CASE: OD-3A DATE: NOVEMBER 21, 2002 WIND RIVER SYSTEMS (A) Jerry Fiddler and Tom St. Dennis sat in their adjacent corner offices on November 4, 2002 in Wind River’s Alameda, California headquarters and pondered the future of the embedded systems market. Embedded software was that which runs a microchip or smart device and was dedicated to performing few functions repeatedly without fail. St. Dennis and Fiddler were planning a reorganization to reposition Wind River as a strategic, enterprise-wide outsourcing partner with their clients instead of a market-specific software provider, an important move to facilitate growth and build lasting client relationships. They knew their customers needed an easily-integrated, highly tailored package that included professional services, but did not know how effective the reorganization would be, or if their clients would welcome the “new” Wind River. This was not the first reorganization the two had engineered at Wind River. Three years prior, only weeks after St. Dennis was hired as CEO, he and Fiddler, co-founder and chairman, had shifted the company from a horizontally organized software products company to a vertically organized market-specific bundled products company. The move from a horizontal organization (product teams grouped by technology) to a vertical organization (product teams organized by target industry) was an expensive maneuver that had not yet paid for itself. The competition was like nothing they had faced before. On the one hand, they faced niche players in each of their target vertical markets, which included aerospace and defense, automotive, network telecommunications, digital consumer products, and industrial controls. On the other, they faced the potential threat of Linux and the open source software movement. And there were their customers’ internal development teams, many of whom continued to design embedded systems in-house. This, combined with the slumping economy, would make it difficult to grow to implement their new strategy. THE EMBEDDED SYSTEMS MARKET Greg Powell prepared this case under the supervision of Professors William Barnett and Glenn Carroll as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Special thanks to Ted Hartnell for his help in facilitating this case. Copyright © 2002 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: [email protected] or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business. Wind River Systems OD-3A p. 2 Embedded systems were those that ran the microchips in all “smart” devices. Devices such as cell phones, auto antilock braking systems, oscilloscopes, and network routers all required embedded operating systems. Unlike the operating systems in PCs (such as Windows), embedded systems were transparent to the user and were usually required to perform one function unfailingly countless times. Embedded systems were therefore measured against their reliability (the more reliable the system, the less downtime it would suffer and the more “mission critical” it could be), speed (the less processing overhead there was, the more reliable it would be), and memory (the less memory, or “footprint,” the system required, the less expensive it was). More complex devices often had more than one microprocessor, each dedicated to performing specific tasks consistently and repeatedly in coordination. Through 2002, embedded systems represented a vast majority of the processing chips made each year. It was estimated that almost 7 billion microprocessors running embedded software were sold in 2001 and over 10 billion would be sold in 2005.1 The combined commercial and in-house embedded software market was estimated at $23 billion for 2002. Of this, commercial embedded development accounted for roughly 9 percent, or $1.7 billion, in 2002.2 Wind River’s revenue for fiscal year 2002 was $351 million. In 2002 and during the preceding decade, Wind River was the market leader in designing commercial embedded systems.3 The commercial embedded software industry was smaller than $100 million annually when Wind River entered. Original equipment manufacturers (OEMs) typically developed code for their microchips in-house. When Wind River first launched VxWorks, their value proposition to the OEMs was reduced costs with increased speed and reliability. Eventually, as customers began adopting VxWorks, and as more competitors to Wind River emerged, embedded software became a recognized industry. There were three main components to embedded systems: the OS itself, the interactive design tools that facilitated software development, debugging, and integration, and the middleware. Tools, also called Interactive Developer Environment (or IDE), provided a setting for creating the application software specific to each customer’s product. Tools eventually split from the operating system as its own sub-market within the embedded space. Wind River’s tools, called Tornado, came bundled with their operating system though clients could purchase different quantities of OS licenses and tool sets. The Tornado tools were among Wind River’s top-sellers annually, accounting for roughly 40 percent of revenue. Tools also embodied a distinct competitive advantage for Wind River, as Tornado represented years worth of intellectual property and research and development – something that had been argued Wind River’s competitors could not replicate. Middleware, or OS extensions, consisted of all of the remaining components to an embedded system, such as the graphics, memory, and networking packages, which tailored the system to a particular client’s needs. In 2002, much of the perceived value to an embedded system resided in the middleware, as it left fewer components for the client to develop or integrate on their own. 1 Don Young and Gerry McCormack, UBS Warburg LLC Analyst Report, July 18, 2002, p. 18. 2 McKinsey & Company and Wind River Systems, Building a New Business Model to Drive Enterprise Growth, September 26, 2002, Property of Wind River Systems, prepared by McKinsey & Company, p. 2. 3 Young and McCormack, op. cit., p. 18. Wind River Systems OD-3A p. 3 In 2002 the embedded software market could be divided into five categories: Wind River, in- house developers, Linux developers, niche-market developers, and Microsoft. In-House Proprietary Developers In 2002, in-house embedded software developers accounted for roughly 90 percent of the total market.4 While that number was expected to shrink as outsourcing became more popular, when devices grew more complex and embedded systems, therefore, became more costly to develop, the in-house proprietary market nonetheless represented the most substantial piece of the embedded market. Often companies would develop an embedded system in-house when they could not find a commercial alternative that met their unique specifications. A commercial embedded developer might sell the appropriate operating system and tools, but if the system lacked the necessary middleware, the company would need to employ their internal development team to integrate the entire package regardless. Thus, some would skip buying the components and design the entire system themselves. Many companies cited two competitive reasons for pursuing their own proprietary embedded OS: they owned all of the intellectual property, and it was very difficult for competitors to duplicate in-house development. If they were to outsource this development to a company like Wind River, Wind River could sell a similar solution to their rival competitor, thus eliminating many of the advantages that the software might bring to their product. Other companies choose in-house development to control costs. These companies often already had the expertise to design an embedded OS, and they simply took advantage of these resources. The drawback to in-house proprietary development could be the cost over time. Maintaining the OS, adding functionality, and keeping the software cutting-edge could be very expensive and time-consuming. One Wind River manager agreed, stating, “Time-to-market and development costs are the drawbacks. They’re re-inventing the wheel and they’re not getting best-of-breed. As you’re spending all this time integrating and building platforms, you’re losing time. Cisco claims that one month delay in time-to-market is equal to 14 percent of market share. That’s huge.” By 2002 in-house proprietary developers began using Linux as the starting point for designing a proprietary embedded system increasingly often. Developers could download the Linux kernel, or core code, for free. They could then develop their own code around the Linux kernel.5 The Rise of Linux Linux, the open source software, gained inroads into the embedded systems world in 2000. The rise of Linux in the embedded space could largely be attributed to the dedicated community of anti-proprietary software developers, the in-house developers looking for a starting point for source code, and the eagerness of some corporations to use software they could