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Int'l Cover Story--Europe

SILICON CONTINENT (int'l edition)

Surprise! Europe is finally getting its software act together--and going after America's lead

Staid German bankers probably wouldn't think much of Black Sun Interactive's corporate culture. At the software startup's Munich headquarters, artists have nailed artificial plants to the wall "to create a feeling of surrealism," says its exuberant chief executive, Franz W. Buchenberger. A life-size puppet named Jeff sits in the conference room, ready "to take the blame for bad decisions." By day, workers listen to music downloaded from the Internet. And during midnight powwows in the company's online chat room, participants don virtual identities called avatars, so Buchenberger is never quite sure who's speaking to him.

But the 36-year-old Buchenberger and his seven co-founders, mostly in their 30s, thumb their noses at European business conventions. Instead of approaching local banks to help launch the company last year, they pitched their technology to a Boston-based venture-capital firm called CMGVentures and came away with $4 million. That was before Black Sun even released its first product, a three-dimensional Internet browser called CyberGate. "We don't take ourselves too seriously," says Buchenberger with a laugh. "But we're serious about our business."

This is serious business for American software companies as well. For the first time, the U.S. industry is tasting competition across a wide array of niches in the fragmented global software market--and that rivalry is coming from Europe. Germany's SAP is the world leader in software that companies use to unify computer systems handling accounting, payroll, and other operations. SAP, the world's fifth-largest software company, grossed $1.8 billion last year--much of it in contracts with large multinationals that U.S. rivals PeopleSoft and Oracle Corp. have courted aggressively.

SAP is by no means unique. Selling similar types of software, Dutch champion Baan will see total sales of $328 million this year--some $80 million of it from U.S.-based customers such as Boeing Co. and Ford Motor Co. French startups are challenging Steven P. Jobs's NeXT Computer Inc. in a sexy niche known as object-oriented programming. Britain excels in all walks of 3-D graphics, used in computer games, scientific modeling, and virtual-reality applications.

Consider entertainment software. Most game players don't realize that top-selling titles such as Mortal Kombat and Donkey Kong Country come from British boutiques that have been acquired by U.S. and Japanese software companies. Or that EMME Interactive, the tiny Paris startup founded by Philippe Guttieres Lasry, is taking on Microsoft Corp.'s William H. Gates III himself by sewing up exclusive rights to digital versions of cultural treasures. Its portfolio includes the Vatican museum and Florence's Scala Acta, the world's largest private art archive. And don't forget that it was British engineer Timothy Berners-Lee who wrote the main programming language for the World Wide Web, HTML (Hypertext Markup Language), at the CERN particle physics lab in Switzerland. "We're seeing some very strong companies with fresh ideas coming out of Europe," says Thierry Costa, international program manager at Hewlett-Packard Co.

To be sure, Americans still supply three-quarters of the world's packaged software. But they can no longer count on that as a birthright, according to market researcher International Data Corp. (IDC) in Framingham, Mass. Hundreds of new software companies have sprouted in Europe since 1990, many of which double their sales every year.

Together, these companies will soon start to compensate for the shrinking sales of systems software by Europe's struggling hardware giants such as France's Groupe Bull. Europe-based companies already supply more than 18% of the global packaged-software market, which should top $100 billion this year. "Europeans will slowly start to gain market share," predicts Anthony Picardi, IDC's group vice-president for worldwide software.

Why are Europeans coming on strong? For one thing, startups are leveraging the Continent's traditional skills in science and math. They're also benefiting from a rapidly changing investment climate in Europe. But perhaps most important, the emergence of networked computing and the rise of the Internet have caused a profound shift in the kinds of software that business customers demand and in the way these products are distributed.

"THE NEXT NETSCAPE." The software boom, however, has even broader implications. Since each of the complex changes behind this renaissance has an impact on other industries, software could be a harbinger of a high-tech revival in other venture-backed areas, from chips and telecommunications to biotechnology. "Europe is developing the ability to market its technology," says Cristina M. Morgan, managing director at Hambrecht & Quist in San Francisco. "The chances of finding the next Netscape in Europe are just as high as in Boston or Cupertino."

An increasingly vibrant software industry could help pump up more traditional sectors of the European economy, especially as more software applications are embedded in traditional products such as household appliances. Equally important, a cadre of successful European startups and millionaire founders may finally begin to revamp the stifling anti-entrepreneurial culture in Europe.

Certainly, the raw talent is there. Europe has always boasted world-class software-development capability. In the 1960s, its engineers invented cutting-edge programs for compiling software code, wrote breakthrough programming languages, and helped pioneer artificial intelligence. But a business climate hostile to entrepreneurs made it nearly impossible to spin good technology into commercial successes. The best talent went to universities or computer conglomerates, and the most innovative projects never left the lab.

In the 1980s, as technology developed, some European software startups began to spring up. But many starved from lack of funding or were snapped up by bigger American and Japanese companies. The lucky ones became national or regional players, but they rarely developed the critical mass, marketing talent, or gumption to tackle the U.S. market.

For today's savvy players, success in the U.S. is top priority. Although most of their names are still unknown outside the industry, they have demonstrated explosive growth--much of it outside their home markets. Many juggle dual headquarters in Europe and the U.S. Two or three years after being founded, many of Europe's software startups generate 50% of their sales in the U.S.

In the intensely competitive telecommunications arena, for example, Germany's LHS Communications Systems is winning big deals with U.S. carriers for innovative billing products. The company benefited from the fact that Europe settled early on a digital cellular standard--something the U.S. still lacks. Now LHS--with $10 million in venture capital from General Atlantic Partners, based in Greenwich, Conn.--has signed up customers such as BellSouth Corp. and Pacific Bell Mobile Services, a subsidiary of Pacific Telesis. The startup is looking at $15 million in U.S. sales this year, a fivefold increase over 1995.

Pacific Bell chose LHS software because it was first to deliver "real-time" billing capability. The current industry practice is to calculate the billing for calls on a monthly basis. That's not good enough if, say, a cellular company wants to lease out mobile phones in rented cars and calculate bills when the car is returned. The runner-up system from a U.S. company "would have taken 6 to 12 months to match LHS," says Hamid Alipour, billing systems director at Pacific Bell Mobile Services.

It's impossible to overstate the role that U.S. venture capital has played in Europe's software transformation. Since the early 1990s, U.S. investors have been dazzled by the twin successes of SAP and Baan, which together own 70% of the $2.5 billion global market for enterprise integration software. Drawn by these shining stars, venture capitalists discovered dozens of other companies that appeared to be on similar sales-growth trajectories. The investors were willing to help in two critical ways: They could find top-flight managers and marketing experts, and they could groom the startups to raise capital on NASDAQ and other exchanges.

For investors, the rewards have been breathtaking. For example, after starring on NASDAQ as the hottest technology stock offering of 1994, Paris-based Business Objects doubled its sales last year, to $60.6 million, and profits soared 239%, to $8 million. Venture capitalist Bill Grabe at General Atlantic bet big on Baan and turned a $21 million investment into a stock fortune of $400 million after Baan's 1995 public offering.

All told, 10 European software companies have gone public on NASDAQ since 1992, raising $665 million, and more are preparing IPOs. "With more cross-border access to capital, you will see an explosion of interesting [European software] companies," says Jeffrey P. Harmon, director of investment banking for Cowen & Co. in San Francisco.

One after another, West Coast-based technology stock watchers are piling into Europe. In February, Hambrecht & Quist hosted its first conference on European growth companies, with half of the 40 companies software startups. Cowen sponsored a similar conference in April, featuring another dozen software debutantes. "Baan and Business Objects are just the tip of the iceberg," says Gartner Group's Helmut Gumbel.

BIDDING UP VALUES. Price is a big attraction for U.S. investors. Early-stage investments in European software companies are still relatively inexpensive compared with those of their U.S. counterparts. A runup has lifted the valuation of U.S. software companies sky-high for early-stage investors. By contrast, the supply of potential investors in European companies is still smaller than in the U.S., so European startups cannot command the same kind of pre-IPO valuations their U.S. counterparts can. Bernard Liautaud, co-founder and CEO of Business Objects, for example, fought for weeks with Paribas European Investment in August, 1990, over the valuation of the company, settling for a sum well below what he might have received in Silicon Valley from venture investors. When the company was introduced on NASDAQ in September, 1994, investors immediately bid up the price from $17.50 to $29.50. The offering was oversubscribed 20 times.

European startups have proved particularly adept at exploiting business needs that American vendors missed. Europeans are traditionally strong in complex systems management and in manufacturing, but they also are quicker to adapt products to the global market because their home markets are so small. SAP, for example, grabbed the attention of multinationals by creating products that linked applications for companies' worldwide operations. Its R-2 package was the first to take stock of differences in tax and accounting rules around the world. "A minute after midnight at the end of a quarter, you hit one keystroke and consolidate for the whole quarter," says John R. Luongo, CEO of Vantive Corp. in Santa Clara, Calif., a leader in customer-service software.

Europe's software industry has also gotten a lift from the emergence of global standards in the information technology industry. During the 1980s, hardware platforms and markets varied from country to country, saddling French companies, for example, with standards that didn't apply outside their home market. The development of global standards such as Microsoft Windows in the PC world, the Unix operating system in the business world, and the homogeneous landscape of the World Wide Web, means companies can design for the world market as easily in Bordeaux as in Mountain View, Calif.

"BLEEDING EDGE." The ascent of Baan, a powerhouse in complex software used by large manufacturers, is a case in point. Its fortunes grew rapidly during the 1980s in Europe because it excelled in so-called open systems that help enterprises integrate their databases. But Baan's U.S. fortunes sank until Corporate America embraced open systems in the early 1990s--later than Europe. Cracking the U.S. market didn't come cheap. Baan spent the lion's share of a $21 million venture-capital investment in 1993 to build up visibility in the U.S. That paved the way for the company's big break--a $20 million contract from Boeing in June, 1994. Now, U.S. sales make up 34% of its total revenues.

Another case in point: the growth of the Internet, which is adding momentum to Europe's software surge. The Net eliminates the lead time Silicon Valley software companies once enjoyed as a result of proximity to the California computer industry. Black Sun exploited this principle when it developed its 3-D browser for the Internet. Before launching the product, founders spent weeks on the Net figuring out what rivals were doing to ensure that their technology was "bleeding edge." Says Cowen analyst Brian Skiba: "Barriers to innovation around the globe are falling."

Spurred by this surge of activity, U.S. software developers are turning to Europe for partners. Sun Microsystems Inc.'s software subsidiary, SunSoft, last month chose France's ILOG to help develop a bridge between Sun's popular Java language and a standard programming language called C++. As news of such deals spreads, so does the willingness of U.S. customers to experiment with European software. Chrysler Corp.'s design engineers use ILOG's development tools to simulate the seat height, dashboard, and door layout of a car before they commit to a final concept. Says Chrysler design engineer John Mrozowski: "We can paper the wall with 10 or 15 iterations of a design, whereas before we had to choose between one or two."

Customer care seems to play a role in the Europeans' ability to win big contracts in the U.S. Motorola Inc., for example, appreciates the hand-holding it gets from London-based Superscape, which makes 3-D development tools. Motorola is adopting Superscape's software to build virtual assembly lines for training purposes. When the company wants to add new levels of complexity to the lines, Superscape goes back to the drawing board and redesigns the program. Says Sanjiv Patel, Motorola's manager of advanced manufacturing technology: "They've given us tremendous support."

SHOPPING SPREE. While momentum is building, Europe won't supplant the U.S. as software supplier to the world any time soon. It will take years to build up customer volume on a scale equal to America's top software companies. Many U.S. industry leaders, including Microsoft Executive Vice-President Steven A. Ballmer, don't believe Europe poses a competitive threat. "Business is good in Europe. Business is good in the U.S. I don't see a lot of change," he says.

Yet Microsoft itself has been on a European shopping spree. In October, 1994, it bought a British firm, NextBase, for its computerized road atlas. Four months later, it snapped up another British outfit, RenderMorphics, and built its 3-D graphics into Windows 95 so users could enjoy more exciting games. Last July, Microsoft acquired a network-management system from Britain's Network Managers Ltd., which the company will integrate into its BackOffice software. And Microsoft also relied on France's Nat Systems International to co-develop programming languages sold under the names Quick Pascal and Quick C++.

The acquisition record of Microsoft and other blue-chip U.S. software makers in Europe speaks volumes about the quality and creativity of European software developers. So does the commitment from America's leading venture capitalists. Just a few years ago, smart money would have bet against any European software company with global ambitions. Now, the first group of winners already has beaten the odds. It may not be long before Europe serves up its next software surprise.By Gail Edmondson, with Marsha Johnston in Paris, Neil Gross in New York, Seanna Browder in Seattle, and Kathy Rebello in San FranciscoReturn to top


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