SmoothSpan Blog

For Executives, Entrepreneurs, and other Digerati who need to know about SaaS and Web 2.0.

Enterprise Software’s Youth Drain: Bubble Economics, Meet the New Business Models: SaaS and Open Source

Posted by Bob Warfield on October 13, 2007

M.R. Rangaswami writes on GigaOm that there is a youth drain in Enterprise Software.  He’s right, but there is a discontinuity that accounts for it.  The traditional Enterprise Software world is caught between three extremely powerful yet opposing forces:  consolidation, SaaS, and Open Source.

Consolidation is personified by SAP’s recent acquisition move with Business Objects followed up by a counter chess move by Oracle to try to take in BEA.  Why is this happening?  There is almost no growth in traditional Enterprise Software.  Business Objects announced they were going to miss their numbers, for example, even on the eve of the announcement with SAP.  Why are these companies missing their numbers?  Where is the growth?  Why was their growth before and not now?

I want to repeat my controversial theory that the growth numbers we were calibrated to expect from the Enterprise World were a result of successive bubbles of one kind or another.  First there was the client/server retooling.  That built the likes of SAP, Peoplesoft, Oracle Financials, and many others.  Then the Y2K panic assured another few years of unnatural growth for these companies.  This was then followed up with still more years by the Internet Bubble, where companies were convinced that unless they made still more radical investments in IT, they were going to be beaten by kids operating out of their Stanford dorm rooms.  The mantra was to quit investing in bricks and mortar and turn that investment to technology.  These bubbles followed nearly back to back and afforded an unprecedented opportunity to create huge Enterprise Software empires for the masters of these domains.

What’s another data point that these empires were built on bubble economics?  Just look at the war stories for how many of these massive boil-the-ocean Enterprise projects failed versus how many produced real measurable ROI.  It shouldn’t be any wonder when you consider that the old wisdom was that it should cost $6-7 of services to install $1 of Enterprise Software License.  So if you paid $1M for the license, you were going to spend $6M more to get the software live, plus millions more in hardware and IT support charges. 

We’re now at a stage where the old models are consolidating because it is no longer possible to grow perpetual license revenues at rates that result in interesting businesses.  The budgets involved are too large, and the distrust towards vendors promising moonshot ROI if you write the big checks is too prevalent.  So, most traditional Enterprise vendors are bumping along with relatively poor growth.  At the same time, there is no incentive for new players to enter using those rules.  The writing is on the wall in terms of what their fate would be, so such business plans are completely unfundable.  What remains of that world will continue to be consolidated into the rollup engines that consist of private equity plays and the very largest tier of Enterprise players such as Oracle and SAP.  The empires are built on number crunching acquisitions and software that is already well past its prime.  It remains to be seen whether radical architectural surgery along the lines of Oracle’s Fusion or SAP’s ByDesign will take.

Meanwhile, the dynamics of the Big Enterprise SW Co maturation process created a speed bump in the pipeline of new Enterprise upstarts.  The business model had to be reinvented before young companies could experience healthy growth and prosperity.  The good news is that it has been reinvented, and quite successfully as a matter of fact.  That brings us to the other two forces that have the Enterprise Software world tightly gripped in their jaws:  SaaS and Open Source.

Both of these models radically change the dynamics of the Enterprise Model to more closely align costs with risks and thereby make the new solutions more palatable to jaded IT departments.  They seek to eliminate the huge up front investment by different vehicles, and allow consumers of the technology a pay-as-you-go plan.  But the two have operated in fairly different ways.

Open Source harnesses the power of community to radically lower costs and commoditize various segments.  Databases have been hit hard by software such as mySQL.  Application servers are there too (lest we forget why BEA may want to reconsider rejecting a consolidation opportunity) in the form of software such as JBoss and Tomcat.  There are many other examples including application software such as SugarCRM.

SaaS harnesses the power of multitenancy, highly focused services, and often an outright refusal to deliver complex customization to radically reduce the cost of adoption and align the expenses with the risks.

Both models have gotten away from a focus on really large Enterprises.  They’re content to build from the SMB end of the spectrum and take the larger Enterprise business as those entities are ready to accept the new models.

Both of these models are highly disruptive.  It’s very hard for a traditional vendor to go back and adopt either one very easily.  This provides breathing room for the new generation.  And guess what?  The folks behind the new wave are not 50 year olds.  Marten Mickos at mySQL is 38.   Marc Benioff is 42.  SaaS CEO Chris Cabrera of Xactly, whom I recently interviewed, is a young man as is Concur’s Steve Singh.

But there has been a speed bump as I mention.  We’re relatively early yet in the transition to the new business models.  I expect to see the largest companies, the SAP’s and Oracle’s, to continue to play consolidation games.  They will roll up the old carpet from the top, acquiring and assimilating the remaining larger conventional players.  Meanwhile, the new business model will be gnawing away at market share from the bottom up.  These companies are able to generate real growth and opportunity because they’ve adjusted to what it takes to be able to grow in an IT spending environment that’s not dominated by bubble economics.  The challenge for the big guys will be to avoid having all of the acquisition activity distract them from the fundamental problem that their core business models are based on perpetual on-premises licenses, and those models are in the twilight of their years.

Now here is the really interesting piece.  Take a look at this chart of business productivity gains that came from the SF Venture blog:

Productivity

You can see that productivity has fallen off in recent years quite considerably.  The blog’s author, Keith Benjamin, says:

I’ve been tracking many enterprise software companies, including some in our portfolio, that deliver significant ROI to customers.  The current generation of software is just beginning to penetrate the market, suggesting significant potential for productivity enhancements over the next few years, helping to accelerate adoption of technology for venture-backed companies, both private and public. 

I think he’s right.  This curve presages the likelihood that Enterprise IT has worked off it’s binge of projects from the last round of bubbles and is ready to start looking for new opportunities to bring ROI to the business.  The difference this time around is they’re much savvier.  They know to look for alternative business models and bigger ideas.  They’re no longer willing to spend a fortune on pie-in-the-sky promises about silver bullet apps.  They want immediate ROI.  SaaS and Open Source are two blockbuster opportunities for conventional Enterprise Software to fit into this brave new world.  Two others that I will mention are Web 2.0 and Virtualization.  Web 2.0 is going to become an increasing requirement as business seeks to keep up with the changing nature of the World Wide Web.  Virtualization is a way to make the old school investments go further by upping server utilization and making IT’s management of its hardware resources for more nimble.  Think of virtualization as the equivalent of going to hybrid automobiles when getting better mileage from your hardware dollars.

From my perspective, there’s a bold new world on which a number of exciting new Enterprise businesses will be built right around the corner.  The motto of the Special Forces around the world is, “Who Dares Wins.”  So it will be with this round of Enterprise Software.  Whether we’re talking VC or angel investors, enterpreneurs, or conventional vendors placing heavy bets on the new models, those who dare to embrace the new models will see unusually rich opportunities in the next several years.  As the top of the old guard run out of acquisition feed stock, the new players will be coming into their own, and it will be hard to see how the old guard fights them off unless they’ve managed to embrace these models themselves by then.  As Jason Wood says, give it a few years and these new models and their more youthful executives will be very much more in control of the Enterprise scene.

About these ads

One Response to “Enterprise Software’s Youth Drain: Bubble Economics, Meet the New Business Models: SaaS and Open Source”

  1. […] You Want to Favor Diversisty on the Internet, Increase Friction (+ Insights from Genetic Algorithms)Enterprise Software’s Youth Drain: Bubble Economics, Meet the New Business Models: SaaS and Open Sou…ESB vs REST (Another Case for Multi-Language Programming)AboutiPhone, iTouch, iTrojanHorse?Are […]

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

 
Follow

Get every new post delivered to your Inbox.

Join 324 other followers

%d bloggers like this: