Enterprise Software’s Future

What’s the direction of the software industry? As an analyst, I might ask this several times a week, but it’s not idle curiosity. Things are changing, and today’s events are signaling a significant shift.

The rollout of Software as a Service and the emergence of relatively good platforms — which will only get better — suggest to me that the software industry of 2000, in which cloud and SaaS began to emerge, is now well in the past.

In the 20th century, software was hand-coded, expensive, hard to change, and available only for fundamental business processes that were mostly in the back office. It ran on expensive hardware. You had to own everything, and you had to maintain it yourself or pay an army of consultants big bucks to do the job. It was also hard to modify, so business processes tended to be set in stone.

When I started as an analyst, it was not unreasonable to pay a million dollars for a CRM system and then pay two to three times that much to implement it.

In the ensuing years, all kinds of software applications have been forced down a steep commoditization curve. Today you subscribe to powerful and complex systems for a few dollars per seat, or you buy apps for your phone for 99 cents. Commoditization has been so successful that it should leave us all wondering where we go from here — or more precisely, how do we make a living?

Step Up to the Auction Block

At current pricing levels, it’s hard to see how a company can get started or make money unless it has a mega-hit application. That may be one of the bigger reasons there has been so much merger-and-acquisition activity lately. Startups today need increasing amounts of runway, translating into more time and startup capital.

The alternative route for a less-than-well-funded company is to sell itself to the highest bidder. It’s a good deal for the participants: The VC gets a return in short order; the startup gets folded into a bigger entity with deep pockets; the acquiring company buys proven research and development, thus reducing its risk; and the founders make enough to give them options about what to do next.

Truth be told, many of the acquired companies today look more like they were designed to be appendages of something bigger than to be freestanding. I see the hand of commoditization in all of this, but what’s truly interesting is what it says about the direction of the industry.

One consequence, to me, is that we’re well on the way to becoming a two-tiered industry, with one small group of platform providers and a much larger group of application developers.

The developers might work on multiple platforms, but I suspect most will stick with one. That’s the easy part. The hard part is how they make money. The platform vendors increasingly will rely on selling generic seats, much as Salesforce and others do right now.

I wrote a paper about this likelihood in 2004 — but it’s something else to see it happening, because there are some downside consequences.

Zero-Cost Software

As with most forms of commoditization, the process can sideline or make redundant people and capital investments — what the economist Joseph Schumpeter called “creative destruction.” If you use a hub-and-spoke model for the industry undergoing commoditization, the winners are in the middle of the wheel, and the losers are strewn around the outer reaches.

If I had to guess, I’d say that the relative winners in the software world will be the platform providers — but I’d only say relative.

In this model, there might be many application vendors dedicated to any application type, and they’d be competing with each other even if they were on the same platform. The relative winners would be the providers selling generic seats on their platforms, but increasing competition would drive down their prices too.

About the only thing they’d be able to do to keep prices up would be to continue adding value to their platforms in the form of additional apps and services — many of which would be acquired.

You could charge for services, but increasingly software costs would go to zero.

As a matter of fact, platform providers encourage this by providing app development tools that make it easy for nontechnical people to build their own apps. Taken to its logical conclusion, the price of an app could fall to zero, and the idea of bartering between people and companies for application templates would become a real possibility, as the folks at Metavine and other vendors are demonstrating.

Zero-cost software isn’t a bad thing — but as commoditization continues, we come face to face with the reality that software is becoming less and less profitable. So the question of where the software industry is going comes into sharp relief.

If technology isn’t generating big profits and lots of jobs, then it can’t be the locomotive of the economy it was just a few years ago. What will take its place?