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BEA: A Little Down In The Valley


When Alfred S. Chuang took over as chief executive of software maker BEA Systems Inc. (BEAS) three years ago, he inherited one of the great Silicon Valley success stories of the 1990s. Started in 1995 by Chuang and two other former Sun Microsystems Inc. (SUNW) executives, BEA had rocketed to nearly $1 billion in annual revenues by 2001. It dominated the fast-growing market for software that serves as a foundation for Web sites and complex run-the-business applications, with a 34% share. And it appeared ready to take a seat alongside the software industry's giants.

Then BEA stalled. Fierce price competition from rivals coupled with sluggish overall demand led to the stagnating revenues of the past three fiscal years. IBM (IBM) now has 41.3% market share of the $3.5 billion market for application servers, compared to 27.5% for BEA, according to market researcher Gartner Inc. BEA's situation is hardly desperate -- it has $1.6 billion in the bank and a base of more than 16,000 customers. But if Chuang can't find a way to get his revenues growing strongly again, his company could suffer the fate of other software pioneers such as Novell Inc. (NOVL) and Sybase Inc. (SY) -- onetime leaders that were outmaneuvered by more effective competitors. Like them, BEA is in danger of fading in importance and becoming an also-ran rather than fulfilling what once looked like its destiny as a true industry powerhouse.

Can Chuang get BEA going again? The odds are stacked against him. That's because his own leadership is partly to blame for the severity of the company's problems. He has been unwilling to make BEA's prices more competitive with those of its top rivals -- IBM and Oracle Corp. (ORCL), according to analysts and former execs. And while he has begun diversifying BEA's product portfolio, he hasn't put more aggressive sales and marketing programs in place to build those newer businesses rapidly. At the same time, at least six of BEA's top execs have abandoned ship in the past six months, including the chief technology and marketing officers. Two interviewed by BusinessWeek said they had become frustrated with Chuang's leadership. Former CTO Scott Dietzen would not reveal why he left but he acknowledged the company's predicament: "BEA has the opportunity to be successful and resume its growth, but it's going to be a challenging road."

DAMN THE TORPEDOES

Rather than reassessing his strategies in the face of widespread evidence that they're not working, Chuang is determined to stay the course. He takes great comfort in the fact that BEA has weathered the tech downturn relatively well compared with some of the 1990s' other software upstarts, such as Siebel Systems Inc. (SEBL). He believes that his aggressive investments in research and development -- $140 million for the fiscal year ended in January, up 87% from 2001 -- will eventually pull the company out of its slump. "In the end, we are not a sales and marketing company," says Chuang. "We differentiate ourselves in the marketplace by being a very, very innovative company."

But that focus alone has never proved successful in creating large and powerful software companies. Consider Oracle, SAP (SAP), and Microsoft (MSFT). They focus on operational expertise and selling -- in addition to technology. Indeed, it is typically at the $1 billion revenue mark that tech companies either develop a balanced approach to doing business or start to struggle. Often that transition includes a change of management philosophy or a change at the top. "It's the point where you go from being just a technology company to a sales and execution company," says analyst Joanne Correia of Gartner, who thinks Chuang needs help. "Alfred is a strong technologist, but they really need a strong businessperson over there." Chuang insists that he's up to the job. Members of BEA's board of directors declined to comment.

In spite of the tumult, Chuang has been able to hold on to many talented engineers. During the downturn, the company only had one round of layoffs -- of 300 people. In fact, Chuang has nearly doubled employees devoted to R&D, to about 700, while sales staffing has stayed about the same.

The problem is, those investments in technology talent haven't yet shown up in strong top-line growth. In the fiscal quarter that ended Oct. 29, software-license sales slipped by 10.4% to $114.9 million, even as total sales, which include maintenance fees, grew 4.8% to $264 million. Analysts expect more trouble in the current fiscal quarter, which ends in January. Software sales are expected to be $130 million, down 9% from a year ago, says Jason D. Brueschke of Pacific Growth Equities LLC. He forecasts overall sales of $283 million, up 2% from a year ago, with net income of $39.8 million, down 7% from a year ago. BEA's stock is trading around $8.75 per share, almost 40% below its 52-week high and a long way from the $90 per share of its glory days in late 2000.

INTROVERT AT THE HELM

Chuang, 43, is probably the last guy you would expect to be running a high-profile software company. A self-described introvert, he said in a 2002 interview that he became interested in computers while a college student at the University of San Francisco because "you stare at a glass tube, and you don't talk to anyone." The son of a wealthy Hong Kong businessman, he was so concerned about dealing with the public that he took stand-up comedy classes to help him conquer his shyness. In recent years he has become more confident, even a little flashy. He typically dresses in tailored suits and owns a collection of Ferraris.

He has made a few bold moves at BEA, first as a top exec and later as chief executive. It was Chuang's idea to spend $192 million to buy a smaller company called WebLogic in 1998. It seemed like a crazy amount of money for an upstart with 94 employees, but WebLogic's application server turned out to be the key to BEA's rapid rise. Chuang also has tried to improve BEA's effectiveness with customers. In August, he combined sales, marketing, and services -- and assigned Tom Ashburn, who had earlier run services for Hewlett-Packard Co. (HPQ), to head up the combined departments. Also, after hearing complaints from customers including Wells Fargo & Co. about slow response to solving problems, he redeployed some of BEA's engineers to work directly with customers.

What Chuang has been unwilling to do for customers is significantly reduce BEA's prices. BEA's typical starting price for its application-server software is $17,000, about $2,000 more than a comparable product from IBM. Even bigger is the price difference to keep the software humming. IBM customers usually pay $6,000 for five years of maintenance and support, while BEA's can spend three times as much. BEA argues that IBM's real costs to customers are hidden in consulting fees.

Chuang says he doesn't need to reduce prices because he's not fighting a price war with competitors. But analysts say he's just plain wrong. "I don't know how you could say there's no pricing pressure," says analyst Correia. Indeed, IBM, Oracle, or Sun can sell their competing software at a discount to BEA's list price because they have other products such as databases or consulting services to make up the difference. E-tailer 1-800-Flowers.com Inc. recently moved from BEA to IBM in part because of price, says Enzo J. Micali, the company's chief technology officer.

Chuang's refusal to lower prices led to several defections from his executive team. Two former executives, who spoke on the condition that their names not be used, said that starting a year ago and continuing through this summer, at least three of Chuang's managers urged him to drop prices. The former executives also advised Chuang to spend some of the company's cash to acquire companies with promising new technologies and make BEA even less dependent on the slow-growing application-server business. Newer pieces of the company's portfolio, including Web portal and application integration products, now account for 46% of revenues, up from 30% three years ago. But Chuang said no to any major acquisitions. His reasoning: Rather than buying new products, he says he wants to develop them internally. Before the end of the year, he expects to release software tailored for telecommunication companies offering voice service over the Internet.

But innovation is no longer a trump card for BEA. While analysts say it still has the best products, the gap has narrowed to a sliver. And the history of tech has shown that a company with slightly better products almost never beats out a rival with a much cheaper offering. With so many aggressive competitors closing in, time is running out for Chuang to come to grips with that brutal reality.

By Jim Kerstetter in San Jose, Calif., with Jay Greene in Seattle


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