Open source vendor SugarCRM partners with Microsoft, the latter a company not known for fondness of free software and with clearly stated intentions in the CRM space. Oracle, the world’s larget database vendor (by far) buys not one but two open source database companies. Jboss announces a partnership with Microsoft, probably the most unlikely pairing of all, given Microsoft’s double distaste for Java and open source. At the time of this writing Oracle’s acquisition of Jboss is imminent.

What gives?

Let me digress for 2 paragraphs. The last 5 years have been really really bad for 95% of all software vendors. Companies like BEA Systems, Siebel, and Borland (just to name three, but pick just about anyone) have struggled mightily. Notice I didn’t even mention Sun. The 5% who’ve done comparatively well? Oracle, IBM, Microsoft, and SAP. It’s been like a nightmarish realization of supply-side economics gone amok – the rich get richer, everyone else struggles. Why? Large companies haven’t been spending much money on software (they’ve been digesting a lot of shelfware they bought in the go-go days) and CIOs have become more and more risk adverse – a lot of money was ill-spent, and the economy as a whole hasn’t been great, so their budgets have been tight and they’ve focused on keeping costs down rather than starting new projects. (This seems to be starting to change a bit, but don’t hold your breath…) In an environment like the one we’ve had over the past few years, customers have run to safe harbors – the large software vendors and “solution providers” (a fancy term for custom software services and bundled offerings – what IBM and HP do essentially.)

This doesn’t mean, of course, that innovation and entrepreneurship have stopped. It’s been alive and well – primarily focused on “new business models,” namely software as a service and open source. Poster children: RedHat and Salesforce.com. From the ashes of any downturn new businesses are born. MySQL and JBoss are two smaller companies on similar tragectories. (There’s certainly been some excellent technical innovation as well – out of pure stubborn resistance to jump on any sort of Web 2.0 bandwagon, I’ll cite XenSource and Azul as examples.)

With this background, back to the subject at hand. If you’re a giant software or services vendor, in today’s market you know that you’re going to get a good chunk of a customer’s business, for the reasons stated above. Your goal becomes figuring out how to “grow the pie”, and how to compete with other large companies. How to go about doing that?

There are four easy rules for a huge software vendor these days:

• Make sure your software works easily with all the other software your customers are using. This increases the number of projects and customers you can work with.
• Co-opt innovation where you find it (by partnering, acquiring, or in the case of standards, simply promoting and adopting)
• Acquire small companies when they’ve established that they have something customers want, but customers clearly would prefer to buy from you. This is a super low-risk strategy that, I would argue, is behind the Oracle/Jboss combo.
• Don’t let smallish companies growing quickly get large enough to have their own momentum – beat them or buy them.

Most of the partnerships and acquisitions we’ve seen can easily be attributed to one or more of these four strategies. Moreover, most of the “low hanging fruit” – the medium sized companies like Peoplesoft, Siebel, Rational, etc. —have been gobbled up. The Larry Ellisons of the world have turned their sights on smaller fry. It’s an interesting environment where the companies that count are the largest and the smallest – and the “tweeners” get left behind.

So if these conditions stay true, what could be on the horizon? Clearly more partnerships between upstarts and large vendors. But what about our poster children? RedHat and Salesforce.com are certainly threats to the large incumbants if they continue their success. The Salesforce.com case is easy – I’d look for companies like SugarCRM to continue to land big-name partnerships until they are successful enough to be bought. RedHat is a more difficult case, but it’s certainly hard to imagine that there are calm waters ahead for the crew from North Carolina.