innovative features. Firefox
is a cross-platform Web browser released by the open-source based Mozilla
Corporation. Firefox 1.0 saw 25 million downloads in the first 99 days and 50 million
downloads in the first six monthsxxxviii (see Figure 15). It has also built a rapid
adoption rate, rising in usage share since its release (see Figure 16).




                                          20
                   60


                   45
   Millions




                   30


                   15


                    0
                         Nov-04 Dec-04 Jan-05 Feb-05 Mar-05 Apr-05

Figure 15: Downloads of the Firefox Browserxxxix



                   12%


                    9%
      Percentage




                    6%


                    3%

                    0%
                         Feb- Apr- Jun- Aug- Oct- Dec- Feb- Apr-
                          04   04   04   04  04    04   05   05

Figure 16: Increasing Usage Share (percentage of users viewing a group of
sites through the browser ) of the Firefox Browserxl


        Firefox adoption is driven by competitive features prevalent in Netscape’s
offerings, while also introducing many new features. For example, by avoiding built-
in support for technologies such as Active X, VBScript or Browser Helper Objects
(BHOs)xli, Firefox is often perceived as being more secure than IE (however, Firefox
recently suffered a significant security vulnerability).

       Innovations of Firefox have also driven end user adoption, for example its
user interface, rendering engine, and RSS (Rich Site Summary, or Really Simple



                                                 21
Syndication) reader. Simplicity in the user interface is emphasized by the use of
tabbed browsing, thereby reducing the clutter of windowing. Firefox also innovated in
its ability to render Websites extremely quickly4 using rendering capabilities based on
the CSS standard.xlii These features are driving competition with Microsoft, inducing
them to introduce Internet Explorer 7 more quickly (Internet Explorer 7 is expected
to support tabbed browsing, integrated Web searching, RSS, and anti-phishing
technology).xliii

       Beyond driving the pace of new feature introduction for consumers, the
successful market penetration of the Firefox browser may enable Firefox to become
another Keystone platform for the developers of “Add-ins.” Most add-ins target the
Internet Explorer platform today because of IE’s large installed base. With add-ins,
Firefox effectively becomes a platform alternative for Internet content providers
(ICPs). This is another example of how rapidly competition can emerge in the IT
ecosystem. The most popular Internet Content providersxliv, a key domain addressed
in the Consent Decree, are building support for Firefox and the commercial open-
source rendering enginexlv on which Firefox is based (including Google, Yahoo, CNET,
and InfoSpace).


New Integrated Platforms
       The pattern of competition and innovation found in the software domains of
the IT ecosystem is repeated in its hardware domains. Case examples of platforms
in music, multimedia, and converged handheld devices show that innovation is
driving competition between vendors and rapid adoption of new products by end
customers.

Music Platforms: iPod and iTunes
        The digital music industry referred to henceforth includes both hardware and
software constituents, e.g. MP3 players and music download software. Rapid growth
of online music has been at the center of attention in this industry. It has
promulgated interesting network effects involving portable music players, peer-to-
peer service providers and recording companies. At the forefront of this online music
movement were the highly publicized companies such as Napster, Kazaa and
Audiogalaxy. Technological innovation by these and other companies in the online
music domain has been met with stiff resistance by the incumbents, but only to
continue its upsurge and eventually be embraced by the very same incumbents. The
figure below provides evidence of the rapid adoption of new music technologies.




                                          22
              10

               8

               6
   Millions




               4                   `


               2

               0
                   2002     2003         2004       2005Est.

Figure 17: Internet and Satellite Subscriber Growth in the Music Industry
2002-2005(E) xlvi
       The traditional music industry’s turnaround in incorporating the Internet is
evident in services such as Sony’s Connect, Universal Music Group’s music
downloads through retailers like Best Buy and Circuit City, and the popular Apple
iTunes. These are interesting examples of how innovation is thriving and influencing
a whole ecosystem of well-established members beyond the IT industry.

       Apple is an example of a company that has innovated by introducing an
alternative business model in music services. Its integrated offering consists of both
hardware and software platforms in the form of the iPod device and the iTunes
service. Figure 19 below shows that since the time of the Consent Decree the Apple
iPod has experienced very rapid growth for a hardware platform.




                                         23
               30

               24

               18
    Millions




               12

                6

                0
                    2001   2002     2003        2004      2005

Figure 18: iPod Shipments Growth 2001-2005xlvii

Multimedia Platforms: Real, Media Player, and QuickTime
        PC-based multimedia platforms have been a popular addition to the PC users
experience and a fertile ground for competition. These platforms provide individuals
with a method of playing audio and video files on their PCs. The 15 most popular
multimedia software platforms have been downloaded more than 1.25 billion
times.xlviii

        The market for multimedia platforms is diverse.            Many users have
downloaded and installed multiple players in order to take advantage of new features
or different formats of available multimedia content. The integration of these players
into the user’s experience makes it possible for users to utilize all installed players.
According to Nielsen/NetRatings in 2002, RealNetworks led in penetration of at-home
users, 60% of whom have downloaded the Real player to their PCs. RealNetworks
was followed by Microsoft’s Windows Media Player at 53% penetration and Apple’s
QuickTime at 28% penetration.xlix

       This diversity has encouraged innovation and competition.              Apple
incorporated MPEG-4 into its version six release of its QuickTime multimedia player.
MPEG-4 offers significant advantages over the common MPEG-2 video format. It can
deliver similar image quality at half the required bit-rate (required bandwidth) as
MPEG-2 streams. According to Philip Schiller, Apple’s SVP of worldwide product
marketing, since 2003 “QuickTime 6 has taken off like a rocket, with over 25 million
downloads in 100-days.”l

       Innovation in this area is not limited to improvements in multimedia players
alone.   Innovations in multimedia content distribution are also occurring. For
example, capabilities present in the popular open RSS (really simple syndication)
standard make it possible to distribute multimedia files created in any format.
Individuals can easily use RSS both to distribute multimedia (audio and video files)
to a wide audience and to subscribe to downloads of these files from multiple



                                           24
sources. Subscribers can time-shift their use of these files and download them to
multiple platforms such as the iPod. Within the audio file area, this has led to the
development of what is called Podcasting (which takes its name from the ability to
download files to an iPod player for time-shifted, mobile usage). Numerous firms
have emerged to develop business models around the categorization and distribution
of Pod casting feeds. Additionally, Apple has incorporated support for Podcasting into
its popular iTunes software.

       In summary, the music industry is seeing increased diversity in new and
innovative products, services and business models despite resistance from
incumbents. The enormous popularity of new alternatives with consumers has
resulted in a large number of competitors entering the market behind Apple’s
success. This will continue to provide end consumers with new, exciting alternatives.

Multi-purpose Platforms: Converged Mobile Devices
        Beyond the music and media industries, rapid IT innovation and competition
are influencing the telecommunications industry as well. Over the past two years
there has been strong growth in converged mobile devices as a subset of the overall
growth of mobile phones. These devices in part replicate the feature functionality of
personal digital assistants (PDAs) and personal computers. Annual mobile phone
sales alone have grown by almost 70% from 2001 to 2004 as is shown below.


              800


              600
   Millions




              400


              200


                0
                    2001     2002        2003         2004

Figure 19: World Wide Mobile Phone Shipments 2001-2004li
       Perhaps more importantly, a large portion of the mobile phone hardware sold
now incorporates features and functionality traditionally delegated to more powerful
PC’s or Personal Digital Assistants (PDA’s). As shown below, these converged mobile
devices have grown fivefold in unit sales over the two years from 2003 to 2005.




                                         25
              50

              40

                                                 PDAs
              30
   Millions




                                                 Converged Mobile
              20                                 Devices

              10

               0
                   2001 2002 2003 2004 2005

Figure 20: Worldwide PDA and Converged Mobile Device Shipments 2001-
2005lii
        Converged devices offer to mobile users many of the applications once limited
to personal computer users. Software applications on converged mobile devices
include e-mail access, electronic entertainment, e-commerce, PDA functionality, and
digital photography. To address the growing demand for these devices, a diverse set
of software platforms have emerged. These platforms include Symbian, Palm, and
Microsoft at the operating system level, with Symbian leading the way as shown
below.




                                         26
                2


               1.5
                                                  Palm
   M illions




                1                                 Microsoft Powered
                                                  Symbian

               0.5


                0
                     2001 2002 2003 2004 2005E

Figure 21: US Mobile Device Shipments by OS 2001-2005(E) liii
       Additionally, a large number of application developers and independent
service providers have emerged to supply services to these converged mobile device
users through Internet connections. For example: Yahoo’s Flickr allows camera
phone users to upload photos to online albums. Subscribers to various wireless data
services such as Flickr are growing extremely rapidly, as is shown below.


               60
                                                     Messaging
               50
                                                     Personalized
               40                                    Services
   Millions




                                                     Commerce
               30
                                                     Entertainment
               20

               10                                    E-Mail


                0
                     2002   2003   2004   2005E

Figure 22: Wireless Data Subscribers by Application (North America) 2002-
2005(E) liv
       In summary, the rapid growth of wireless data services and the rapid
adoption of alternative hardware platforms are creating many new alternatives for
consumers. The rate of innovation and adoption since the retrenchment in 2002 in a



                                           27
completely new domain provides further evidence of the health and competitiveness
of the IT ecosystem.

B Innovative New Business Models
       Innovation is generally discussed in the context of products or technologies.
However, since the Consent Decree, new business models have emerged that have
transformed traditional industries such as auctions, financial payments, retail
merchandise, advertising, and enterprise software. These changes in business
models have also created completely different solution alternatives for consumers as
well as a host of very successful new competitors providing those solutions. To
explore this, we detail the growth of Google, eBay, and Salesforce.com.

Google: Performance-based Advertising
       Google began with a simple value proposition: to provide relevant online
search results. Its success in this goal has led the company to become one of the
Internet’s most popular search engines. Today, approximately 46% of all Internet
searches are accomplished through Google. To capitalize on its central position in the
important Internet search arena, Google has developed a diversified portfolio of
business offerings.


                       Netscape,       Others,
                        1.60%          7.90%
  Ask, 1.60%

     My Way,
      2.20%                                    Google,
                                               46.20%

 AOL, 5.40%

       MSN,
      12.60%           Yahoo,
                       22.50%

Figure 23: Percentage of Internet Searches by Search Engine, July 2005lv
        A critical part of Google’s business performance has been the success of its
search-based advertising system. This service makes it possible for advertisers to
select specific search terms on which to advertise. This specificity enables advertisers
to reach potential customers that are looking for information and products related to
their own offerings in a very targeted and efficient manner. Additionally, Google only
charges advertisers when a customer clicks on their advertisement.                  This
performance-based aspect of Google’s method is a substantial improvement over
impression-based methodologies where advertisers pay a fee based on the number
of times their advertisement is viewed by a customer regardless of whether the




                                          28
customer clicks on the advertisement (impression based advertising through banners
has been increasingly replaced by performance-based methods).

       Google is in the process of expanding its performance-based advertising
service to other search areas. For example, the launch of Google Maps in 2005 will
increasingly allow the company to extend performance-based advertising to local
businesses and travel related business (flights, hotels, etc.). Google Maps provides
the company with a way to tap into the multi-billion dollar yellow pages market. To
enhance the attractiveness of Google Maps, it has added satellite views and opened
the software as a service to modifications and enhancements by individuals and
partners.


                   Email    Referrals     Slotting Fees
                    2%        2%                2%
      Rich Media
         8%

                                                     Search
                                                      40%
 Sponsorship
     9%                           1



     Classifieds
        17%                 Display Ads
                               20%


Figure 24: Search Based Advertising as a Percentage of Total Advertising
Q2 2004lvi
       In other parts of its portfolio, the rapid growth of personal publishing through
Weblogs led Google to acquire Blogger in 2003, a leader in Weblog hosting. Weblogs
have grown rapidly in 2005 according to Technorati, a Weblog tracking firm. As of
April 2005, there were 14.2 million Weblogs, double the number from only five
months earlier, with a growth rate of 80,000 a day. To capture value from the
growth of Weblogs, Google has extended its performance-based advertising system
to Blogger users and Webloggers in general. Weblog owners can post Google ads on
their Weblogs for a share of the advertising revenue generated.




                                          29
                                   1400
  Daily Pageviews (Per Million)


                                   1200
                                   1000
                                    800                                       blogger.com
                                    600                                       nytimes.com

                                    400
                                    200
                                      0
                                                      Jul-04

                                                     Nov-04




                                                                    Jul-05
                                            Jan-04

                                            May-04




                                                     Jan-05


                                                                   May-05
                                            Mar-04



                                                     Sep-04



                                                                   Mar-05


Figure 25: Growth in Blogger.com Page Views Relative to the New York
Times 2004-2005lvii
      The cumulative result of these rapid, sustainable, and successful innovations
at Google has been robust revenue and profit growth (see Figure 26).


                                   $3,500
                                   $3,000
             Millions US Dollars




                                   $2,500
                                   $2,000                                    Annual Revenue

                                   $1,500                                    Net Income

                                   $1,000
                                    $500
                                      $0
                                             2001    2002   2003   2004

Figure 26: Google Annual Revenue and Net Income 2001-2004lviii
        In summary, adoption of Google’s suite of services highlights the growing
importance of software delivering services such as search over the Internet as an
alternative to traditional packaged software. As a result of Google’s extremely
profitable business model, they are a very credible contender for delivering novel
solutions in many software application areas in the future.




                                                                     30
eBay: auctions between anonymous peers
       eBay is regarded as the most successful online auction business, both in
terms of user popularity and financial growth. From its inception in 1995, eBay’s
online commerce platform has grown to include a diverse set of buyers and sellers.
An important aspect of eBay’s impact on the ecosystem is that it provides an
alternative online commerce solution for a very large number of sellers such as small
businesses who would otherwise lack the technical capabilities to sell online. A
second aspect of eBay’s impact on the ecosystem is eBay’s enormous end-customer
reach that allows sellers to find quality buyers for their products.

       eBay’s market performance during the timeframe relevant to our analysis,
beginning in 2001 and extending through 2005 (see Figure 27), has risen above
industry and Wall Street’s expectations because eBay has achieved impressive levels
of revenue growth and profitability.lix,lx,lxi


                         $3,500
                         $3,000
   Millions US Dollars




                         $2,500
                         $2,000                               Annual Revenue

                         $1,500                               Net Income

                         $1,000
                          $500
                            $0
                                  2001   2002   2003   2004

Figure 27: eBay Annual Revenue and Net Profit 2001-2004lxii




                                                         31
       eBay’s positive impact on customers is evidenced by the very large base of
eBay users shown in the figure below (note that 2005 represents only the first 3
months). This rapid adoption has provided a very large base of customers with
access to ecommerce technologies that may otherwise be inaccessible.


              160
              140
              120
              100
   Millions




               80
               60
               40
               20
                0
                    2001   2002    2003        2004   Q1-2005

Figure 28: eBay Registered Users (Cumulative) 2001-2005lxiii
        eBay’s growth has allowed it to extend other offerings to its user base. eBay
acquired a simple online payment system, PayPal, to facilitate online payment
transactions in 2002. This software-enabled service makes it simple, secure, and
relatively inexpensive for buyers and sellers to transact over the Internet. By early
2001, PayPal had processed more than $2 billion in payments with a daily
transaction volume of $8 million and 160,000 transactions. More than 25% of all
eBay transactions were accomplished via this system. As a result, PayPal’s year-
over-year growth in transactions was 48% in the US and 148% internationally (see
Figure 29).




                                          32
                                   90

                                   75
   Millions (Users)




                                   60

                                   45

                                   30

                                   15

                                    0
                                             2001         2002    2003        2004    2005 Est.

Figure 29: PayPal Accounts Growth 2001-2005lxiv
       Another example of eBay’s expansion into new business opportunity is its
acquisition of Skype in September of 2005. Skype is a software-enabled service for
global voice communications. Because its service leverages the large installed base
of PCs and Internet access, its marginal costs per new user are low. This makes it
possible for Skype to offer global voice communications to its users for free -- it only
charges for advanced services. Skype’s low costs, ease of use, and connection
quality has led to strong growth (see Figure 30). eBay acquired Skype for both
Skype’s potential as a stand-alone business and Skype’s ability to improve eBay’s
online marketplace.


                                   160
   New Users per day (Thousands)




                                   140
                                   120
                                   100
                                    80
                                    60
                                    40
                                    20
                                        0
                                            Jan-   Mar-   May- Jul-04 Sep- Nov-      Jan-
                                             04     04     04          04   04        05

Figure 30: Skype User Base Growthlxv




                                                                         33
       In summary, through auctions, PayPal, and Skype, eBay is creating a suite of
services offerings with a fee for use model that has increased the penetration of
these commerce and communications technologies. This innovation provides
consumers with competitive opportunities where they may not otherwise have skill to
work with traditional software offerings.

Salesforce.com: Corporate applications as a service
       Salesforce.com provides another example where innovation in a business
model using the Internet has changed the competitive landscape of software vendors
and increased the accessibility of software technologies to end customers.
Salesforce.com provides Customer Relationship Management (CRM) software, but
Salesforce.com’s software-as-a-service model is based on providing outsourced
customer data storage and software management to clients. Task automation,
analysis tools, and sales lead management are just some of the hosted services
Salesforce.com offers. Its product suite serves as an out-of-the-box option for
organizations looking to manage the aforementioned standard operations as well as
a platform for developing custom applications for more specialized and complex
procedures.

       Since its inception in 1999, Salesforce.com has provided varied versions of its
software and services to large and small organizations worldwide. Salesforce.com
has expanded from a simple application to an entire Web platform, now enabling
customization and collaboration between clients and customers.

        Salesforce.com has effectively leveraged the ubiquity of the Internet and
declining network bandwidth prices to make a business out of selling software as an
online service. Its innovation lies in the fact that many of an organization’s routine
procedures need not in fact be developed and maintained in-house. As such
Salesforce.com found a business opportunity to provide these as services in a more
cost effective, on-demand manner.


                  $200

                  $150
   Millions USD




                  $100                                    Revenue
                                                          Net Income
                   $50

                    $0

                  -$50
                         Jan-   Jan-   Jan- Jan-   Jan-
                          01     02     03   04     05

Figure 31: Salesforce.com Annual Revenue and Net Income 2001-2005lxvi


                                                    34
       Salesforce.com’s business innovation provides customers with an alternative
to purchasing more traditional software applications that run on in-house servers and
personal computers. This innovation extends the availability of business software
applications to more customers because the complexity of these applications might
otherwise exceed the management capabilities of smaller businesses. Salesforce.com
thus provides another example of innovation resulting in greater value for customers
and increased competition with the IT ecosystem.

C Rapid innovation changes the focus of competition

       In conclusion, there has been very substantial innovation across a diverse set
of market segments in both products such as Web browsers, music hardware and
software, multimedia players, converged mobile computing devices and business
models such as those of Google, eBay, and Saleforce.com. These trends illustrate
how the IT ecosystem since the Consent Decree is witnessing extensive
experimentation and innovation. New models incorporating the advantages of selling
software as a service are gaining particular prominence, which is redirecting the
focus of competition away from client applications toward Internet based
applications.




                                         35
IV Conclusion: IT is healthy and competitive
       The Information Technology ecosystem in mid-2005 shows positive signs of
health and competitiveness.

        After the shocks of 2001 and 2002, we see signs of recovery across the
sector. The ecosystem appears to have shown its robustness, with overall levels of
firm value and growth prospects improving across the board. The ecosystem is
regaining in productivity, not just in the hardware domains, but also across software
specialties. Perhaps most critically, the ecosystem is showing strong signs of
innovation with a recovery in the levels of and returns to venture capital investment.

        When we look more deeply at the domains that were the subject of the 2002
Consent Decree, we see these overall trends illustrated by numerous examples of
increased competitiveness, innovation, and business model evolution. We see new
software platforms such as Linux, Apache, and Firefox enjoying strong growth and
adoption; and new device platforms in areas such as music and converged wireless
products being offered by a diverse set of competitors. We also see innovation in
business models from a new generation of Internet content and service providers,
including eBay, Google, and Salesforce.com.

       The resilience of the IT ecosystem and its impressive level of innovation is a
function of the large diversity of organizations that populate it. Tens of thousands of
companies and millions of developers are benefiting from new applications and
functionality. Like in biological ecosystems, the constituents of the IT ecosystem
interact in a complex, highly interdependent manner. These contributors rely on the
ecosystem’s top platforms as a foundation, offered by companies like Microsoft, Red
Hat, and Apple. The tools and technological components offered by these platforms
are a critical ingredient in the innovative efforts of the broad community of
companies in the ecosystem, ranging from eBay, to small start-ups founded this
year.

       Finally, the particular domains targeted by the 2002 Consent Decree have
shown strong levels of innovativeness and growth, with new competitors repeatedly
challenging the more established companies. Software and hardware platforms are
witnessing significant innovation and evolution, which is in turn fueling innovation in
a broad variety of applications and business models.




                                          36
Appendix A: Goldman Sachs Technology Indices
Constituents
       The Goldman Sachs Technology Index is a composite tracking index
consisting of six separate tracking indices for major sectors of the IT industry: GSTI
Hardware Index (GHA), GSTI Semiconductor Index (GSM), GSTI Software Index
(GSO), Goldman Sachs Services Index (GSV), GSTI Multimedia Index (GIP), and the
GSTI Internet Index (GIN).

      The following tables describe the top 10 market capitalization contributors to
each Goldman Sachs Technology Index.lxvii

  Ticker Symbol        Company Name               Weight            Returns (%)
                                                                      1 Month
       RIMM           Research in Motion           11.14               26.77
        STX                Seagate                 6.73                 23.7
                          Technology
      NTAP            Network Appliance             8.7                  14.85
      AAPL             Apple Computer              10.46                 12.35
       EMC                   EMC                   8.25                  7.15
      QLGC                  QLogic                 3.01                  13.79
       WDC             Western Digital              1.99                 17.83
      SUNW            Sun Microsystems              7.73                  4.39
       HPQ             Hewlett Packard              6.98                  4.81
       LXK               Lexmark Intl               7.37                 -5.02
Figure 22: GTSI Hardware Index: The Top Ten Firms


  Ticker Symbol        Company Name               Weight            Returns (%)
                                                                      1 Month
       MOT                 Motorola                9.46                 11.7
        TXN           Texas Instruments             8.8                  8.9
        ADI             Analog Devices             5.38                11.69
       SNDK                SanDisk                 1.73                24.71
       AMAT            Applied Materials           9.21                 3.78
       NSM                 National                2.05                 16.2
                        Semiconductor
       MRVL           Marvell Technology           2.55                  13.02
                             Group
       KLAC              KLA-Tencor                3.01                  11.01
       AMD             Advanced Micro               1.7                  13.74
                            Devices
       INTC                  Intel                 7.37                  -5.78
Figure 23: GTSI Semiconductors Index: The Top Ten Firms




                                           37
 Ticker Symbol     Company Name              Weight   Returns (%)
                                                        1 Month
      SYMC             Symantec               8.73       14.43
      ORCL               Oracle               8.96       13.14
       CA              Computer               7.83        8.59
                       Associates
      PSFT             Peoplesoft              3.7       14.08
      ADBE               Adobe                6.04        7.85
      VRSN              Verisign              2.52       14.52
      INTU                Intuit              4.57       7.35
      TIBX          TIBCO Software            0.86       34.65
      ADSK              Autodesk              2.81        9.5
      ERTS           Electronic Arts          7.12       -7.61
Figure 24: GTSI Software Index: Top Ten Firms


 Ticker Symbol     Company Name              Weight   Returns (%)
                                                        1 Month
      CSTH             Cognizant              3.32       11.27
      GPN             Global Pmts              1.7       20.72
      CAN            Accenture Ltd            9.47        3.64
      DOX             Amdocs Ltd              3.96        8.61
      ADP           Automatic Data            8.06        3.9
                       Processing
      PER           Perot Systems              1.5       20.66
      FDC           First Data Corp           8.65       2.96
      SDS            SunGard Data             5.79       3.35
                        Systems
      TSG           Sabre Holdings            2.87       6.65
       BE             BearingPoint            1.48       10.78
Figure 25: GTSI Services Index: Top Ten Firms


 Ticker Symbol     Company Name              Weight   Returns (%)
                                                        1 Month
      RIMM         Research in Motion         8.15       26.77
      MOT                Motorola             8.61        11.7
      GLW                Corning               8.3        9.49
       AV                 Avaya               3.57       15.02
      MRVL         Marvell Technology         3.99       13.02
                          Group
     QCOM               Qualcomm             10.83        2.6
     JDSU             JDS Uniphase           2.68         8.36
     JSPR           Juniper Networks         7.23         3.1
     CSCO             Cisco Systems          7.29        -3.52
      NT             Nortel Networks          8.13       -9.57
Figure 26: GTSI Multimedia Index: Top Ten Firms



                                        38
    Ticker Symbol            Company Name                      Weight                  Returns (%)
                                                                                         1 Month
        ASKJ                   Ask Jeeves                        7.84                       26.2
        INSP                    InfoSpace                        8.24                     24.71
        MNST                Monster Worldwide                    8.75                      21.8
        YHOO                      Yahoo                          9.72                     18.94
        CNET                 CNET Networks                       7.13                     12.55
        EBAY                       eBay                          9.82                       6.24
        DCLK                   DoubleClick                       4.37                     12.57
        AMZN                  Amazon.com                          7.5                      7.13
        ELNK                     Earthlink                       8.82                       2.9
        RNWK                  RealNetworks                       4.29                      -6.24
Figure 27: GTSI Internet Index: Top Ten Firms



i
    For much additional detail and discussion see Moore (1995); The Keystone Advantage: What the New
Dynamics of Business Ecosystems Mean for Strategy, Innovation, and Sustainability, Iansiti, M., Levien,
R., Harvard Business School Press, 2004
ii
    For much additional detail, see The Keystone Advantage: What the New Dynamics of Business
Ecosystems Mean for Strategy, Innovation, and Sustainability, Iansiti, M., Levien, R., Harvard Business
School Press, 2004
iii
     Keystone Strategy, Inc.
Abbreviations used:
            ‘WMA’, ‘MP3’ – electronic music file formats
            App Dev – Software Application Development
            DB – Database (Software)
            ERP – Enterprise Resource Planning
            CRM – Customer Relationship Management
            SCM – Supply Chain Management
            DSL – Digital Subscriber Line
iv
     The Keystone Advantage: What the New Dynamics of Business Ecosystems Mean for Strategy,
Innovation, and Sustainability, Iansiti, M., Levien, R., Harvard Business School Press, 2004.
v
    Keystone Strategy, Inc., January 2005.
vi
     Keystone Strategy Inc.
vii
     Gartner; numbers don’t include other Win OS versions (ME, NT etc)
viii
      The Keystone Advantage: What the New Dynamics of Business Ecosystems Mean for Strategy,
Innovation, and Sustainability, Iansiti, M., Levien, R., Harvard Business School Press, 2004
ix
     Extensive discussions of robustness and its implications for many fields, along with a review of various
definitions for the term can be found online at the Santa Fe Institute’s robustness Website
(<http://discuss.santafe.edu/robustness/>).
x
    A capitalization-weighted index of companies involved in the computer hardware domain of the IT
ecosystem
xi
     A capitalization-weighted index of companies involved in the semiconductor sector of the IT ecosystem
xii
     : A modified capitalization-weighted index of companies involved in the Computer Software domain of
the IT ecosystem
xiii
      : A modified capitalization-weighted index of companies involved in the Computer Services domain of
the IT ecosystem
xiv
      A modified capitalization-weighted index of companies involved in the multimedia networking sector of
the IT ecosystem
xv
     A modified capitalization-weighted index of companies involved in the Internet related sector of the IT
ecosystem
xvi
      Data presented represents the performance of Goldman Sachs Technology Index (GTC) tracking fund,
IGM, which closely tracks the index with the added benefit of incorporating the effects of dividends and
splits into the adjusted final values (values plotted represent adjusted values for these dividends and
splits). Source: Yahoo! Finance




                                                    39
xvii
       GSTI sub-Index Historical Prices - Yahoo! Finance
xviii
       See the Bureau of Labor Statistics, www.bls.gov.
xix
      Bureau of Labor Statistics, www.bls.gov
xx
      Industries as classified in the North American Industry Classification System (NAICS), by the U.S.
Census Bureau; http://www.census.gov/epcd/www/naics.html
xxi
      Labor Productivity historical values - U.S. Bureau of Economic Analysis
xxii
       U.S. Bureau of Economic Analysis
xxiii
       http://www.bea.gov/bea/newsrel/gdpindnewsrelease.htm
xxiv
       Through Sept 30, 2004, Pooled Gross Means of Companies Receiving Initial Investment In Year,
Source: Cambridge Associates, LLC (through VentureOne)
xxv
       United States Only, Venture One, Dow Jones Inc., 2005, Valuations are defined as the US IT Median
Pre-Money company valuations at time of investment.
xxvi
       Venture One, Dow Jones Inc., April 2005. Represents funds raised by venture capital firms, corporate
development groups, corporate venture arms, and SBICs headquartered in the United States. Hangover
describes funds remaining for investment cumulative of all prior years.
xxvii
        Venture One, Dow Jones / Ernst & Young, March 2005.
xxviii
        Netcraft Web Server Survey www.netcraft.com
xxix
       www.e-janco.com
xxx
       Usage Share, http://en.wikipedia.org
xxxi
       Usage share of Web browsers, http://en.Wikipedia.org; “non-IE”: Mozilla, Firefox, Opera, Netscape and
Safari. Percentages are obtained based on data from multiple sources such as onestat.org,
Websidestory.com and e-janco.com
xxxii
        Browser Market Share – www.e-janco.com
xxxiii
        http://www.pcmag.com/article2/0,1759,1787708,00.asp
xxxiv
        http://www.mobilemag.com/content/100/340/C2183/
xxxv
        http://www.3g.co.uk/PR/July2004/8083.htm
xxxvi
        http://www.theregister.co.uk/2005/02/16/opera_orange_browser
xxxvii
         www.onestat.com (Onestat.com provides usage share statistics based on worldwide usage)
xxxviii
         The Fox Is in Microsoft’s Henhouse (and Salivating), Stross, R., New York Times, Dec 19th, 2004
xxxix
        Mozilla Firefox, http://en.wikipedia.org, www.mozilla.org
xl
     Firefox Market Share - www.e-janco.com, April 2005.
xli
      http://www.pcmag.com/article2/0,1759,1815952,00.asp
xlii
      http://www.computergripes.com/firefoxsites.html
xliii
       Coming Very Soon – Internet Explorer 7.0 - http://www.pcmag.com/article2/0,1759,1765275,00.asp
xliv
       http://www.hoovers.com/internet-content-providers/--HICID__1457--/free-ind-factsheet.xhtml
xlv
      http://www.news.com.au/help/#7.5
xlvi
       Parks Associates, www.parksassociates.com
xlvii
       Apple Computer, Inc. 10-K FY2004; 2005 source – Needham & Co AAPL Equity Research Note July 18,
2005
xlviii
        Software.com, Macromedia.com, RealNetworks, San Jose Mercury News
xlix
       Statistics firms revisit Quick Time counts, News.com; June 2002
l
    Apple Press Release October 15, 2002
li
     Gartner
lii
     Gartner, IDC
liii
     IDC
liv
      Gartner
lv
     Nielsen NetRatings Megaview Search Reporting Service; July 2005
lvi
      The Decade in Online Advertising 1994-2004 - www.doubleclick.com, Apr 2005
lvii
     The Decade in Online Advertising 1994-200 - www.doubleclick.com, Apr 2005 (Tracked by Alexa.com;
users are those using Alexa (owned by Amazon) toolbar)
lviii
       Google Annual Report
lix
      http://news.com.com/2100-1017-269211.html?legacy=cnet
lx
     http://www.sfgate.com/cgi-bin/article.cgi?f=/news/archive/2001/07/19/financial1850EDT0269.DTL
lxi
      http://www.sfgate.com/cgi-bin/article.cgi?f=/news/archive/2003/07/24/financial1844EDT0408.DTL
lxii
      eBay Annual Reports
lxiii
       eBay Annual Reports
lxiv
       The PayPal Community: 56M Accounts and Counting – www.paypal.com
lxv
       Skype, en.wikipedia.org
lxvi
       Reuters
lxvii
        Source: Goldman Sachs Equity Derivatives Research, As of close Sep 30, 2004
http://www.styleadvisor.com/support/download/gstimth.pdf One-Month return contribution (1-Mth RC)
reflects how the 1-month stock return impacts (positively or negatively) the 1-month index return.



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