Just Turned 25, Pegasystems See Big Ride Ahead

In 1975, at age 19, former New England junior chess champion and then Dartmouth College student Alan Trefler decided to enter the World Open chess tournament in New York—and play for all the marbles against the best players of any age. The kid from Brookline, MA, lost his first game but then won eight straight, and when the dust settled over the chessboards the largely unknown Bay Stater had stunned the chess world by tying veteran grandmaster Pal Benko for first place.

His feat ranks as one of the greatest-ever sports upsets, according to one list, Trefler told me recently over lunch at Legal Seafood in Kendall Square. “Sadly, the Patriots are another now,” he couldn’t help but add (and I share his pain).

Trefler long ago traded his chessboard for a briefcase and business attire. Since 1983, he has been running Pegasystems (NASDAQ: PEGA), the Cambridge, MA, software company he founded when he was 27. Though it has experienced its ups and downs (one way down) over the years Pega—which just celebrated its 25th birthday in April—now stands as one of the quiet success stories of New England high-tech business. The firm is enjoying rapid growth and strong profits and eyeing $200 million in revenues this year.

But Trefler thinks the good times have only just begun. He believes Pega is on the way to claiming the title in the competition to provide business-process-management software that automates many critical computer programming tasks in financial services, health care, insurance, and other industries. A Forrester report from last year predicts the highly fragmented field will surge from $1.6 billion in 2006 to $6.3 billion by 2011. And, says Trefler, “As the market consolidates, our intent is to be the leader.” Indeed, during our lunch (which was joined by Pega VP of corporate development Max Mayer) Trefler made it clear that he thinks the company’s next few years could see more growth than did its entire first quarter century.

First, though, a picture of the company’s present. In March, Pega reported record 2007 sales of $162 million, up 29 percent from a year earlier. Profits came in at a less overwhelming $6.6 million, but that was more than three times the $1.8 million profit of 2006. Pega’s stock, however, closed yesterday at $10.57—and it hasn’t traded much above $12 since the first quarter of 2000.

If only the stock was as buoyant as the company’s founder, investors would surely be happy. Trefler is an energetic, youthful-looking guy with a quick sense of humor, and a rep as being willing to mix it up—which he’ll have to do to come out on top in the competitive world of business process management software. But, some say, his personality and long tenure—after all, very few entrepreneurs can successfully lead a company from startup to billion-dollar status—are two of the question marks surrounding Pega. At the same time, Trefler has weathered at least one big storm—and the numbers from the last few years are impressive.

Trefler got into the software field not long after his stunning chess victory, when he began studying computers at Dartmouth. (One of his instructors was Dartmouth president John Kemeny, co-developer of the BASIC programming language.) Trefler spent some time on computer chess, and one of his realizations was that programs would do better if they focused not just on crunching every possible move, but on incorporating enough “understanding” about the problems and processes of chess to adapt to new situations. As he went out into the work world, Trefler saw a need for such adaptability in business software as well. But to get anything changed, you had to bring in computer programmers, who had to translate business aims into software code. Nothing was straightforward enough for the business users to make changes themselves. “I was amazed at how stupid the systems were,” he says.

Trefler was interested in making systems smarter by taking regular business metaphors, or everyday descriptions of business processes and goals, and developing software that would enable a computer to understand them and automatically code for them. Now, this is deep stuff and I won’t pretend to do it justice, but the gist is that Pega was formed to automate much of the code writing needed to keep up with changing business processes: in fact, the company’s copyrighted slogan is “Build for change.”

Mayer explains that Pega asks customers to create a diagram of how an operation works on a sketchpad—customers literally draw shapes for the business processes or steps that should be automated by the software. They then create an Excel spreadsheet that spells out in plain language the policies governing each step. For instance, a credit card company might want gold customers to go straight to the front of the phone queue, or it might want software that automatically settles a dispute in their favor if it’s under $500.

Of course, companies modify these rules from time to time, and offer new features or specials. Instead of calling programmers to update everything, all business users have to do is update their diagrams and spread sheets (or create new ones for a new service)—something Mayer and Trefler say they can learn to do in just a week or two of training—and Pega’s software automatically rewrites the code to enable the new policies. “The key here is not better tools for engineers,” Trefler says. “The goal is to get rid of 80 or 90 percent of the programming by turning it over to the business.”

Pega’s initial products, of course, weren’t as sophisticated as they are today—and the firm didn’t have customers beating down its door for its services. “The first 10 to 12 years, about, we were really a tech boutique,” says Trefler, with sales peaking around $12 million. In the mid 1990s, though, the company went on a growth spurt; Pega went public in 1996 on sales of about $35 million, and it surpassed $80 million in 1999. But the company itself fell off a cliff in 1998, plummeting to an $11.6 million loss after a small profit the year before. “I didn’t know it was possible to lose that much money,” Trefler has said, citing accounting changes with which the company inadvertently failed to comply as a large part of the problem. “We ended up growing so fast that we really lost control of the business.” The stock, which had traded in the high $30s, went on a long, hard tumble and was hovering just over $2 per share in the fall of 2001 before things finally turned around.

A watershed occurred in 2005, when the company reoriented itself around what Trefler calls the fourth generation of Pegasystems software—a “from-scratch rewrite” that offered far greater flexibility and power to its customers. Revenues grew 25 percent in 2006 and surged again last year (Pega now employees some 700 people, 300 of whom are in Massachusetts, along with a few hundred subcontractors).

Trefler touts a Pega customer base that includes Blue Cross Blue Shield, American International Group, JPMorgan Chase, and other leading firms. “All of these businesses share a common problem,” he says—namely that the needs of the business are outpacing their ability (or their computer systems’ abilities) to keep up with such factors as enrolling customers, sharing information between departments, processing claims, and handling myriad other business transactions such as special offers that change regularly. Trefler calls this the “execution gap.” And, he says, “these gaps end up getting filled with manual processes and training,” which of course add costs and increase the likelihood of inefficiency.

But they also increase the potential market for Pega. As much as 80 percent of work in back offices can be automated, according to Trefler—and he says his customers sometimes experiences productivity gains of 40 to 50 percent within just a few months of implementing the company’s tools. Presuming Pega can deliver anything close to that kind of improvement, it’s little wonder that he says, “We see a good growth potential despite the dour economic climate.”

Time will tell whether Trefler and Pega’s latest gains are the beginning of another title-winning streak.

Bob is Xconomy's founder and chairman. You can email him at bbuderi@xconomy.com. Follow @bbuderi

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